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Dividends: Relevance, rigidity, and signaling

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  • Karpavičius, Sigitas

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.

Suggested Citation

  • Karpavičius, Sigitas, 2014. "Dividends: Relevance, rigidity, and signaling," Journal of Corporate Finance, Elsevier, vol. 25(C), pages 289-312.
    • Handle: RePEc:eee:corfin:v:25:y:2014:i:c:p:289-312
    DOI: 10.1016/j.jcorpfin.2013.12.014
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    More about this item

    Keywords

    Dividend smoothing; Payout policy; Signaling theory; Partial equilibrium model;
    All these keywords.

    JEL classification:

    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
    • D21 - Microeconomics - - Production and Organizations - - - Firm Behavior: Theory
    • D58 - Microeconomics - - General Equilibrium and Disequilibrium - - - Computable and Other Applied General Equilibrium Models

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