Disappearing Dividends: A Rational Explanation and Implications
68 Pages Posted: 13 Oct 2011
Date Written: August 2, 2011
This paper provides risk and information asymmetry-based explanations of the disappearing dividend puzzle first documented by Fama and French (2001). Dividends serve as signaling device and, under models of dividend signaling under information asymmetry, the cost of signaling increases with volatility of firms’ cash flows. Declining propensities to pay dividends imply that information asymmetries have become lower and/or cost of signaling has increased. We find evidence consistent with both. First, we find abnormal returns associated with dividend initiations have been declining over the years. We attribute this decline to increasing stock price informativeness: as stock prices become more informative, dividends contain lower information content, which in turn result in lower price reactions. Consistent with this, we find that firms with more informative stock prices are less likely to pay dividends. In addition, we also show that firms with higher (lower) information asymmetries are more (less) likely to pay dividends. Second, we find that firms with higher (lower) cash flow volatilities are less (more) likely to pay dividends. Our risk and information asymmetry proxies could explain a significant portion of the disappearing dividend trend.
Keywords: dividends, infotmation asymmetry, stock price informativness, abnormal announcement returns
JEL Classification: G14, G35
Suggested Citation: Suggested Citation