Do Investors Value Dividend-Smoothing Stocks Differently?

It is almost an article of faith that managers have a preference for smooth dividends. Yet, it is not clear if this reflects investors’ preferences. In this paper, we study whether investors indeed value dividend smoothing stocks differently by exploring the implications of dividend smoothing for firms’ stock prices and cost of capital. Using over 80 years of data, we find no robust relationship between the smoothness of a firm’s dividends and the expected return or market value of its stock. Similarly, we find no association between the path of dividend changes and changes in firm value. The asymmetric reaction to dividend increases and decreases is largely attributable to the first time the firm cuts its dividend. Finally, we find that retail investors are less likely to hold dividend smoothing stocks, while institutional investors, and especially mutual funds, are more likely. This evidence for a smoothing clientele offers a potential explanation for the prevalent use of dividend smoothing. *Larkin is from Penn State University ([email protected]), Leary is from Washington University, St. Louis ([email protected]), and Michaely is from Cornell University and IDC ([email protected]). We thank Alon Brav, Harry DeAngelo, Alan Crane, George Gao, Gustavo Grullon, Bruce Grundy, Kristine Hankins, and the participants of Penn State Finance seminar, the 2011 Finance Down Under Conference at the University of Melbourne, the 2012 FIRS Conference, and the WFA 2013 annual meeting for very helpful discussions and suggestions. The remaining errors are our own.