The Information Content of Dividends: Safer Profits, Not Higher Profits
75 Pages Posted: 18 Jan 2018
There are 5 versions of this paper
Signaling Safety
The Information Content of Dividends: Safer Profits, Not Higher Profits
The Information Content of Dividends: Safer Profits, Not Higher Profits
Signaling Safety
Date Written: November 28, 2017
Abstract
Contrary to the central prediction of signaling models, changes in profits do not empirically follow changes in dividends. We show both theoretically and empirically that dividends signal safer, rather than higher, future profits. Using the Campbell (1991) decomposition, we are able to estimate expected cash flows from data on stock returns. Consistent with our model’s predictions, cash-flow volatility changes in the opposite direction from that of dividend changes and larger changes in volatility come with larger announcement returns. We find similar results for share repurchases. Crucially, the data supports the prediction - unique to our model - that the cost of the signal is foregone investment opportunities. We conclude that payout policy conveys information about future cash flow volatility. Our methodology can be applied more generally to overcoming empirical problems in testing theories of corporate financing.
Keywords: dividends, payout policy, cash flow volatility, signaling model
JEL Classification: G350
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