Business Insight: The secret science behind ‘rounding’

Company directors are regularly faced with the decision on whether to pay out a percentage of their profits as dividends to shareholders. For instance, if dividends are paid to shareholders, how much of the firm’s profits are distributed and how often? Interestingly, in making such decisions, the behavioural finance literature indicates that certain biases could be influencing corporate directors, thus, resulting in the numerical heaping (or rounding) of dividends.

Numerical heaping is a phenomenon in which reported numbers tend to be rounded to intervals or increments, for example the number of glasses of wine per week, age in years, weight in kilos, etc. In terms of consumer value perception, prices are often rounded down. For example, cars always seem to be priced at $29,990 at dealerships because a cognitive reference point suggests it looks cheaper to potential buyers than $30,000. On the other hand, a dividend per share of $1.00 will appear to investors as being significantly larger than $0.99, although the price difference is negligible.  

In a recent study, I examined the extent of dividend heaping in listed Australian firms between 1976 and 2015. The findings revealed that approximately 27 per cent of all dividends paid in the Australian stock market were heaped in 2.5-cent intervals (e.g. $0.025, $0.05, $0.075, $0.10, etc.). The heaping phenomenon seems to have decreased over time, however. Reductions in dividend heaping may be due to less information uncertainty faced by firm directors. For instance, decreases in dividend heaping could be attributable to more sophisticated technology that allow firms to manage information uncertainty more effectively. Decreases in dividend heaping could also imply that directors have developed better forecasting abilities and capabilities to deal with financial complexity. Therefore, with lower forecasting errors, directors can be more accurate with their dividend distribution decisions and round less.

I also found that despite a decrease in dividend heaping over time, average dividend size had increased. Larger dividends in Australia could be explained by: (1) the ongoing low interest rate environment; (2) a lack of suitable investment opportunities for firms; (3) dividend decisions being driven by clientele effects, information signalling and/or agency costs; and (4) fund managers and investors having a distinct love affair with dividends due to favourable tax treatment (e.g. franking credits).

Even though dividend heaping has declined over the past four decades in Australia, firm directors still appear to be confronted with behavioural barriers and are heaping when determining their dividend distributions. For instance, the likelihood of heaping seems to increase with firm-level characteristics such as dividend size, stock return volatility (or uncertainty), firm size and age. Ultimately, further research is needed to better establish whether directors are being imprecise when it comes to setting their dividend policies or are simply exploiting investor biases.

This article originally appeared in the Business Insight section of the Gold Coast Bulletin newspaper and is for general information purposes only.