Seminar – The Information Content of Dividends: Safer Profits, Not Higher Profits

Professor Stefano Rossi, Bocconi University

A large body of empirical literature suggests that dividend changes are not followed by like changes in future earnings. Stefano’s research shows theoretically that dividends may signal safer, rather than higher future profits, for example, dividends signal the second moment of future profits rather than the first moment. He uses the Campbell (1991) decomposition to estimate changes in cash flow volatility around dividend events from data on stock returns. He finds that cash flow volatility is significantly lower after dividend increases and higher after dividend decreases. Crucially, consistent with this model, larger changes in dividends are associated with larger changes in cash flow volatility in the expected direction; and larger changes in volatility following a dividend change are associated with larger announcement returns. Stefano’s research also finds that for the same dollar of dividend paid there are larger changes in cash flow volatility for firms with smaller current earnings, consistent with the model’s prediction that the cost of the signal is foregone investment opportunities. Finally, this methodology can be applied to overcome empirical problems in testing theories of corporate financing more generally.