Optimal Money Burning: Theory and Application to Corporate Dividend Policy
46 Pages Posted: 21 Oct 1996 Last revised: 3 Oct 2010
Date Written: July 1996
We explore signaling behavior in settings with a discriminating signal and several costly nondiscriminating ( money burning ) activities. In settings where informed parties have many options for burning money, existing theory provides no basis for selecting one nondiscriminating activity over another. When senders have private information about the costs of these activities, each sender's indifference is resolved, the taxation of a nondiscriminating signal is Pareto improving, and the use of the taxed activity becomes more widespread as the tax rate rises. We apply this analysis to the theory of dividend signaling. The central testable implication of the model is verified empirically.
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