The influence of managerial reputation on dividend smoothing

Abstract

This paper develops and empirically tests a dynamic model of dividend smoothing and signaling. Intertemporal dividend smoothing results from a “signal jamming” problem whereby the manager uses dividends not only to convey information about future cash flows but also to influence perceptions of his abilities. Any excess cash left after the dividend is paid must be carried into the future at a dissipative cost, and any cash shortfall arising from promising too high a dividend must be borrowed at a cost. Since these costs are higher for low-ability managers, high-ability managers promise a lower dividend when future cash flows are high and a higher dividend when future cash flows are low. Thus, high-ability managers not only credibly signal their type and the firm's future cash flows, but also smooth dividends more than low-ability managers. Consistent with the model, I find that firms that smooth more have higher future values, larger price appreciations to unexpected dividend increases, and smaller price declines to unexpected dividend decreases. Further, I find that high-ability managers smooth dividends more than low-ability managers.

Citation

Fuller, K.P. (2001), "The influence of managerial reputation on dividend smoothing", Advances in Financial Economics (Advances in Financial Economics, Vol. 6), Emerald Group Publishing Limited, Leeds, pp. 83-115. https://doi.org/10.1016/S1569-3732(01)06004-2