Dividend Policy Decisions

Although firms have been distributing dividends to their shareholders for four centuries (Baskin, 1988), the motivation for this corporate policy is under debate in the academic community. In an early paper, Black (1976, p. 5) coined the term the “dividends puzzle” to illustrate the poor understanding of dividend payment policy: “The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don’t fit together.” Over the years, dozens of theories have attempted to explain the dividends phenomenon with no consensus reached. Many of the theories view agents as rational and dividends either serve as an efficient way to resolve agency problems or as a signaling device to mitigate information asymmetry problems. Allen and Michaely (2003), Frankfurter and Wood (2006), Baker (2009), and DeAngelo, DeAngelo, and Skinner (2009) provide excellent reviews of these theories and the related empirical facts. After reviewing the literature, Allen and Michaely (2003) and Frankfurter and Wood (2006) conclude that theories based on agency or signaling are not consistent with the empirical evidence and that the question of why firms distribute dividends remains a puzzle. DeAngelo et al., however, reach a different conclusion and argue that asymmetric information could provide an explanation for the dividends phenomenon. This chapter reviews the main stylized facts about dividends and examines the behavioral theories that attempt to explain the evidence. Given the focus on the behavioral perspective, this chapter reexamines and reclassifies some of the empirical facts that previous researchers have used to support rational theories. As such, it does not replace the many surveys written about dividends over the years (e.g., Allen and Michaely, 2003; DeAngelo et al., 2009). Rather, this chapter tries to assess whether the empirical evidence is consistent with a departure from rational behavior on the part of investors or managers. The role of behavioral finance in explaining the existence of dividends is debated as a matter of academic dispute. Miller (1986) presents a traditional argument against behavioral finance by contending that behavioral theories may be able to explain the micro-behavior of agents, but that rational theories should suffice to explain the aggregate behavior of firms. Frankfurter and Lane (1992) and Frankfurter and Wood (2006) emphasize the normative aspects of dividend payments