The Banking and Finance Review

The Impact of SEC Rule 10b-18 on the Ratchet Effect

Christi Rebecca Wann, D. Michael Long, Christopher M. Brockman


SEC Rule 10b-18 in 1982 revised the Securities and Exchange Act of 1934 and led to a substantial rise in repurchase activity in 1984. We propose that this rise in repurchase activity may weaken the existence of the long-run target payout ratio, or ratchet effect, in the traditional terms of dividends and earnings. We find support for this hypothesis by demonstrating that pre-1984 payout ratios are mean reverting but post-1984 payout ratios are not mean reverting. This finding implies that SEC Rule 10b-18 has had a significant effect on the tradition of maintaining a target payout ratio. Regressions of future changes in earnings and dividends against target payout ratio deviations for both pre- and post-1984 time periods reveal greater support for the ratchet effect before the adoption of SEC Rule 10b-18. These results should modify the long-standing view that all firms strive towards a long-term dividend payout ratio. Further, future dividend signaling research should account for this structural shift in dividends and repurchases.



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