Dividends as Reference Points: A Behavioral Signaling Approach
We outline a dividend signaling approach in which rational managers signal firm strength to investors who are loss averse to reductions in dividends relative to the reference point set by prior dividends. Managers with strong but unobservable cash earnings separate themselves by paying high dividends but retain enough earnings to be likely not to fall short of the same level next period. The model is consistent with several features of the data, including equilibrium dividend policies similar to a Lintner partial-adjustment model; modal dividend changes of zero; stronger market reactions to dividend cuts than increases; relative infrequency and irregularity of repurchases versus dividends; and a core mechanism that does not center on public destruction of value, a notion that managers reject in surveys. Supportive new tests involve nominal levels and changes of dividends per share, announcement effects, and reference point currencies of ADR dividends.
Baker gratefully acknowledges the Division of Research of the Harvard Business School for financial support. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.
I have an ongoing consulting relationship with Acadian Asset Management, an investment management firm. I also serve on the board of directors of TAL Incorporated, a publicly traded, container leasing firm.
Malcolm Baker & Brock Mendel & Jeffrey Wurgler, 2016. "Dividends as Reference Points: A Behavioral Signaling Approach," Review of Financial Studies, Society for Financial Studies, vol. 29(3), pages 697-738. citation courtesy of