Empirical Evidence on Dividends as a Signal of Firm Value

The role of dividends in firm valuation continues to be a theoretical puzzle as well as an empirical obsession with economists. The pioneering work by Modigliani and Miller (MM) ([32], [29]) is the archetype of the theoretical dilemma. Whereas the authors proved convincingly the irrelevance of dividend policy to firm value within a perfect capital market, they tempered their irrelevance proposition with what is usually referred to as the “information content of dividends” (ICD) hypothesis. In a more scientific sense, this hypothesis should be labeled as a conjecture, since it is essentially an ad hoc observation that dividends may convey information to the capital market concerning a firm's future earnings potential. Even though the ICD hypothesis was not derived from a well-specified economic model, it has, nevertheless, been subjected to a plethora of empirical studies. In general, these studies have focused upon the precise influence of dividend changes upon a firm's common stock price. Overall, the results can be described as being supportive of the notion that stock price movements are positively correlated with cash dividend changes. This correlation, of course, is consistent with the ICD hypothesis.