Holding everything else equal, which of the following firms would likely have a high payout ratio? Further, as time progresses (in the long run), would the retention ratio of similar firms be expected to increase or decrease?
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A. B. C. D. E. F.Explanation
Remember that a positive relationship exists between the maturity of an industry and the payout ratio of firms within that industry. The automobile industry is a mature industry, more so than most other industries including pharmaceuticals or specialty retailers. As an industry advances in maturity, growth of the overall industry will decline. As growth opportunities diminish, companies within the industry will be forced to pay out a larger proportion of their earnings as dividends; i.e. the dividend payout ratio of firms within the industry will increase. Remember that the retention ratio is equal to (1 - the dividend payout ratio). Thus, the retention ratio of companies will likely decline as the industry advances in maturity. The relationship between the dividend payout ratio and the maturity of the industry is negative and loosely linear. As an industry becomes more mature, growth opportunities decline. This relationship is also loosely linear.