Empirical Evidence on Dividend Policy and Its Implications for Value

Finance literature has two different views on the dividend policy. One view suggests that dividends are irrelevant for value whereas the other view states that dividends have implications for value. The original theory of irrelevance of dividends for value was empirically tested by DeAngelo and DeAngelo (2006) and the authors rejected the model that was suggested by Miller and Modigliani (1961). The research demonstrated that the payout policy was relevant and investment policy was not the only determinant of firm value. The observations were inherent even to frictionless markets. However, the study paid attention to total payouts rather than cash dividends only. Thereby, no distinction was made between distributing earnings to shareholders in the form of dividends or stock repurchases (Handley, 2008).

Magni (2007) continued the analysis of the dividend irrelevance theory and also focused on the assumption that dividends were distributed to equity holders out of positive cash flows from investments, thus ignoring share repurchases. The author demonstrated that dividend policy did not affect equity value in companies, thus confirming the Miller and Modigliani (1961) position. In the meanwhile, an empirical investigation by Rees and Valentincic (2013) tested publicly quoted UK companies over the period of 22 years and proved that dividends were strong determinants of firm value. However, they also noted that the coefficient of dividend significance was considerably lower when the sample was restricted to profitable dividend-paying enterprises or when proxies for core income or other information were included. The major relationship that was captured by the study was between dividends and expected earnings. Thereby, the study showed that dividends could be value relevant under some circumstances, thus rejecting the dividend irrelevance theory (Rees and Valentincic, 2013).

The research conducted by Baker et al. (2002) was different from the aforementioned studies, as the authors explored the views of managers on dividend policy and its relation to firm value. The research analysed the opinions of NASDAQ firms’ managers and showed that they tended to emphasise the significance of keeping dividend payments consistent. The managers agreed that changes in dividends influenced firm value. The research rejected the tax preference and bird-in-the-hand explanations of the dividend policy, while they gave some support to a signaling explanation for dividends distribution. Specifically, managers assumed that dividend increase announcements provided information about the future firm value (Baker et al., 2002). In contrast to this, Graham and Kumar (2006) found confirmation of the clientele effect of the dividend policy. The authors showed that the retail investor stock holdings were associated with a preference for dividend yield that grew with age and decreased with income. Thereby, age and tax clienteles respectively were confirmed. Trading patterns contributed to the evidence, as older and low-income investors purchased stocks before the dividend announcement day. Moreover, the ex-day price decrease was lower with age and higher with income. This observation confirmed the clientele effects and tax preference theory of dividends (Graham and Kumar, 2006).

The preference of some companies to pay dividends instead of repurchasing shares was explored by Allen et al. (2000). The study showed that institutional investors that were less taxed than individual investors created ownership clientele effects. Firms that paid dividends attracted more institutions, as the institutions could better identify high firm quality and ensure appropriate management of companies. The study showed that the absolute tax payments were not able to determine dividend payments. Yet, the tax difference between retail investors and institutions predicted the dividend policy (Allen et al., 2000). The observations were expanded by Short et al. (2002) who found a link between the dividend policy and institutional ownership. Analysing a UK panel data set, the study confirmed the hypothesis about a positive relationship between institutional ownership and dividend payout. Furthermore, a positive earnings trend enhanced the relationship. In addition, the research confirmed the assumption that a negative association existed between managerial ownership and dividend payout policy (Short et al., 2002).

The research conducted by Zheng and Ashraf (2014) provided an alternative approach to the explanation of the dividend policy. The authors explored a sample of banks from over 50 countries and analysed the effects of national culture on dividend policies. The research showed that banks in countries with high uncertainty avoidance, high long-period orientation and low masculinity paid lower dividends and were less likely to distribute dividends. Uncertainty avoidance was determined as the degree to which companies felt uncomfortable with uncertain situations. The observations about the high uncertainty avoidance investors that preferred lower dividends rejected the bird-in-the-hand theory of dividends (Zheng and Ashraf, 2014). At the same time, the study by Frankfurter and Wood (2002) showed that no dividend model alone or jointly with other models was able to explain dividend policies. The authors empirically showed that managers decreased dividends only when it was absolutely necessary. Dividends could relay information in line with the dividend signaling theory, but the use of dividends to convey information was not able to explain why companies paid dividends. The effects of signaling in the preferences of investors were less certain due to the ambiguity that was inherent to signals (Frankfurter and Wood, 2002).

Dividend signaling theories were challenged by the research of DeAngelo et al. (2000), as the authors showed that special dividends had almost disappeared. This fact rejected the ability of dividend signals to be an important function. Furthermore, most managers preferred to demonstrate that they did not assign strong importance to the opportunity to send signals. At the same time, the research showed that special dividends historically played a signaling role, but eventually were replaced by more effective signaling techniques (DeAngelo et al., 2000). However, Grullon et al. (2005) provided an alternative explanation of the inability of the dividend signaling theory to explain the dividend policy. The authors challenged the assumption of the theory that dividend changes were positively related to future changes in earnings and profitability. The study concluded that dividend changes conveyed no information about the changes in future earnings. Furthermore, dividend changes had a negative correlation with future return on assets that measured profitability. In addition to this, the study demonstrated that models which incorporated dividend changes were not able to outperform the models that did not include dividend changes. The authors assumed that dividend increases provided some signals, but the signals were not related to abnormal earnings increases or abnormal profitability increases in future (Grullon et al., 2005).



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Baker, H.K., Powell, G. and Veit, E.T. (2002) “Revisiting managerial perspectives on dividend policy”, Journal of Economics and Finance, 26 (3), pp. 267-283.

DeAngelo, H. and DeAngelo, L. (2006) “The irrelevance of the MM dividend irrelevance theorem”, Journal of Financial Economics, 79 (2), pp. 293-315.

DeAngelo, H., DeAngelo, L. and Skinner, D. (2000) “Special dividends and the evolution of dividend signalling”, Journal of Financial Economics, 57 (3), pp. 309-354.

Frankfurter, G. and Wood, B. (2002) “Dividend policy theories and their empirical tests”, International Review of Financial Analysis, 11 (2), pp. 111-138.

Graham, J. and Kumar, A. (2006) “Do Dividend Clienteles Exist? Evidence on Dividend Preferences of Retail Investors”, The Journal of Finance, 61 (3), pp. 1305-1336.

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Handley, J. (2008) “Dividend policy: Reconciling DD with MM”, Journal of Financial Economics, 87 (2), pp. 528-531.

Magni, C.A. (2007) “Relevance or irrelevance of retention for dividend policy irrelevance”, Applied Economics Research Bulletin, MPRA Paper 15689.

Miller, M. and Modigliani, F. (1961) “Dividend Policy, Growth, and the Valuation of Shares”, The Journal of Business, 34 (4), pp. 411-433.

Rees, W. and Valentincic, A. (2013) “Dividend Irrelevance and Accounting Models of Value”, Journal of Business Finance & Accounting, 40 (5-6), pp. 646-672.

Short, H., Zhang, H. and Keasey, K. (2002) “The link between dividend policy and institutional ownership”, Journal of Corporate Finance, 8 (2), pp. 105-122.

Zheng, C. and Ashraf, B.N. (2014) “National culture and dividend policy: International evidence from banking”, Journal of Behavioral and Experimental Finance, 3, pp. 22-40.

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