The Cash Holdings Hypothesis of Dividend Policy: Evidence from Dividend Initiations
36 Pages Posted: 14 Jan 2007
Date Written: August 30, 2007
Abstract
Grossman and Hart (1980), Easterbrook (1984), and Jensen (1986) argue that dividends may help reduce the agency problem by reducing the amount of cash executives have at their disposal. In this paper, I use the stock price reaction to dividend initiations to test this "cash holdings" hypothesis. I find that the stock price reaction is indeed positively related to cash holdings, information uncertainty, and entrenchment. Furthermore, I find that the stock price reaction is not significantly different from zero for firms with low cash holdings and for firms with low information uncertainty. However, I do not find evidence that the stock price reaction to initiations is even more positive for firms with high cash holdings and low growth opportunities. I conclude that the cash holdings hypothesis does a fair job in explaining the positive stock price reaction to dividend initiations.
Keywords: Entrenchment, Corporate Governance, Dividends, Dividend Initiations, Executive Stock Ownership
JEL Classification: G33, G35, G39
Suggested Citation: Suggested Citation
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