The Information Content of Dividends: Safer Profits, Not Higher Profits
AbstractContrary to signaling models’ central predictions, changes in profits do not
empirically follow changes in dividends, and firms with the least need to signal
pay the bulk of dividends. We show both theoretically and empirically that
dividends signal safer, rather than higher, future profits. Using the Campbell
(1991) decomposition we find that cash-flow-volatility changes follow dividend and
repurchase changes (in opposite direction), and that larger volatility changes come
with larger announcement returns consistent with our model’s predictions. The data
support the prediction that the signaling cost is foregone investment opportunities.
We conclude payout policy conveys information about future cash-flow volatility.