Dividends: the evidencel a tendency for the younger, smaller businesses (mentioned by Benito and Young
and by Fama and French (see above)) now to have become larger and more profit-
able with less requirement for investment capital, leaving them with spare cash;
l businesses using dividends as a means of reassuring investors that their profits are
genuine, following the corporate governance scandals such as Enron (discussed in
Chapter 3); and
l a more favourable tax treatment of dividends in the USA.Stability of dividend policy
The evidence of casual observation is that directors treat the dividend decision as
an important one. It also seems that they try to maintain dividends at previous levels;
reductions in dividends seem relatively rare occurrences.
This is very much supported by more formal evidence. Baker, Powell and Veit
(2002) undertook a survey (during 1999) of the opinions of 187 senior financial man-
agers of larger US businesses that were regular dividend payers. They found that over
90 per cent of the managers felt:l dividend increases should not occur unless there was confidence that the business
could sustain the higher level in future (93 per cent);
l dividends should never be missed (95 per cent); and
l the market places a higher value on a business that maintains a stable level of divi-
dends paid than on one that pays a constant proportion of its profit as a dividend
(which therefore varies with profit levels) (94 per cent).
Note that the managers surveyed were with businesses that paid regular dividends,
so they were not a random sample. Whether these managers were correct in their
judgements is, to some extent, not the issue. If they believe that investors are benefited
by regular dividends that are never decreased or missed, then they are likely to strive
to adopt such a dividend policy.Effect of dividends on share price
Early studies of the relationship between share prices and dividend policy (such as
Friend and Puckett 1964 and Black and Scholes 1974) tended to find no evidence that
higher or lower dividend levels lead to higher or lower returns either before or after
taxes. However, Fama and French (1998), based on the US experience, did show such
a relationship. These researchers inferred that increases in dividends are treated by the
market as a signal of higher expectations of managers. This tends to lead to enhanced
share prices as investors reassess the value of the business. The Fama and French
findings were supported by other researchers including Akbar and Stark (2003), who
based their study on UK businesses, and Hand and Landsman (2005), using US data.Informational content of dividends (signalling)
Pettit (1972) found clear support for the proposition that the capital market takes
account of dividend announcements as information for assessing share prices.
This finding has fairly consistently been supported by subsequent studies, for ex-
ample Aharony and Swary (1980). Nissim and Ziv (2001) found that dividend changes