The information content of dividends: a signalling approach

The adoption of the incentive-signalling framework gives a reasonably good explanation of the corporate dividend decision. The equilibrium optimal dividend decision under such a framework is presented and analyzed, assuming a reward-penalty managerial incentive scheme is used. It is shown that the size of the declared dividend is an increasing function of expected cash flow. However, there exists a trend that points out that the higher the level of expected cash flow, the lower the marginal effects of cash flow on dividends. A similar relationship is observed with respect to changes in expected cash flows. These conclusions are in harmony with "real world" behavior as reported by several empirical studies. The effects of uncertainty and interest rates on dividends are also analyzed. It is shown, in agreement with observed phenomena, that the higher the uncertainty, the lower the dividend/payout ratio.