Dividend Signaling and Sustainability

Abstract

Since the 1970s, dividends have not only become less common (Fama and French, 2001), they have become less sticky, too. Today, it is not uncommon for a firm to cease dividend payments within three years of initiation. I examine the differences between firms that continue to pay dividends for a long period of time after initiation and those that do not. Although investors do not distinguish between the two groups at the time of the dividend initiation announcement, the firms that pay over a long period of time experience superior operating performance in subsequent years. I construct a model that predicts, at the time of the initiation announcement, whether a firm is likely to pay dividends well into the future. My predictions also extend to performance; the firms that I predict to pay for a long period of time also outperform those whose payments I predict to be temporary. Thus, it appears that the relationship between dividend stickiness and long-run performance is not fully reflected in stock returns surrounding the announcements of dividend initiations.