Three essays on payout policy

Abstract

This thesis studies dividend payout policy and its effect on firms' financial policy. It comprises three chapters. The first chapter, "The Real and Financial Effects of Dividend Rigidity", explores the consequences of an inflexible dividend policy. We study dividend smoothing in tandem with debt and investment. Avid smoothers resort to net debt to absorb cash flow variations because altering dividends is not fully available. Financially constrained firms are unable to rely entirely on debt to mitigate smoothing frictions, curbing investments to fund cash flow shocks. The effect persists for transitory cash flow, making it unlikely to be driven by heterogeneous growth options. We exploit differences in the loadings of smoothing on dividend strip returns as instruments to address endogeneity concerns. Our findings result from dividend rigidity rather than total payout and the results are magnified for extreme smoothers.

The second chapter, "Dividend Hibernation and Future Earnings: When No Dividend News Is Good News", studies a specific type of dividend smoothing called dividend hibernation. Firms frequently enter into dividend hibernation, periods during which dividends remain unchanged for consecutive quarters. We employ a dividend event framework to show that, compared with matched non-hibernating firms, hibernating firms experience higher unexpected future earnings growth for up to five years by reducing underinvestment. We construct an index of adverse selection measures and find that hibernating firms are more opaque, indicating that the information gap between insiders and outsiders widens when there is no change in dividends. Extended hibernation episodes increase the opaqueness, while dividend changes after prolonged periods of no signalling reduce the information gap more effectively.

A question may arise with a section of the first chapter claiming that dividend smoothing can have a negative impact on firm value while, in the second chapter, it is argued that hibernation (a specific form of smoothing) can have a positive impact on firm value. One must note that, in the first chapter, it is argued that dividend smoothing destroys value in the presence of financial constraints. If a firm has sufficient access to external funds, smoothing is not necessarily a policy with adverse valuation outcomes. Hence, to be clear, the two chapters focus on different aspects of payout policy.

In the third chapter, "Estimating Permanent Earnings Surprise", we estimate unexpected changes in permanent earnings for individual firms by using lagged stock return responses to dividend changes. We show that the estimated surprises in permanent earnings represent aggregate permanent earnings. Moreover, we document that firms return 82% of permanent earnings to shareholders through dividends, on average.