Dividend Smoothing and Predictability

56 Pages Posted: 12 Oct 2008 Last revised: 16 Mar 2011

See all articles by Long Chen

Long Chen

Luohan Academy; Cheung Kong Graduate School of Business

Zhi Da

University of Notre Dame - Mendoza College of Business

Richard Priestley

Norwegian Business School

Date Written: November 19, 2010

Abstract

The relative predictability of returns and dividends is a central issue since it forms the paradigm to interpret asset price variation. A little studied question is how dividend smoothing, as a choice of corporate policy, affects predictability. We show that, even if dividends are supposed to be predictable without smoothing, dividend smoothing can bury this predictability in a finite sample. We further show that aggregate dividends are dramatically more smoothed in the postwar period than before. Therefore, the lack of dividend growth predictability in the postwar period, as widely documented in the literature, does not necessarily mean that there is no cash flow news in stock price variations; rather, a more plausible interpretation is that dividends are smoothed. Using two alternative measures that are less subject to dividend smoothing -- net payout and earnings -- we reach the consistent conclusion that cash flow news plays a more important role than discount rate news in price variations in the postwar period. Our take-away messages are that (i) dividend smoothing can severely affect dividend predictability in a finite sample, (ii) there is significant cash flow news in stock price variations, and (iii) when smoothed, dividends do not represent well the outlook of future cash flows.

Keywords: Dividend-price ratio, earning-price ratio, dividend growth, earnings growth, predictability, dividend smoothing

JEL Classification: G12, E44

Suggested Citation

Chen, Long and Da, Zhi and Priestley, Richard, Dividend Smoothing and Predictability (November 19, 2010). Available at SSRN: https://ssrn.com/abstract=1280833 or http://dx.doi.org/10.2139/ssrn.1280833

Long Chen (Contact Author)

Luohan Academy ( email )

No. 556, Xixi Road, Z Space
Xihu District
Hangzhou, Zhejiang 310013
China
+86-0571-2688-8888-75520 (Phone)

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Zhi Da

University of Notre Dame - Mendoza College of Business ( email )

Notre Dame, IN 46556-5646
United States

Richard Priestley

Norwegian Business School ( email )

Nydalsveien
37
N-0442 Oslo, 0283
Norway
47 46410515 (Phone)

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