Investment as the Opportunity Cost of Dividend Signaling
68 Pages Posted: 10 Jun 2019 Last revised: 6 Jan 2020
Date Written: January 6, 2020
We examine the interaction between investment opportunities and the information content of dividends. Consistent with investment opportunities acting as the opportunity cost of communicating earnings information through dividends, we show that both dividend levels and changes contain more earnings information among firms with weaker investment opportunities. In contrast, firms with stronger investment opportunities are more likely to fund dividend changes by changing investment policy. Variation in aggregate investment opportunities leads to inter-temporal variation in the earnings information content of dividend changes, and aggregate investment opportunities explain inter-temporal variation in payout better than behavioral models (e.g., the ‘dividend premium’). Market reaction tests suggest that earnings news, and not investment, is the ‘signal’ driving market reactions. Collectively, our results contrast with the predictions of costly signaling theories, as we show that dividends provide earnings information predominantly when the costs of foregone investment are low.
Keywords: dividends, payout policy, signaling, earnings, capital structure
JEL Classification: G15, G32, G35
Suggested Citation: Suggested Citation