Overview

The subject of this chapter is an empirical investigation of the determining factors of dividend policies. ^[1] A structural model, based on determinants of earlier dividend theories, is designed and tested.

The body of literature dealing with dividend determinants can be grouped into two distinct categories: (1) those based on the implicit assumption of symmetric information and (2) those based on the explicit assumption of asymmetric information.

In the symmetric information milieu, the seminal work is that of Lintner (1956). According 3931to Lintner s model, current dividends are predicated upon past dividends and current profits. Lintner s two-variable model is supported by the empirical evidence of Fama and Babiak (1968). ^[2]

Theories based on the supposition of asymmetric information include agency, pecking order, and, most profoundly, dividend-signaling theories. Agency theory explanations of dividend policy build on the works of Easterbrook (1984) and Jensen (1986). The pecking order theory (the complete opposite of the agency theory explanation ^[3]) is espoused by Myers (1984) and Myers and Majluf (1984).

Signaling theory, first proposed by Bhattacharya (1979, 1980), asserts that good firms are able to signal their expected fortunes via the disbursement of dividends, the tax costs of which are fully recovered by ensuing stock price increases. Further, dividend payments as signals result in a separating equilibrium between the signaling firms (the good guys and bad ones that are unable to signal).

The work described in this chapter differs from preceding studies in three ways. First, this study explicitly tests the free-cash-flow...