article review on dividend policy

Dividend policy, systematic liquidity risk, and the cost of equity capital

• Original Research
• Published: 18 November 2022
• Volume 60 , pages 839–876, ( 2023 )

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• Khelifa Mazouz 1 ,
• Yuliang Wu 2 ,
• Rabab Ebrahim 3 &
• Abhijit Sharma 4  

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This paper examines a new channel through which dividend policy can affect firm value. We find that firms that pay dividends exhibit lower systematic liquidity risk than those that do not. We also report a significant negative relationship between dividend payment and systematic liquidity risk. The liquidity improvement associated with dividend payments translates into an economically meaningful reduction in the cost of equity capital. Our results are robust to endogeneity concerns, to alternative measures of liquidity risk and dividend payouts, and to alternative model specifications. Further analysis suggests that the reduction in liquidity risk associated with dividend payouts is more pronounced for weakly governed firms and firms with opaque informational environment. Finally, we find that the recent financial crisis led to a greater increase in systematic liquidity risk for firms with no or low dividend payouts. Overall, our study implies that dividend policy can be used by corporate managers to shape liquidity risk and mitigate the adverse impact of economic downturns on the value of their firms.

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Dividend tax capitalization and liquidity

Stock Market Liquidity and Company Decisions to Pay Dividends: Evidence from the Warsaw Stock Exchange

The US financial crisis and corporate dividend reactions: for better or for worse?

Earlier studies also find that dividend payments have a positive relationship with stock liquidity, implying that dividend policy is relevant for liquidity (e.g., Howe and Lin 1992 ; Mitra and Rashid 1997 ; Gurgul et al. 2003 ; Dasilas and Leventis 2011 ).

Although Pastor and Stambaugh’s measure is known to reflect the sensitivity of stock returns to innovations in aggregate liquidity, the measure is designed to capture the illiquidity that relates to the price impact of trades rather than the liquidity risk arising from trading continuity (Lin et al. 2009 ) and works better for portfolios than individual stocks (Pastor and Stambaugh 2003 ).

However, our results are still held if we do not winsorize all continuous variables.

See “ Appendix ” for the definitions of variables.

Acharya and Pedersen ( 2005 ) decompose liquidity risk into three components. The first one implies that the expected return is higher for assets with a higher covariance between the liquidity of the stock and the liquidity of the general market \({(\beta }_{1}^{L})\) . The second one accounts for the covariance between the return of the stock and the liquidity of the general market \(({\beta }_{2}^{L}\) ). The third one considers the covariance between the liquidity of the stock and the return on the general market ( \({\beta }_{3}^{L}\) ). The estimated 1.1% difference in cost of equity capital is due to the total liquidity risk premium from the three components, out of which the return premium due to the covariance between stock return and market liquidity ( \({\beta }_{2}^{L}\) ) is 0.16%.

Considering the limited number of the events based on dividend omissions and initiations, we also estimate the impact of the change of dividend payouts on liquidity risk. In untabulated results, we find that the change of dividend payouts also exhibits a significant and negative relationship with liquidity risk, consistent with our baseline results based on the level of dividend payouts.

For example, assuming that a firm has a fiscal year end of December, the firm pays dividends over the period from 2001 January to 2001 December. We estimate the liquidity beta over the pre-treatment period from 2000 January to 2000 December and over the post-treatment period from 2002 January to 2002 December.

We require that a stock must be followed by at least three analysts to be included in the sample for this analysis.

The Management Score measures a company’s commitment and effectiveness towards following best practice corporate governance principles. The Shareholders Score measures a company’s effectiveness towards equal treatment of shareholders and the use of anti-takeover devices. The CSR Strategy Score reflects a company’s practices to communicate that it integrates the economic (financial), social and environmental dimensions into its day-to-day decision-making processes.

Following Sloan ( 1996 ), we define accruals as follows. Accruals = ((ΔCA − ΔCash) − (ΔCL − ΔSD − ΔTP) − DP)⁠, where ΔCA is the change in current assets, ΔCash is the change in cash and equivalents, ΔCL is the change in current liabilities, ΔSD is the change in short-term debt included in the current liabilities, ΔTP is the change in income tax payable, and  DP  denotes depreciation and amortization expenses. All of the numbers are scaled by lagged total assets.

See Amihud ( 2019 ) for the details on the construction of ILM. This factor is used by Amihud et al. ( 2013 ), Amihud et al., ( 2015 ), and Amihud and Noh ( 2017 ).

In theory, the decisions to pay dividends or repurchase stocks should convey information about future earnings and profitability to the market (Dittmar 2000 ; Grullon and Michaely 2004 ). However, prior empirical studies find mixed results in support for the information based explanation of stock repurchases. For example, Grullon and Michaely ( 2004 ) and Wang et al. ( 2021 ) find that repurchasing firms experience no significant improvement in long-term performance and analysts do not change their expectations of the repurchasing firms through earnings forecasts. However, Lie ( 2005 ) finds that repurchasing firms incur improvements in operating performance following the quarters when the firms actually repurchase the stocks. Therefore, the information channel through which stock repurchases affect liquidity risk is not of a main focus in this section.

The daily Fama–French three factors and the momentum factor are obtained from Xfi Centre for Finance and Accounting, University of Exeter. See http://business-school.exeter.ac.uk/research/centres/xfi/famafrench/files/

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Appendix: Variable definitions

• *See http://business-school.exeter.ac.uk/research/centres/xfi/famafrench/files/

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Mazouz, K., Wu, Y., Ebrahim, R. et al. Dividend policy, systematic liquidity risk, and the cost of equity capital. Rev Quant Finan Acc 60 , 839–876 (2023). https://doi.org/10.1007/s11156-022-01114-3

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Accepted : 05 October 2022

Published : 18 November 2022

Issue Date : April 2023

DOI : https://doi.org/10.1007/s11156-022-01114-3

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Managerial Finance

ISSN : 0307-4358

Article publication date: 23 January 2007

This paper aims to briefly review principal theories of dividend policy and to summarize empirical evidences on these theories.

Design/methodology/approach

Major theoretical and empirical papers on dividend policy are identified and reviewed.

It is found that the famous dividend puzzle is still unsolved. Empirical evidence is equivocal and the search for new explanation for dividends continues. Also a number of stylized empirical facts about dividends discovered by researchers are noted.

Research limitations/implications

As with any review paper, the major limitation is that necessarily some papers will be left out. Also as newer research is published the review paper will become more dated.

Originality/value

This paper will give the reader a comprehensive understanding of the dividend puzzle and the major paradigms of dividend policy. The paper will also give the reader the major stylized facts about dividend policy.

• Corporate finance

Bhattacharyya, N. (2007), "Dividend policy: a review", Managerial Finance , Vol. 33 No. 1, pp. 4-13. https://doi.org/10.1108/03074350710715773

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There Is Nothing Special About Dividends

Why they’re not a tax-efficient way to return capital to shareholders.

In my role as head of financial and economic research at Buckingham Wealth Partners, I am often asked by investors about dividend growth strategies—strategies that are popular among retail investors who, for behavioral reasons, have been found to have a preference for dividends. I’ll review the financial theory about dividends and then the empirical evidence on the performance of dividend growth strategies.

A Dollar Is a Dollar

In their 1961 paper “ Dividend Policy, Growth, and the Valuation of Shares ,” Merton Miller and Franco Modigliani famously established that dividend policy should be irrelevant to stock returns. As they explained it, at least before frictions like trading costs and taxes, investors should be indifferent to $1 in the form of a dividend (causing the stock price to drop by $1) and $1 received by selling shares. This must be true, unless you believe that $1 isn’t worth $1. This theorem has not been challenged since.

Moreover, historical evidence supports this theory—stocks with the same exposure to common factors (such as size, value, momentum, and profitability/quality) have the same returns whether or not they pay a dividend. Yet, many investors ignore this information and express a preference for dividend-paying stocks.

Dividend Aristocrats

One popular dividend strategy is to invest in the “dividend aristocrats.” For example, the S&P 500 Dividend Aristocrats measures the performance of S&P 500 companies that have increased dividends for the last 25 consecutive years. And there is an exchange-traded fund based on that index, the ProShares S&P 500 Dividend Aristocrats NOBL . In a January 2019 blog post titled “ Dividend Growth Strategies and Downside Protection ,” S&P’s Phillip Brzenk, global head of multi-asset indexes, examined the performance of dividend growth strategies, specifically during periods of negative market performance. He found: “Since year-end 1989, there have been six calendar years of negative performance for the S&P 500—and in all six years, the S&P 500 Dividend Aristocrats outperformed the equity benchmark by an average of 13.28%. In fact, the S&P 500 Dividend Aristocrats produced a positive total return in three of those years.”

Examining the performance on a monthly basis, he found: “The S&P 500 Dividend Aristocrats outperformed the S&P 500 53% of the time, by an average of 0.16%. When isolated to down markets, the S&P 500 Dividend Aristocrats outperformed over 70% of the time and by an average of 1.13%. In up markets, the S&P 500 Dividend Aristocrats underperformed 56% of the time, but at a lower average magnitude (-0.34%). This shows that the S&P 500 Dividend Aristocrats has delivered downside protection in months when the S&P 500 lost ground.” Of course, markets tend to be up more than they are down, so an advantage in down markets doesn’t necessarily translate into an advantage overall.

Brzenk also found that “the lower the return of the S&P 500, the better the relative performance was for the S&P 500 Dividend Aristocrats. We see the batting average was typically better for the more negative months than the less negative months. Additionally, we observe that the average excess return over the S&P 500 was higher in the most negative months. Since 1989, the S&P 500 has lost 5% or more in 31 out of 348 months (~9% of the time). In these months, the average excess return for the S&P 500 Dividend Aristocrats was 2.46%, with a hit rate of 81%. The median excess return was of similar magnitude (2.32%); therefore, the results were not skewed by only a few months—rather, there was consistent outperformance.”

Is It Dividends or the Quality Factor?

The evidence seems to conflict with financial theory that says dividends don’t matter, which raises the question of whether a focus on dividend growth adds value, especially in down markets: Is there something unique about companies with growing dividends? Or can the returns of the stocks with growing dividends be explained by exposure to common factors that have been found to explain the vast majority of equity returns—market beta, size, value, momentum, and quality? In other words, do companies with the same exposure to these factors have the same performance whether or not they have growing dividends or even pay dividends at all?

To answer the question, I’ll examine the performance of the two largest dividend-growth ETFs (with a total of more than $89 billion in assets) demonstrating that investors believe the strategy adds value. I used the regression tool available at Portfolio Visualizer . The table below shows the loadings (how much exposure the funds have to each factor) as well as the funds’ annual alpha.

Performance of Two Largest Dividend-Growth ETFs

What do we learn from the above data? First, the high R-squareds (especially in the case of Vanguard Dividend Appreciation VIG ) demonstrate that the returns of the two funds are well explained by their exposure to these well-documented common factors. Second, some of the outperformance in down markets is explained by the fact that the market betas of the two funds are below 1—they have less exposure to market beta than the market does. Third, the funds also have negative exposure to the size factor—their holdings are larger than those of the market. And large stocks tend to outperform riskier small stocks in bear markets. Fourth, the two funds have large and highly statistically significant (t-stat of at least 5) exposure to the quality factor. Quality stocks are “defensive,” tending to outperform in down markets. And finally, and perhaps most importantly, the two ETFs both have economically significant negative alphas (negative 1.89% for NOBL and negative 0.94% for VIG), far greater than their expense ratios. That means the funds were subtracting value, not adding value.

The evidence is consistent with economic theory: There is nothing special about dividends, with the returns of dividend-paying stocks well explained by exposure to common factors. Dividends are neither positive nor negative, at least from a pretax perspective. For taxable investors, dividends have negative implications relative to share repurchases. In addition, a focus on dividends reduces diversification because about 60% of US stocks and about 40% of international stocks don’t pay dividends. Thus, any screen that includes dividends results in portfolios that are far less diversified than they would be if dividends were not included in the portfolio design. Less-diversified portfolios are less efficient because they have a higher potential dispersion of returns without any compensation in the form of higher expected returns (assuming the exposure to common factors is the same). And finally, a focus on dividends often leads to investing in US equities, creating a home-country bias and a less diversified portfolio.

The bottom line is that dividend-growth strategies are basically quality strategies. The good news about the quality factor is that the premium (about 4.8% a year since 1958) has been persistent and pervasive around the globe. However, there are no generally accepted, logical, risk-based explanations for the quality premium because quality stocks are, by definition, safer investments. And safer investments should have lower returns. Thus, the quality premium is a behavioral anomaly. And without a risk-based explanation, it’s possible that the premium could shrink or even disappear, especially because the premium has become well known since the publication of research such as the 2013 studies “ Global Return Premiums on Earnings Quality, Value, and Size ” and “ Buffett’s Alpha .” The popularity of the strategy could cause the trade to be “crowded,” driving valuations higher and expected returns lower.

Investor Takeaways

First, there is nothing special about dividends except that they are a tax-inefficient way to return capital to shareholders, and they are certainly not income (except from a tax perspective); they are just a return of capital. Second, investors are better served by focusing on investing in strategies that provide exposure to the factors they want to invest in. A focus on dividends, whether dividend growth or high-dividend yield, is not likely to add value.

Larry Swedroe has authored or co-authored 20 books on investing. All opinions expressed are solely his opinions and do not reflect the opinions of Buckingham Strategic Wealth or its affiliates. This information is provided for general information purposes only and should not be construed as financial, tax or legal advice. Certain information is based on third party data and may become outdated or otherwise superseded without notice. Third-party information is deemed reliable, but its accuracy and completeness are not guaranteed. Mentions of specific securities are for informational purposes only. Neither the Securities and Exchange Commission (SEC) nor any other federal or state agency have approved, determined the accuracy or adequacy of this article.

Larry Swedroe is a freelance writer. The opinions expressed here are the author’s. Morningstar values diversity of thought and publishes a broad range of viewpoints.

The author or authors do not own shares in any securities mentioned in this article. Find out about Morningstar’s editorial policies .

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Larry Swedroe is head of financial and economic research with Buckingham Strategic Wealth. He has written and cowritten 16 books about investing. His latest work, "Your Complete Guide to a Successful & Secure Retirement," was cowritten with Kevin Grogan and published in January 2019. He holds an MBA in finance and investment from New York University and a bachelor's degree in finance from Baruch College in New York.

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Analyzing Dividend Policies and Their Impact on Shareholder Returns

Explore how different dividend policies can affect dividends per share..

Dividend policy structures the dividend payout a company distributes to its shareholders. Stable, constant, and residual are three dividend policies. These policies dictate how much and how often a company pays out dividends to its shareholders. The choice of dividend policy can have a significant impact on shareholder returns and overall stock performance.

Whether it's a stock split, a reverse split, a merger, or a spinoff, a corporate action can tell the savvy investor plenty about a company's financial health and future prospects. In the case of dividends, the policy chosen by a company can determine how much shareholders receive in dividend payments. Understanding the fluctuations in dividends per share can help investors make informed decisions about their investments.

The underwriters may also purchase from us up to an additional Series A Preference Shares at the public offering price, less the underwriting discount. This additional purchase option can impact the overall dividend payout to shareholders. By analyzing the terms of such agreements, investors can gain insights into the potential fluctuations in dividends per share.

Lloyds is one of Morningstar analysts' preferred names in their review of the European banking sector's dividends. By examining the dividend policies of companies like Lloyds, investors can gain valuable insights into the potential returns they may receive from their investments. Understanding which dividend policies are more likely to cause fluctuations in dividends per share can help investors make more informed decisions.

Dividend irrelevance theory holds the belief that dividends don't have any effect on a company's stock price. While this theory may be debated among investors, it highlights the importance of understanding the impact of dividend policies on shareholder returns. By analyzing the different dividend policies available, investors can determine which ones are more likely to lead to fluctuations in dividends per share.

Dividend-paying stocks form a major component of many investors' portfolios, and with good reason. Since 1926, dividends have contributed nearly one-third of total equity returns in the stock market. This highlights the importance of dividends in generating consistent returns for investors. By choosing the right dividend policy, companies can attract more investors and potentially increase shareholder returns.

In conclusion, analyzing the impact of different dividend policies on dividends per share can help investors make more informed decisions about their investments. By understanding the implications of stable, constant, and residual dividend policies, investors can better predict potential fluctuations in dividend payments. Companies like Lloyds serve as examples of how dividend policies can impact shareholder returns and overall stock performance. By staying informed and conducting thorough research, investors can navigate the complexities of dividend policies and maximize their investment returns.

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