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Dividends: Relevance, rigidity, and signaling

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  • Karpavičius, Sigitas
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    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.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Corporate Finance.

    Volume (Year): 25 (2014)
    Issue (Month): C ()
    Pages: 289-312

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    Handle: RePEc:eee:corfin:v:25:y:2014:i:c:p:289-312

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    Web page: http://www.elsevier.com/locate/jcorpfin

    Related research

    Keywords: Dividend smoothing; Payout policy; Signaling theory; Partial equilibrium model;

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    3. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411.
    4. Franklin Allen & Antonio E. Bernardo & Ivo Welch, 2000. "A Theory of Dividends Based on Tax Clienteles," Journal of Finance, American Finance Association, vol. 55(6), pages 2499-2536, December.
    5. Roni Michaely & Richard H. Thaler & Kent Womack, 1994. "Price Reactions to Dividend Initiations and Omissions: Overreaction or Drift?," NBER Working Papers 4778, National Bureau of Economic Research, Inc.
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    7. Garrett, Ian & Priestley, Richard, 2000. "Dividend Behaviour and Dividend Signaling," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 35(02), pages 173-189, June.
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      • Allen, Franklin & Michaely, Roni, 2003. "Payout policy," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 7, pages 337-429 Elsevier.
    12. Jagannathan, Murali & Stephens, Clifford P. & Weisbach, Michael S., 2000. "Financial flexibility and the choice between dividends and stock repurchases," Journal of Financial Economics, Elsevier, vol. 57(3), pages 355-384, September.
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    14. Murphy, Kevin J., 1999. "Executive compensation," Handbook of Labor Economics, in: O. Ashenfelter & D. Card (ed.), Handbook of Labor Economics, edition 1, volume 3, chapter 38, pages 2485-2563 Elsevier.
    15. Mark T. Leary & Roni Michaely, 2011. "Determinants of Dividend Smoothing: Empirical Evidence," Review of Financial Studies, Society for Financial Studies, vol. 24(10), pages 3197-3249.
    16. Rodney D. Boehme & Sorin M. Sorescu, 2002. "The Long-run Performance Following Dividend Initiations and Resumptions: Underreaction or Product of Chance?," Journal of Finance, American Finance Association, vol. 57(2), pages 871-900, 04.
    17. Gustavo Grullon & Roni Michaely, 2002. "Dividends, Share Repurchases, and the Substitution Hypothesis," Journal of Finance, American Finance Association, vol. 57(4), pages 1649-1684, 08.
    18. Brav, Alon & Graham, John R. & Harvey, Campbell R. & Michaely, Roni, 2005. "Payout policy in the 21st century," Journal of Financial Economics, Elsevier, vol. 77(3), pages 483-527, September.
    19. DeAngelo, Harry & DeAngelo, Linda, 2006. "The irrelevance of the MM dividend irrelevance theorem," Journal of Financial Economics, Elsevier, vol. 79(2), pages 293-315, February.
    20. John R. Graham & Lillian F. Mills, 2007. "Using Tax Return Data to Simulate Corporate Marginal Tax Rates," NBER Working Papers 13709, National Bureau of Economic Research, Inc.
    21. Gustavo Grullon & Roni Michaely & Shlomo Benartzi & Richard H. Thaler, 2005. "Dividend Changes Do Not Signal Changes in Future Profitability," The Journal of Business, University of Chicago Press, vol. 78(5), pages 1659-1682, September.
    22. Yi Liu & Samuel H. Szewczyk & Zaher Zantout, 2008. "Underreaction to Dividend Reductions and Omissions?," Journal of Finance, American Finance Association, vol. 63(2), pages 987-1020, 04.
    23. Bart M. Lambrecht & Stewart C. Myers, 2012. "A Lintner Model of Payout and Managerial Rents," Journal of Finance, American Finance Association, vol. 67(5), pages 1761-1810, October.
    24. Eugene F. Fama & Kenneth R. French, . "Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay?."," CRSP working papers 509, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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