Payout Policy, Innovation Value and Investors' Beliefs

Abstract

We examine whether a firm's payout policy influences investors' beliefs about the value of its investments. We argue that the uncertainty underlying the investment process and the commitment implied by the payout policy jointly affect investors' valuation of a firm's investment. Leveraging the high uncertainty surrounding the timing and outcomes of the innovation process, we predict managers will increase their payout commitments as uncertainty resolves positively. Consistent with this hypothesis, we find that managers with more successful and valuable innovations raise sticky dividends while reducing more flexible share repurchases. The higher commitment of dividend payments implies a different information value for investors compared to share repurchases. By exploiting the plausibly exogenous timing of patent grants (i.e., the resolution of uncertainty), we provide asset-level evidence that investors assign a higher value to patents granted following dividend increases but find no evidence they do so following repurchase authorizations. Taken together, our findings suggest that innovative firms adjust their payout commitments based on the expected value of current investments in innovation, prompting investors to update their beliefs accordingly.

Keywords: Payout Policy, Investors’ Beliefs, Innovation, Firms’ Signaling

JEL Classification: D82, D83, G31, G35, O32, O34