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.
Original language | English |
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Pages (from-to) | 289-312 |
Number of pages | 24 |
Journal | Journal of Corporate Finance |
Volume | 25 |
Early online date | 2014 |
DOIs | |
Publication status | Published - Apr 2014 |
Keywords
- Dividend smoothing
- Partial equilibrium model
- Payout policy
- Signaling theory