Article

A Catering Theory of Dividends

The Journal of Finance (Impact Factor: 4.22). 06/2004; 59(3):1125-1165. DOI: 10.2139/ssrn.342640
Source: RePEc

ABSTRACT We propose that the decision to pay dividends is driven by prevailing investor demand for dividend payers. Managers cater to investors by paying dividends when investors put a stock price premium on payers, and by not paying when investors prefer nonpayers. To test this prediction, we construct four stock price-based measures of investor demand for dividend payers. By each measure, nonpayers tend to initiate dividends when demand is high. By some measures, payers tend to omit dividends when demand is low. Further analysis confirms that these results are better explained by catering than other theories of dividends. Copyright 2004 by The American Finance Association.

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    • "Black and Scholes (1974) and Allen et al. (2000) propose clientele theories underlying firms " dividend policies. Baker and Wurgler (2004) argued that there are several reasons for the existence of several clientele effects. First, market imperfections, such as transaction costs, taxes, and institutional investment constraints cause traditional dividend " clienteles " . "
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    • "Management therefore 'cater' for investors by paying dividends to shareholders who require it and not paying when the investors do not require dividends. Baker and Wurgler (2004) argue that investors have uninformed and time varying demand for dividend paying shares. This demand is not influenced by any arbitrage as the prices of the payers and non-payers remain unperturbed. "
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    • "For some other explanations of dividend policy, see Shefrin and Statman (1984), who in the one of the …rst papers that utilized behavioral …nance in the dividend area, develop a framework that explains why investors exhibit a preference for dividends, based on the theory of self-control advanced by Thaler and Shefrin (1981) and prospect theory developed by Kahneman and Tversky (1979). More recently, Baker and Wurgler (2004) develop a " catering theory " for dividends, wherein investor sentiment drives dividend decisions and, in Baker and Wurgler (2012) a model is developed with behavioral underpinnings for the dividend decision on the basis of stockholders evaluating current dividends against a reference point derived from past dividends. "
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