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Dividend payments and excess cash: an experimental analysis

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  • Jia, Zi Tingting
  • McMahon, Matthew J.

Abstract

There is an observed positive correlation between the size of firms’ dividends and the amount of cash they keep on hand. We specify a new channel of precautionary cash holdings as related to dividend-smoothing, which predicts that increased dividends should cause firms to keep more cash on hand. In the reverse direction, theory’s predictions depend on the source of the increased cash on hand. General dividend-smoothing theory predicts that temporary increases in cash due to natural market fluctuations should not affect dividends. If the increased cash is due to a permanent increase in profitability, both the marginal benefit and the marginal cost of paying dividends also increase, and the net effect is unclear. Theory’s predictions of causality cannot be tested empirically using observed firm data, however, due to an underlying endogeneity issue. We instead turn to a laboratory experiment to determine causality. In the lab, we separately and exogenously vary each relevant variable to test each theoretical hypothesis. Increased dividends lead to increased cash on hand. One-time increases in firms’ cash on hand, representing natural market fluctuations, do not affect firms’ dividends. Increases in cash on hand due to a permanent increase in firm profitability, however, cause dividends to decrease.

Suggested Citation

  • Jia, Zi Tingting & McMahon, Matthew J., 2019. "Dividend payments and excess cash: an experimental analysis," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 83(C).
    • Handle: RePEc:eee:soceco:v:83:y:2019:i:c:s2214804319300552
    DOI: 10.1016/j.socec.2019.101458
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    Cited by:

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    2. Saleh F. A. Khatib & Dewi Fariha Abdullah & Ernie Hendrawaty & Ahmed A. Elamer, 2022. "A bibliometric analysis of cash holdings literature: current status, development, and agenda for future research," Management Review Quarterly, Springer, vol. 72(3), pages 707-744, September.
    3. Wang, Di & Guo, Liangju & Xing, Saipeng, 2024. "Compulsory liability insurance and excess cash holdings: Evidence from China," International Review of Financial Analysis, Elsevier, vol. 91(C).

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    More about this item

    Keywords

    Dividends; Cash on hand; Precautionary cash holdings; Principal-Agent problem; Behavioral finance; Experiment;
    All these keywords.

    JEL classification:

    • C91 - Mathematical and Quantitative Methods - - Design of Experiments - - - Laboratory, Individual Behavior
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy
    • G40 - Financial Economics - - Behavioral Finance - - - General

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