Dividends: Relevance, Rigidity, and Signaling
Posted: 10 Feb 2014
There are 2 versions of this paper
Dividends: Relevance, Rigidity, and Signaling
Date Written: January 9, 2014
Abstract
This paper uses a dynamic partial equilibrium model to explain a puzzle of dividend smoothing. In contrast to the Modigliani–Miller theory, I show that firm value depends on payout policy. The analysis implies that firms with more stable dividend stream are more valuable. This explains why dividends are rigid over time. A volatile component of dividends is introduced to reduce the likelihood of dividend omission in bad times while keeping the same historical average dividends. I show that the empirically observed positive relation between dividends and future firm performance is a statistical artifact driven by dividend smoothing. Thus, the empirical tests of dividend signaling theory might be misspecified.
Keywords: Dividend smoothing, Payout policy, Signaling theory, Partial equilibrium model
JEL Classification: G35, D21, D58
Suggested Citation: Suggested Citation