The Pricing of Dividends in Equity Valuation

34 Pages Posted: 13 Aug 1999

See all articles by John R. M. Hand

John R. M. Hand

University of North Carolina Kenan-Flagler Business School

Wayne R. Landsman

University of North Carolina Kenan-Flagler Business School

Multiple version iconThere are 2 versions of this paper

Date Written: June 24, 1999

Abstract

This paper employs Ohlson's (1995, 1998) accounting based equity valuation model to structure an empirical assessment of the pricing of dividends in stock prices. We address two questions. First, to what extent does the pricing of dividends reflect Modigliani and Miller?s (1958, 1961) one-to-one displacement property? Second, what explains the direction and magnitude of any divergence from dividend displacement? Using annual cross-sections of NYSE, AMEX and NASDAQ firms over the period 1974-1996, we find robust evidence that dividends are materially positively priced, sharply contrasting with the negative relation predicted by dividend displacement. We also find that the positive pricing of dividends is at least three times larger for loss firms than for profit firms. Our explanation for these results is that managers of loss firms use dividends to signal future profitability, while to a lesser degree managers of profit firms use dividends to alleviate concerns about the misuse of free cash flow. We conclude that dividends are a component of, and rich proxy for, other information about future abnormal earnings that is reflected in price but is not yet captured by current financial statements.

JEL Classification: G12, G35, M41

Suggested Citation

Hand, John R. M. and Landsman, Wayne R., The Pricing of Dividends in Equity Valuation (June 24, 1999). Available at SSRN: https://ssrn.com/abstract=169300 or http://dx.doi.org/10.2139/ssrn.169300

John R. M. Hand (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States
919-962-3173 (Phone)
919-962-4727 (Fax)

Wayne R. Landsman

University of North Carolina Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States
919-962-3221 (Phone)
919-962-4727 (Fax)

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