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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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    References

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    6. 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.
    7. Gustavo Grullon & Roni Michaely & Bhaskaran Swaminathan, 2002. "Are Dividend Changes a Sign of Firm Maturity?," The Journal of Business, University of Chicago Press, vol. 75(3), pages 387-424, July.
    8. Franklin Allen & Roni Michaely, 2002. "Payout Policy," Center for Financial Institutions Working Papers 01-21, Wharton School Center for Financial Institutions, University of Pennsylvania.
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    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.
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    20. Graham, John R. & Mills, Lillian F., 2008. "Using tax return data to simulate corporate marginal tax rates," Journal of Accounting and Economics, Elsevier, vol. 46(2-3), pages 366-388, December.
    21. 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.
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    25. Shlomo Benartzi & Roni Michaely & Richard Thaler, . "Do Changes in Dividends Signal the Future or the Past?," CRSP working papers 327, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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