Asymmetric Information and Dividend

Policy
Kai Li and Xinlei Zhao
We examine how informational asymmetries affect firms dividend policies. We find that firms that
are more subject to information asymmetry are less likely to pay, initiate, or increase dividends,
and disburse smaller amounts. We show that our main results are not driven by our sample and
that our results persist after accounting for the changing composition of payout over the sample
period, the increasing importance of institutional shareholdings, and catering incentives. We
conclude that there is a negative relation between asymmetric information and dividend policy.
Our results do not support the signaling theory of dividends.

In this paper, we study how informational asymmetries affect firms dividend policies by examining the relation between a firms dividend policy and the quality of its information environment.
Dividends have long puzzled financial economists. Miller and Modigliani (1961) prove that
dividend policy is irrelevant to share value in a perfect and efficient capital market. However, the
observation that share prices typically rise when firms increase dividend payments suggests that,
on the contrary, dividends do matter after all.
Various studies have proposed various explanations for firms dividend behavior (see Allen
and Michaely, 2003, for a comprehensive review of the literature). Among them, the dividend signaling theory is one of the dominant explanations. Under the signaling models of
Bhattacharya (1979), John and Williams (1985), and Miller and Rock (1985), managers know
more about the firms true worth than do its investors and use dividends to convey information to
the market. Thus, these models suggest a positive relation between information asymmetry and
dividend policy. Other studies have developed tests to examine the dividend signaling models.
However, our study may be the first to specifically examine the testable implications of the signaling models in the context of the relation between information asymmetry and firms dividend
policies.
To conduct our research, we ask the following questions: Are corporate dividend policies
affected by the degree of information asymmetry that firms face? Is the relation consistent
with the signaling view of asymmetric information? Given that information asymmetry is a
We thank Xia Chen for her help in obtaining the analyst coverage data, Bill Christie (the editor), an anonymous referee,
Nalinaksha Bhattacharyya, Laurence Booth, Jason Chen, Qiang Cheng, Ming Dong, Charles Gaa, Ron Giammarino,
Rob Heinkel, Harrison Hong, Alan Kraus, Rafael La Porta, Ranjan DMello, Hernan Ortiz-Molina, Gordon Phillips,
Antoinette Schoar, Carina Sponholtz, John Thornton, seminar participants at Kent State University, University of British
Columbia, and participants of the Northern Finance Association Meetings in Vancouver, the FMA European Conference
in Stockholm, and the FMA Annual Meetings in Salt Lake City for valuable comments. We gratefully acknowledge
the contribution of Thomson Financial for providing analyst data, available through the Institutional Brokers, Estimate
System. These data have been provided as part of a broad academic program to encourage earnings expectations research.
Li acknowledges the financial support from the Social Sciences and Humanities Research Council of Canada. Li also
wishes to thank the MIT Sloan School of Management for its hospitality and support when this paper was initially written.
All errors are our own.

Kai Li is the W.M. Young Professor of Finance at the University of British Columbia in Vancouver, BC, Canada. Xinlei
Zhao is an Associate Professor of Finance at Kent State University in Kent, OH.
Financial Management Winter 2008 pages 673 - 694

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major market imperfection and that dividend policies are among the most important corporate
decisions, these are important questions.
We use analyst earnings forecast errors and the dispersion in analyst forecasts to gauge the
degree of information asymmetry between managers and investors. We find that both analyst
earnings forecast errors and the dispersion in forecasts are negatively, and very often significantly,
associated with a firms likelihood of paying dividends, initiating or increasing dividends, and
with the level of dividends paid. Overall, our findings suggest that firms with more transparent
information environments pay out more dividends. This evidence does not support the signaling
theory of dividends.
We also examine the relation between the quality of a firms information environment and
measures of total payout that include both dividends and repurchases. We do not find a positive
association between information asymmetry and repurchase activities. Signaling theory predicts a
stronger positive relation between asymmetric information and dividends than between asymmetric information and repurchases. Our finding of a stronger negative relation between asymmetric
information and dividends confirms our evidence on the lack of support for the signaling theory.
Our results are not broadly consistent with the dividend signaling models.
The paper is organized as follows. In Section I, we discuss the signaling theory, describe
the sample and variables, and provide summary statistics. Section II presents our empirical
results on firms dividend policies. Section III provides robustness checks on our main findings.
Section IV presents our investigation of repurchase activities and total payout policies, and
Section V concludes.

I. Variable Construction and Sample Characteristics

Since dividends provide a costly way of resolving asymmetric information, we examine the
relation between information asymmetry and firms dividend policies under the signaling models.
Because the resolution of asymmetric information is valuable, firms with greater asymmetric
information should be more active dividend payers. Therefore, after controling for other dividend
determinants, if the signaling theory of dividends is valid, we would observe a positive relation
between information asymmetry and firm dividend policy. Further, because dividends imply a
firm commitment and are also historically tax disadvantaged relative to repurchases, dividends
constitute a more costly signal and investors should perceive them as having stronger information
content. Thus, the signaling theory predicts a stronger positive relation between asymmetric
information and dividends than between asymmetric information and repurchases. 1
Following earlier studies, we use Compustat and CRSP to examine dividend policy in industrial
firms. We exclude utilities (SIC 4900-4949) and financial firms (SIC 6000-6999). We note that
doing so does not change our main conclusions (results available on request). To construct
measures of asymmetric information, we merge our initial sample with Institutional Brokers
Estimate System (IBES). Due to the availability of Detailed History Files from IBES, our sample
period is from 1983 to 2003. Our final sample is an unbalanced panel comprising 22,413 firm-year
observations.
A. Measures of Dividend Policies
To explore the role of asymmetric information in dividend policy, we focus on quarterly regular
dividends to common shareholders, the dividends with the greatest possible information content.
1

We thank an anonymous referee for pointing this out to us.

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The dividend items in Compustat (e.g., data items 21 and 26) include nonregular dividend
payments, such as special dividends and liquidation dividends, and thus they may not carry the
same information content as predicted in the models of Bhattacharya (1979), Miller and Rock
(1985), and John and Williams (1985). We note that using the dividend variables in Compustat
to define our dependent variables has no material effect on our main conclusions. We follow
Grullon, Michaely, Benartzi, and Thaler (2005) and Amihud and Li (2006) by using the CRSP
database to identify dividend and nondividend payers.
We collect all regular quarterly dividends on ordinary common stocks in the CRSP daily file
(CRSP distribution code first digit = 1 (ordinary dividend); second digit = 2 (cash, US dollars);
third digit = 3 (quarterly dividend); fourth digit = 2 (normal taxable at same rate as dividend)).
After adjusting for changes in number of shares outstanding, we aggregate the quarterly dividends
into an annual dividend amount. We set our first dividend variable, the payer dummy, equal to
one for firm i in year t if the annual amount of dividends paid is positive, and zero otherwise.
Our second dividend variable captures the initiation decisions of nondividend payers. For firm i
in year t, we set the initiation dummy equal to one if this is the first time firm i pays dividends, and
zero for all the years prior to year t. The dividend initiation sample includes only the firm-years
until the non-dividend-paying firm makes its first dividend payment, or when the sample period
ends, whichever comes earlier. Over the sample period, if a firm omits and then resumes dividend
payments, our initiation dummy variable captures only the very first time that the firm initiated
dividend payment.
The decision that dividend payers have to make on a regular basis is whether or not to increase
dividends. Lintner (1956) shows that dividends are sticky and firms usually are reluctant to cut
or omit dividends. Thus, our next measure of dividend policy examines dividend increases by
dividend payers. We set the increase of dummy equal to one for firm i in year t if the percentage
increase in dividends is greater than 15%, and zero otherwise. To exclude any minor changes in
the sample, we use a cutoff point of 15% when we define dividend increases. Our rationale is
that if the signaling models hold, then we are more likely to find a negative relation between the
quality of a firms information environment and a large increase in dividends. Our main results
are not sensitive to the level of cutoff used in defining the dividend increase dummy.
We obtain our fourth dividend variable, dividend payout, by scaling the annual dividend amount
by total assets. To ensure that our results are not driven by price variation or affected by the fact
that a significant proportion of firms with negative earnings are paying dividends, we normalize
the amount of dividends by book assets, instead of market capitalization or earnings following
Allen and Michaely (2003).
Table I provides summary statistics of our dividend policy variables. Column (1) shows that the
proportion of dividend payers declines steadily over the sample period, starting at 80.0% in 1983
and reaching 30.7% in 2002, with a slight rebound in 2003. We note that the proportion of dividend
payers is higher in our sample than in the one used by Fama and French (2001), suggesting that our
sample firms are on average larger and more mature than the general population of firms covered
in Compustat/CRSP. (We note that as a robustness check, we examine the effect of our sample
selection criterion on our main results.) This difference is due to our sample requirement for the
availability of analyst forecast data. Nonetheless, the same declining trend in the propensity to
pay dividends is evident throughout most of our sample period.
Column (2) in Table I reports the fraction of first-time payers in year t among surviving
nondividend payers from year t 1. In our sample, the fraction of firms that initiate dividends
starts at 7.3% in 1983. This measure drops steadily throughout most of the sample period and
then rises again beginning in 2002. Column (3) shows that there is no apparent time trend in the
fraction of dividend payers increasing dividends. Column (4) shows that the average dividend

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Table I. Time Series Characteristics of Dividend Policy

The sample period is from 1983 to 2003. We obtain accounting information from Compustat, dividend
information from CRSP, and analyst forecasts from IBES. We define dividend payers as firms that pay
quarterly dividends to common shareholders (CRSP four-digit distribution code = 1232) in year t. We
define nondividend payers as firms that do not pay dividends in year t. Dividend initiation takes the value
of one if the firm makes its first dividend payment in year t, and zero for all the years prior to t. Dividend
increase takes the value of one if the percentage increase in dividends is greater than 15%. We present
frequency counts for dividend payers, nondividend payers, and payers that increase dividends. Dividend
payout is the ratio of annual aggregation of quarterly dividends paid to common shareholders to total assets
at the end of year t measured in percentages. We present annual averages for this measure.
Year

(1)
Proportion
of Dividend
Payers

(2)
Proportion
of Nondividend
Payers Initiating
Dividends

(3)
Proportion
of Payers
Increasing
Dividends

(4)
Dividend
Payout

1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003

0.800
0.755
0.716
0.668
0.623
0.620
0.586
0.564
0.550
0.557
0.505
0.447
0.429
0.380
0.360
0.317
0.316
0.325
0.308
0.307
0.330

0.073
0.060
0.056
0.016
0.040
0.039
0.049
0.027
0.009
0.043
0.031
0.009
0.015
0.009
0.009
0.004
0.008
0.006
0.005
0.010
0.037

0.194
0.320
0.286
0.240
0.344
0.401
0.416
0.323
0.211
0.235
0.247
0.255
0.264
0.292
0.202
0.169
0.450
0.213
0.364
0.318
0.276

2.120
1.848
1.688
1.522
1.465
1.461
1.335
1.336
1.299
1.322
1.171
1.041
0.945
0.868
0.809
0.587
0.549
0.615
0.558
0.535
0.569

payout appears to decline steadily over the sample period, from 2.12% in 1983 to 0.54% in 2002,
before rising in 2003. The increasing use of dividends as cash payout toward the end of our sample
period is probably partly due to the tax reform in 2003, after which most dividends were taxed at
a lower 15% rate.
B. Measures of Firms Information Environments
We use analyst earnings forecast errors and the dispersion in analyst earnings forecasts to
capture the quality of a firms information environment. Elton, Gruber, and Gultekin (1984) show
that a large fraction of analyst forecast error is attributable to misestimation of firm-specific
factors rather than to misestimation of economy or industry factors. Their finding suggests that
analyst forecast errors are a reasonable proxy for the degree of information asymmetry about the
firm.

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The dispersion in analyst earnings forecasts represents the dispersion among analysts about
a consensus estimate of the forecast. Since disagreement among analysts is an indication of a
lack of available information, we use this standard deviation as another metric of the degree of
information asymmetry for a firm.
We define analyst earnings forecast error as the absolute value of the difference between the
mean earnings forecast and actual earnings, divided by the absolute value of actual earnings.
Dispersion of analyst earnings forecast is the standard deviation of the earnings forecast scaled
by the absolute value of the mean earnings forecast. We require our sample firms to have both of
these measures available.
We have one reservation regarding our use of analyst forecast errors and forecast dispersion
as measures of asymmetric information, which is that forecast errors and dispersion might not
so much capture asymmetries in information as levels of uncertainty that are common to both
managers and outside investors. For example, our measures might pick up a more risky environment for the firm, implying a greater deviation than what we expected (and a larger variance of
such deviations). We argue that this concern does not pose any serious problems for our analysis.
First, this is because other studies show that our measures for information asymmetry do capture
dimensions beyond firm risk. Ajinkya, Atiase, and Gift (1991) and Lang and Lundholm (1993,
1996) show that as firms enhance information disclosure, analyst earnings forecast accuracy
increases while forecast dispersion decreases. Bowen, Davis, and Matsumoto (2002) show that
conference calls improve analyst forecast precision and reduce forecast dispersion, and Chen and
Matsumoto (2006) find that better access to management is associated with more accurate analyst
forecasts. Second, the concern about risky environments does not pose serious problems for our
analysis because the positive correlation between firm risk and our two measures for asymmetric
information is quite low (to be shown later). And to further lessen this concern, we control for
firm risk in all of our regression specifications. Thus, our results are not contaminated by the
commonality between information asymmetry and uncertainty, which is captured by firm risk.
Panel A of Table II reports summary statistics for our two measures of asymmetric information.
The mean (median) analyst earnings forecast error is 21.7% (3.8%) of actual earnings, but the
mean (median) analyst forecast dispersion is 14% (3.2%) of the mean earnings forecast. The large
difference between mean and median values suggests that the distributions of these two measures
are highly skewed.
Panel B presents summary statistics grouped by firm dividend policies. We find that both
measures of asymmetric information are significantly lower for dividend payers than are those
observed for nondividend payers. In addition, nondividend payers who initiate dividends and
dividend payers with above-median payouts have lower forecast errors and forecast dispersion
than do nondividend payers who do not initiate dividends and dividend payers with below-median
payout, respectively. The univariate results suggest a negative association between the degree of
information asymmetry and dividend policies.

C. Other Firm Characteristics

We also control for other firm characteristics that may affect a firms dividend policy: size,
growth potential (the market-to-book ratio (M/B ratio), and asset growth), profitability, and
firm risk. Fama and French (2001) show that firms paying dividends are usually larger, with
lower growth potential and higher cash flows. We add firm risk because Grullon, Michaely, and
Swaminathan (2002), Hoberg and Prabhala (2008), and Bulan, Subramanian, and Tanlu (2007)
suggest that firms pay dividends as a signal of firm maturity and declining risk.

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We follow Fama and French (2001) in the construction of our first four variables that describe
firm characteristics. We define profitability as earnings before extraordinary items (data 18) +
interest expense (data 15) + income statement deferred taxes (data 50, if available)/total assets
(data 6). We use both the M/B ratio and asset growth as growth opportunity measures. We define
the M/B ratio as the ratio of the market value of total assets to the book value of total assets. We
define the market value of total assets as the market value of equity plus the book value of total
assets minus the book value of equity, and the book value of equity is defined as stockholders
equity (data 216) or common equity (data 60) + preferred stock par value (data 130) or total
assets (data 6) total liabilities (data 181), plus balance sheet deferred taxes and investment tax
credit (data 35, if available) and postretirement benefit liabilities (data 330, if available), minus
the book value of preferred stocks (estimated in the order of the redemption (data 56), liquidation
(data 10), or par value (data 130), depending on availability). We define firm size as the annual
percentile of market capitalization and use NYSE firms to calculate cutoff points. We do so to
neutralize any effects of the growth in typical firm size through time, with the largest (smallest)
firm taking the value of one (0.01). For firm risk, we follow Hoberg and Prabhala (2008) by using
the standard deviation of residuals from a regression of firm daily stock returns on returns of
the market portfolio. Our main results remain the same if we use the standard deviation of daily
returns or the standard derivation of residuals from a regression of daily excess returns on the
three Fama and French (1992) factors.
Panel A of Table II presents the summary statistics for firm characteristics. We show that the
mean (median) profitability of our sample firms is about 7.1% (9.6%), and the mean (median)
M/B ratio is 1.99 (1.49). The mean (median) growth rate of assets is 23.6% (10.1%), suggesting
a highly skewed distribution for asset growth among sample firms. The mean (median) firm risk
is 2.79% (1.37%). Summary statistics of firm size suggest that on average, our sample firms are
slightly smaller than the median NYSE firm but larger than the average publicly traded firm. In
terms of the risk measure, our sample firms are less risky than an average public firm as examined
in Hoberg and Prabhala (2008). The standard deviations indicate that there are large variations
across firms.
In Panel C, Table II, we report the pairwise correlations between firm characteristics and the
asymmetric information measures. The two asymmetric information measures have a correlation
of 0.37, suggesting that when analysts cannot agree on a firms earnings forecast, they are less
likely to provide accurate forecasts. Neither of the asymmetric information measures is highly
correlated with the firm characteristics that we find are important determinants of dividend policy.
In particular, the correlations between firm risk and the two measures of information asymmetry
are below 0.09. This result confirms that there is some overlap between firm risk and our measures
of information asymmetry. However, it also indicates that the extent of overlap is limited, which
suggests that our two measures do pick up aspects of a firms information environment that are
not captured by firm risk. Thus, our two measures are more likely to be exogenous proxies for
asymmetric information, implying that our model specification should be a relatively clean test
of the relation between information asymmetry and dividend policy.

II. Main Results

Given that most of our analyses involve panel data, our estimates are based on robust standard
errors. We estimate these errors by assuming independence across firms, but we account for
possible autocorrelation within the same firm. The robust standard errors are frequently much
larger than conventional estimates, which assume independence among firm-year observations,

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Table II. Summary Statistics

The sample period is from 1983 to 2003. We obtain accounting information from Compustat, dividend
information from CRSP, and analyst forecasts from IBES. We define profitability as earnings before
extraordinary items (data 18) + interest expense (data 15) + income statement deferred taxes (data 50,
if available)/total assets (data 6). The market-to-book (M/B) ratio is the ratio of the market value of total
assets to the book value of total assets. Asset growth is the rate of growth of total assets. Firm size is the
NYSE market capitalization percentile. Firm risk is the standard deviation of residuals from the market
model measured in percentages. We define forecast error as the absolute value of the difference between
mean analyst earnings forecasts and actual earnings, divided by the absolute value of actual earnings. We
define forecast dispersion as the standard deviation of analyst earnings forecast scaled by the absolute value
of the mean earnings forecast. Panel A presents summary statistics of firm characteristics and measures
of firms information environment. Panel B presents summary statistics of measures of firms information
environment for firms with different dividend characteristics. Panel C presents a correlation matrix of firm
characteristics and measures of firms information environment. p-values appear in parentheses.
Panel A. Firm Characteristics and Information Environment

Profitability
M/B ratio
Asset growth
Firm size
Firm risk
Forecast error
Forecast dispersion

Mean

Median

Standard
Deviation

25th
Percentile

75th
Percentile

0.071
1.992
0.236
0.473
2.786
0.217
0.140

0.096
1.494
0.101
0.450
1.371
0.038
0.032

0.203
1.742
1.103
0.289
1.771
0.622
0.357

0.046
1.137
0.012
0.220
2.480
0.013
0.013

0.146
2.199
0.252
0.720
3.479
0.125
0.095

Panel B. Measures of Firms Information Environment Grouped by Dividend Policy

Mean Standard
25th
Median
75th
Deviation Percentile
Percentile
Forecast error
Dividend payers
Nondividend payers
Difference
p-value
Nondividend payers initiating dividends
Other nondividend payers
Difference
p-value
Dividend payers with above-median payouts
Dividend payers with below-median payouts
Difference
p-value
Forecast dispersion
Dividend payers
Nondividend payers
Difference
p-value
Nondividend payers initiating dividends
Other nondividend payers
Difference
p-value

0.162
0.267
0.104
<0.001
0.093
0.264
0.171
0.001
0.105
0.252
0.146
<0.001
0.108
0.168
0.061
<0.001
0.061
0.163
0.102
0.001

0.517
0.700

0.010
0.016

0.030
0.049

0.090
0.167

0.212
0.733

0.010
0.016

0.029
0.048

0.083
0.160

0.383
0.676

0.008
0.015

0.022
0.046

0.060
0.155

0.295
0.402

0.012
0.013

0.028
0.037

0.073
0.124

0.128
0.415

0.009
0.013

0.021
0.035

0.051
0.115

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Table II. Summary Statistics (Continued)

Panel B. Measures of Firms Information Environment Grouped by Dividend Policy (Continued)
Mean Standard
25th
Median
75th
Deviation Percentile
Percentile
Dividend payers with above-median payouts
0.072
Dividend payers with below-median payouts 0.161
Difference
0.089
p-value
<0.001

0.209
0.389

0.010
0.014

0.023
0.037

0.051
0.117

Panel C. The Correlation Matrix

Profitability
M/B ratio
Asset growth
Firm size
Firm risk
Forecast error
Forecast dispersion

0.020
[0.003]
0.017
[0.011]
0.205
[<0.001]
0.342
[<0.001]
0.121
[<0.001]
0.146
[<0.001]

M/B
Ratio

Asset
Growth

Firm
Size

Firm
Risk

Forecast
Error

0.099
[<0.001]
0.159
[<0.001]
0.174
[<0.001]
0.078
[<0.001]
0.065
[<0.001]

0.014
0.038
0.110
[<0.001]
0.005
[0.499]
0.014
[0.033]

0.473
[<0.001]
0.166
[<0.001]
0.141
[<0.001]

0.087
[<0.001]
0.090
[<0.001]

0.372
[<0.001]

so our significance tests are not inflated by the large number of firm-year observations in our
sample.
To address any potential concerns that the fraction of firms paying dividends exhibits a strong
time trend and might be influenced by industry-specific factors, we include year and industry
dummies in our estimation. For each measure of dividend policy, we present results that use three
specifications involving different combinations of our measures for asymmetric information:
analyst earnings forecast errors only, the dispersion in analyst forecasts only, and both measures
together. We include the same set of firm characteristics in all specifications. Our main model
specification is as follows:
Dividend Policyit = 0 + f ind + f t + 1 Profitabilityit + 2 M/B Ratioit
+ 3 Asset Growthit + 4 Firm Sizeit + 5 Firm Risk
+ 6 Information Asymmetryit + eit ,

(1)

where the dependent variable can be any of our dividend policy measures: payer dummy, initiation
dummy, increase dummy, and dividend payout. For the first three measures, we use the logistic
regression; for the last measure, we run panel data OLS tests. We note that running the payout
regression under the tobit model in a panel data setting gives qualitatively similar results.
In Table III, Panel A, we present the logistic regression results from our examination of the
likelihood of making dividend payments. This panel shows that our results on firm characteristics
support the findings in Fama and French (2001): larger firms with higher profitability and lower

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growth potential are more likely to pay dividends. Moreover, we show that risky firms are less
likely to pay dividends. This finding confirms the result in Grullon et al. (2002) and Hoberg and
Prabhala (2008).
More importantly, after controlling for the usual determinants of a firms propensity to pay
dividends, our results show negative coefficients on both measures of information asymmetry,
which suggests that firms in a poorer information environment are less likely to pay dividends.
This evidence does not support the signaling models of dividends.
In Panel B, we report the results from the logistic regressions that we use to examine the
nondividend payers decisions to initiate dividends. Similar to our results on the decision to pay,
we find that larger, more profitable firms are more likely to initiate dividend payments. The
propensity to initiate dividends is negatively associated with the M/B ratio. After we control for
the M/B ratio, we find that the asset growth rate is positively associated with the propensity to
initiate dividends. Also, risky firms are less likely to initiate dividends, a result that is consistent
with the maturity and risk argument. Both measures of asymmetric information are negatively
associated with the likelihood of dividend initiation.
Panel C presents regression results from our examination of the decision to increase dividends
among payers. We find that more profitable firms are more likely to increase dividends. The
positive effect of M/B ratios on the likelihood of increasing dividends appears to contradict
the growth opportunity argument. However, this result can be explained by the dual role played by
the M/B ratio. Fama and French (2002) suggest that the M/B ratio is a measure of both profitability
and growth potential. It is likely that the M/B ratio is more a measure of profitability than a measure
of growth opportunities among dividend-paying firms. Both measures of asymmetric information
are negatively associated with the likelihood of increasing dividends.
In Panel D, we examine the determinants of the level of dividend payout. We show that larger,
more profitable firms with lower risk pay more cash dividends. Consistent with the findings from
the other panels, both asymmetric information measures are negatively related to the amount of
dividends paid.
Our findings lead us to conclude that there is a negative relation between asymmetric information and measures of dividend policy. Our results do not support the signaling theory of dividends.
We note that using insider returns as a proxy for information asymmetry, Khang and King (2006)
show that the amount of dividends is negatively related to returns to insider trades across firms.
They thus conclude that their results do not support the signaling theory of dividends either.

III. Additional Investigation

Here, we address other possibilities that may lead to our results. First, we ask if our sample
construction, which requires firms to have data available on analyst earnings forecasts, could
systematically bias our findings. Second, we ask if a significant part of our results could be
explained by the increasing use of share repurchases as a form of payout. Third, we ask how
sensitive are our results to other factors that have been suggested in the literature to explain
dividend policy, such as institutional monitoring and catering.
A. Sample Selection
As mentioned before, our sample firms are different from the general population covered in
Compustat/CRSP as examined in Fama and French (2001). So the important question is, does
this sample difference drive the results? 2
2

We thank an anonymous referee for suggesting this analysis to us.

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Table III. Explaining Dividend Policy

The sample period is from 1983 to 2003. We obtain accounting information from Compustat, dividend
information from CRSP, and analyst forecasts from IBES. We define profitability as earnings before
extraordinary items (data 18) + interest expense (data 15) + income statement deferred taxes (data 50, if
available)/total assets (data 6). The market-to-book (M/B) ratio is the ratio of the market value of total assets
to the book value of total assets. Asset growth is the rate of growth of total assets. Firm size is the NYSE
market capitalization percentile. Firm risk is the standard deviation of residuals from the market model
measured in percentages. We define forecast error as the absolute value of the difference between mean
analyst earnings forecasts and actual earnings, divided by the absolute value of actual earnings. We define
forecast dispersion as the standard deviation of analyst earnings forecast scaled by the absolute value of the
mean earnings forecast. The dependent variable in Panel A is the payer dummy set equal to one for firm i
in year t if the annual amount of dividends paid is positive, and zero otherwise. The dependent variable in
Panel B is the initiation dummy set equal to one if this is the first time firm i pays dividends, and zero for all
the years prior to year t. The dependent variable in Panel C is the increase dummy set equal to one for firm
i in year t if the percentage increase in dividends is greater than 15%, and zero otherwise. The dependent
variable in Panel D is dividend payout, which we define as the ratio of annual aggregation of quarterly
common dividends obtained from CRSP to total assets measured in percentages. The estimation includes
industry and year dummies. We base the reported p-values on White (1980) heteroskedasticity-consistent
standard errors, adjusted to account for possible correlation within a (firm) cluster.
Panel A. The Decision to Pay Dividends

Profitability
M/B ratio
Asset growth
Firm size
Firm risk
Forecast error

(1)

(2)

(3)

2.446
[<0.001]
0.397
[<0.001]
0.524
[0.018]
1.814
[<0.001]
1.617
[<0.001]
0.061
[0.088]

2.413
[<0.001]
0.396
[<0.001]
0.528
[0.018]
1.819
[<0.001]
1.615
[<0.001]

4.985
[<0.001]

0.119
[0.075]
4.997
[<0.001]

2.370
[<0.001]
0.396
[<0.001]
0.529
[0.018]
1.813
[<0.001]
1.614
[<0.001]
0.045
[0.200]
0.095
[0.151]
5.015
[<0.001]

22,413
0.455

22,413
0.455

22,413
0.455

Forecast dispersion
Intercept
Number of observations
Pseudo R2

Panel B. The Decision to Initiate Dividends

Profitability
M/B ratio
Asset growth
Firm size

(1)

(2)

(3)

7.123
[<0.001]
0.311
[<0.001]
0.053
[0.020]
0.793
[0.021]

7.058
[<0.001]
0.306
[<0.001]
0.052
[0.021]
0.833
[0.015]

6.912
[<0.001]
0.308
[<0.001]
0.052
[0.029]
0.802
[0.019]

Li & Zhao

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683

Table III. Explaining Dividend Policy (Continued)

Panel B. The Decision to Initiate Dividends (Continued)

Firm risk
Forecast error

(1)

(2)

(3)

0.592
[<0.001]
0.559
[0.025]

0.586
[<0.001]

0.581
[<0.001]
0.388
[0.060]
0.744
[0.182]
1.796
[0.007]
10,642
0.173

Forecast dispersion
Intercept
Number of observations
Pseudo R2

1.882
[0.004]
10,642
0.172

1.086
[0.082]
1.871
[0.005]
10,642
0.171

Panel C. The Decision to Increase Dividends

Profitability
M/B ratio
Asset growth
Firm size
Firm risk
Forecast error

(1)

(2)

(3)

5.812
[<0.001]
0.138
[0.003]
0.346
[0.276]
0.207
[0.155]
0.419
[<0.001]
0.129
[0.054]

5.682
[<0.001]
0.141
[0.002]
0.343
[0.278]
0.219
[0.134]
0.427
[<0.001]

3.792
[<0.001]

0.344
[0.016]
3.756
[<0.001]

5.582
[<0.001]
0.143
[0.002]
0.340
[0.281]
0.209
[0.152]
0.428
[<0.001]
0.080
[0.213]
0.294
[0.040]
3.727
[<0.001]

10,631
0.081

10,631
0.081

10,631
0.081

Forecast dispersion
Intercept
Number of observations
Pseudo R2

Panel D. The Decision on the Amount of Dividends

Profitability
M/B ratio
Asset growth
Firm size
Firm risk

(1)

(2)

(3)

0.584
[0.004]
0.070
[0.014]
0.042
[0.243]
1.095
[<0.001]
0.365
[<0.001]

0.559
[0.006]
0.069
[0.015]
0.043
[0.238]
1.093
[<0.001]
0.363
[<0.001]

0.555
[0.007]
0.069
[0.016]
0.043
[0.238]
1.089
[<0.001]
0.362
[<0.001]

684

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Table III. Explaining Dividend Policy (Continued)

Panel D. The Decision on the Amount of Dividends (Continued)
(1)
0.052
[0.001]

Forecast error
Forecast dispersion
Intercept

1.790
[<0.001]
22,413
0.280

Number of observations
Adjusted R2

(2)

(3)

0.173
[<0.001]
1.824
[<0.001]
22,413
0.281

0.021
[0.146]
0.161
[<0.001]
1.830
[<0.001]
22,413
0.281

We add to the baseline model in Table III, a dummy variable, no analyst coverage, which
we set equal to one for firms without analyst coverage, and zero otherwise. By doing so, we
can run regressions on the entire Compustat/CRSP population, including firms with no analyst
following. Since Alford and Berger (1999) and Hong, Lim, and Stein (2000) show that greater
analyst coverage may be associated with several firm characteristics, such as lower firm risk and
less information asymmetry, we opt not to use analyst coverage as the measure for asymmetric
information in our main analysis.
We report the results in Table IV. We find that the no analyst coverage dummy is significantly
and negatively associated with a firms decision to pay dividends and a nondividend payers
decision to initiate dividends. However, the regression results still fail to show a positive relation
between dividend policies and the two information asymmetry measures. In fact, there is a significant negative association between our information asymmetry measures and firms decisions
to initiate dividends, to increase dividends, and how much to pay. Thus, we conclude that the
negative relation between asymmetric information and dividend policy is unlikely to be driven
by the different composition between our sample of firms and the Compustat/CRSP population.
Our evidence does not support the signaling theory of dividends.
B. Share Repurchases
So far, we have not considered other forms of cash payout that firms might use. However,
we could argue that a firms dividend policy may be affected by its repurchase activities. To
investigate this conjecture further, we use two alternative specifications. First, we examine the
relation between measures of asymmetric information and dividends based on the following
model, where we control for the amount of repurchases:
Dividend Policyit = 0 + f ind + f t + 1 Profitabilityit + 2 M/B Ratioit
+ 3 Asset Growthit + 4 Firm Sizeit + 5 Information Asymmetryit
+ 6 Repurchase Amountit + eit .

(2)

We compute the amount of share repurchases using the measure suggested by Fama and French
(2005). The repurchase amount is the product of the change in the split-adjusted number of shares
and the average of split-adjusted share prices at the beginning and the end of the year, normalized
by total assets:

Li & Zhao

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685

Table IV. Sample Selection

The sample period is from 1983 to 2003. To assess the impact of sample selection criterion on our main
results, we expand the sample to include all firms from the Compustat/CRSP merged file. For firms without
information on analyst forecasts, we assign zero to their forecast errors and forecast dispersion. We also add
to the regression model the no analyst coverage dummy, which we set equal to one for firms without any
analyst coverage, and zero otherwise in year t. We define profitability as earnings before extraordinary items
(data 18) + interest expense (data 15) + income statement deferred taxes (data 50, if available)/total assets
(data 6). The market-to-book (M/B) ratio is the ratio of the market value of total assets to the book value of
total assets. Asset growth is the rate of growth of total assets. Firm size is the NYSE market capitalization
percentile. Firm risk is the standard deviation of residuals from the market model measured in percentages.
We define forecast error as the absolute value of the difference between mean analyst earnings forecasts
and actual earnings, divided by the absolute value of actual earnings. We define forecast dispersion as the
standard deviation of analyst earnings forecast scaled by the absolute value of the mean earnings forecast.
The dependent variable in Column (1) is the payer dummy, set equal to one for firm i in year t if the annual
amount of dividends paid is positive, and zero otherwise. The dependent variable in Column (2) is the
initiation dummy, set equal to one if this is the first time firm i is paying dividends, and zero for all the
years prior to year t. The dependent variable in Column (3) is the increase dummy, set equal to one for firm
i in year t if the percentage increase in dividends is greater than 15%, and zero otherwise. The dependent
variable in Column (4) is dividend payout, which we define as the ratio of annual aggregation of quarterly
common dividends obtained from CRSP to total assets measured in percentages. The estimation includes
industry and year dummies. We base the reported p-values on White (1980) heteroskedasticity-consistent
standard errors adjusted to account for possible correlation within a (firm) cluster.

Profitability
M/B ratio
Asset growth
Firm size
Firm risk
Forecast error
Forecast dispersion
No analyst coverage
Intercept
Number of observations
Pseudo/adjusted R2

(1)
Decision
to Pay
Dividends

(2)
Decision
to Initiate
Dividends

(3)
Decision
to Increase
Dividends

(4)
Decision on
the Amount
of Dividends

3.170
[<0.001]
0.450
[<0.001]
0.652
[<0.001]
2.488
[<0.001]
1.024
[<0.001]
0.039
[0.126]
0.040
[0.488]
0.482
[<0.001]
1.851
[<0.001]
70,874
0.443

4.007
[<0.001]
0.227
[<0.001]
0.152
[0.210]
1.251
[<0.001]
0.365
[<0.001]
0.399
[0.024]
0.924
[0.073]
0.570
[<0.001]
3.198
[<0.001]
46,788
0.150

5.426
[<0.001]
0.123
[<0.001]
0.399
[0.026]
0.059
[0.576]
0.267
[<0.001]
0.115
[0.034]
0.244
[0.053]
0.045
[0.491]
2.788
[<0.001]
19,981
0.192

0.077
[0.007]
0.002
[0.660]
0.008
[0.270]
1.776
[<0.001]
0.079
[<0.001]
0.060
[<0.001]
0.245
[<0.001]
0.036
[0.196]
0.644
[<0.001]
70,874
0.169

Repurchase Amountit = [(Adj. Sharesit Adj. Sharesit1 )

(Adj. Priceit1 + Adj. Priceit )/2]/Total Assetsit .

(3)

After controlling for the amount repurchased, we report the results in Table V, whose four
panels correspond to the panels in Table III.

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Financial Management

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Table V. Repurchase, Institutional Ownership, and Catering

The sample period is from 1983 to 2003. We obtain accounting information from Compustat, dividend
information from CRSP, and analyst forecasts from IBES. We define profitability as earnings before
extraordinary items (data 18) + interest expense (data 15) + income statement deferred taxes (data 50,
if available)/total assets (data 6). The market-to-book (M/B) ratio is the ratio of the market value of total
assets to the book value of total assets. Asset growth is the rate of growth of total assets. Firm size is the
NYSE market capitalization percentile. Firm risk is the standard deviation of residuals from the market
model measured in percentages. We define forecast error as the absolute value of the difference between
mean analyst earnings forecasts and actual earnings, divided by the absolute value of actual earnings. We
define forecast dispersion as the standard deviation of analyst earnings forecast scaled by the absolute
value of the mean earnings forecast. The repurchase amount is the product of the split-adjusted change
in shares outstanding and the average of the split-adjusted stock price at the beginning and the end of the
year, normalized by total assets and measured in percentages. Institutional ownership is the fractional share
ownership by institutions. Dividend premium is the difference between log(M/B ratio) for dividend payers
and the same measure for nondividend payers. The dependent variable in Panel A is the payer dummy, set
equal to one for firm i in year t if the annual amount of dividends paid is positive, and zero otherwise.
The dependent variable in Panel B is the initiation dummy, set equal to one if this is the first time firm i is
paying dividends, and zero for all the years prior to year t. The dependent variable in Panel C is the increase
dummy, set equal to one for firm i in year t if the percentage increase in dividends is greater than 15%,
and zero otherwise. We define the dependent variable in Panel D, dividend payout, as the ratio of annual
aggregation of quarterly common dividends obtained from CRSP to total assets measured in percentages.
The estimation has industry and year dummies included. We base the reported p-values on White (1980)
heteroskedasticity-consistent standard errors adjusted to account for possible correlation within a (firm)
cluster.
Panel A. The Decision to Pay Dividends

Profitability
M/B ratio
Asset growth
Firm size
Firm risk
Forecast error
Forecast dispersion
Repurchase amount

(1)

(2)

(3)

2.190
[<0.001]
0.377
[<0.001]
0.421
[0.066]
1.843
[<0.001]
1.597
[<0.001]
0.050
[0.151]
0.095
[0.150]
0.009
[0.009]

2.948
[<0.001]
0.449
[<0.001]
0.626
[0.005]
2.253
[<0.001]
1.444
[<0.001]
0.026
[0.450]
0.088
[0.187]

3.209
[<0.001]
0.462
[<0.001]
0.576
[0.018]
1.853
[<0.001]
1.589
[<0.001]
0.003
[0.943]
0.057
[0.406]

Institutional ownership

0.666
[0.002]

Dividend premium
Intercept
Number of observations
Pseudo R2

4.996
[<0.001]
22,413
0.4559

3.869
[<0.001]
22,413
0.4398

0.020
[<0.001]
3.820
[<0.001]
19,295
0.4414

(4)
2.873
[<0.001]
0.447
[<0.001]
0.480
[0.052]
2.130
[<0.001]
1.585
[<0.001]
0.019
[0.581]
0.090
[0.189]
0.008
[0.010]
0.847
[0.001]
0.021
[<0.001]
4.120
[<0.001]
19,295
0.4446

Li & Zhao

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687

Table V. Repurchase, Institutional Ownership, and Catering (Continued)

Panel B. The Decision to Initiate Dividends

Profitability
M/B ratio
Asset growth
Firm size
Firm risk
Forecast error
Forecast dispersion
Repurchase amount

(1)

(2)

(3)

(4)

7.148
[<0.001]
0.311
[<0.001]
0.051
[0.052]
0.811
[0.017]
0.584
[<0.001]
0.387
[0.063]
0.720
[0.190]
1.353
[0.392]

7.089
[<0.001]
0.312
[<0.001]
0.049
[0.192]
1.023
[0.002]
0.583
[<0.001]
0.369
[0.075]
0.793
[0.175]

8.255
[<0.001]
0.326
[<0.001]
0.064
[0.003]
0.317
[0.388]
0.633
[<0.001]
0.297
[0.100]
0.576
[0.227]

0.002
[0.806]
1.811
[<0.001]
8,703
0.139

8.059
[<0.001]
0.323
[<0.001]
0.059
[0.022]
0.701
[0.065]
0.642
[<0.001]
0.349
[0.090]
0.676
[0.211]
2.404
[0.143]
1.093
[0.005]
0.004
[0.719]
1.410
[0.003]
8,703
0.145

Institutional ownership

0.547
[0.119]

Dividend premium
Intercept
Number of observations
Pseudo R2

1.851
[0.006]
10,642
0.173

2.020
[<0.001]
10,642
0.135

Panel C. The Decision to Increase Dividends

Profitability
M/B ratio
Asset growth
Firm size
Firm risk
Forecast error
Forecast dispersion
Repurchase amount

(1)

(2)

(3)

(3)

5.768
[<0.001]
0.129
[0.005]
0.282
[0.373]
0.202
[0.166]
0.419
[<0.001]
0.075
[0.241]
0.290
[0.045]
0.008
[0.004]

5.455
[<0.001]
0.127
[0.001]
0.343
[0.262]
0.255
[0.088]
0.431
[<0.001]
0.056
[0.371]
0.343
[0.019]

5.927
[<0.001]
0.135
[0.001]
0.332
[0.315]
0.121
0.417]
0.386
[<0.001]
0.038
[0.545]
0.335
[0.031]

5.830
[<0.001]
0.129
[0.002]
0.286
[0.384]
0.186
[0.250]
0.377
[<0.001]
0.042
[0.503]
0.355
[0.026]
0.006
[0.015]
0.342
[0.106]
0.002
[0.514]
2.777
[<0.001]
9,648
0.069

Institutional ownership

0.208
[0.278]

Dividend premium
Intercept
Number of observations
Pseudo R2

3.741
[<0.001]
10,631
0.082

2.811
[<0.001]
10,631
0.064

0.002
[0.494]
2.949
[<0.001]
9,648
0.067

688

Financial Management

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Table V. Repurchase, Institutional Ownership, and Catering (Continued)

Panel D. The Decision on the Amount of Dividends

Profitability
M/B ratio
Asset growth
Firm size
Firm risk
Forecast error
Forecast dispersion
Repurchase amount

(1)

(2)

(3)

(4)

0.460
[0.018]
0.085
[0.007]
0.034
[0.315]
1.087
[<0.001]
0.358
[<0.001]
0.024
[0.103]
0.164
[<0.001]
0.002
[0.037]

0.691
[0.001]
0.052
[0.061]
0.048
[0.210]
1.396
[<0.001]
0.383
[<0.001]
0.017
[0.231]
0.153
[<0.001]

1.283
[<0.001]
0.063
[0.037]
0.032
[0.365]
0.992
[<0.001]
0.448
[<0.001]
0.012
[0.470]
0.076
[0.018]

1.131
[<0.001]
0.077
[0.021]
0.024
[0.471]
1.304
[<0.001]
0.456
[<0.001]
0.006
[0.708]
0.112
[<0.001]
0.002
[0.052]
1.101
[<0.001]
0.003
[0.072]
1.842
[<0.001]
19,295
0.288

Institutional ownership

1.071
[<0.001]

Dividend premium
Intercept
Number of observations
Adjusted R2

1.823
[<0.001]
22,413
0.283

1.671
[<0.001]
22,413
0.281

0.001
[0.410]
1.444
[<0.001]
19,295
0.275

Column (1) of Table V presents the results based on the specification in Equation (2). The
results still show a negative association between the measures of asymmetric information and
dividend policy. Moreover, we observe a significant, positive relation between firms decisions
to pay dividends and the amount of repurchases, and between the amount of dividends and the
amount of repurchases. This finding confirms previous evidence in Fama and French (2001) and
Grullon and Michaely (2002) that repurchases are primarily made by dividend-paying firms, and
that as a result, repurchasing firms are more likely to be dividend payers. It also confirms that
such firms pay more cash dividends.
Unlike previous studies, we show that there is a negative relation between the amount of
repurchases and the likelihood that dividend payers will increase dividends. That is, when firms
repurchase more, they are less likely to increase dividends (see Column (1) of Panel C). When
we replace the repurchase amount with the repurchase dummy, which we set equal to one when
the repurchase amount is positive, and zero otherwise, our main results on the relation between
information asymmetry and dividend policy are unchanged.
Second, we use a seemingly unrelated regressions (SUR) model in which we jointly estimate
the amount of dividends paid and the amount repurchased. In unreported results, we find that our
earlier results do not change: firms that are less subject to the problem of information asymmetry
pay a larger amount of dividends. Thus, after accounting for firms contemporaneous repurchase
activities, we conclude that the negative relation between measures of asymmetric information
and dividend policy is robust. This finding does not support the signaling theory of dividends.

Li & Zhao

Asymmetric Information and Dividend Policy

689

C. Institutional Shareholdings
Allen, Bernardo, and Welch (2000) present a model in which they use dividends to attract betterinformed, monitoring, institutional shareholders. Their theory predicts a positive correlation
between dividends and institutional shareholdings.
To explore whether our results are driven by institutional monitoring, we control for institutional
holdings in our regression specifications, and report the results in Table V, Column (2). We find
that measures of asymmetric information remain negatively related to firms dividend policies.
Further, contrary to the monitoring argument in Allen et al. (2000), but mostly consistent with the
empirical findings in Grinstein and Michaely (2005), we show that, after we control for firm risk,
firms with higher institutional shareholdings are less likely to pay dividends and are associated
with lower dividend payouts. It is clear that the negative relation between asymmetric information
and dividend policy is not explained by the presence of (monitoring) institutional shareholders.
Again, our results fail to lend support to the signaling theory of dividends.
D. The Catering Theory of Dividends
Using aggregate data, Baker and Wurgler (2004) develop their catering theory of dividends.
They find that investor demand for dividend-paying stocks is time-varying. Managers cater to
investor demand for dividends by paying dividends when investors place a premium on dividendpaying stocks, and vice versa.
We use the dividend premium measure provided in Baker and Wurgler (2004), which they
define as the difference in the value-weighted average M/B ratio of payers and the value-weighted
average M/B ratio of nondividend payers. We add this measure to Equation (1). Column (3) of
Table V presents the results. (We note that because the sample in Baker and Wurglers, 2004,
study ends in 2000, the sample size with the catering measure is smaller.) We find that adding the
dividend premium into our model specification has no material effect on the role of asymmetric
information in dividend policy.
Moreover, the coefficient estimate of dividend premium contradicts the argument in Baker and
Wurgler (2004). We show that this finding is mainly due to our inclusion of the year dummies
and firm risk. Once we remove these dummies and the risk variable, the coefficient on dividend
premium is significant and positive. This result is consistent with Baker and Wurglers argument
that the dividend premium primarily captures the temporal variation in market sentiment.
Column (4) of Table V presents our results when we use all additional dividend factors. It is
clear that our main results on asymmetric information do not change with this expanded model
specification. Thus, we conclude that the negative relation between information asymmetry and
dividend policy is not driven by other factors that may affect a firms dividend policy. And again,
our evidence does not support the signaling theory of dividends.

IV. Repurchase and Total Payout

Although our main focus is on the relation between information asymmetry and firms dividend policies, we also examine whether information asymmetry is an important consideration for
repurchases. Vermaelen (1984), Ofer and Thakor (1987), and McNally (1999) extend the models
in Bhattacharya (1979) and Miller and Rock (1985) to repurchases, suggesting that the signaling
motive may also determine firms repurchase decisions. However, the inherent inflexibility in
dividends implies that dividends have stronger informational content than do repurchases. Thus,
if the signaling models are valid, we expect to find a weaker (less positive or more negative)

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relation between asymmetric information and repurchases (or total payouts) than between asymmetric information and dividends. Therefore, we examine the relation between repurchases and
information asymmetry separately, and we opt not to combine repurchase and dividend policies
in our main analysis.
We use the two repurchase measures defined in Section III, the repurchase dummy and the
repurchase amount. We define the total payout policy variables in a comparable way. We set the
payout dummy equal to one for firm i in year t if the firm either pays dividends or repurchases
shares, and zero otherwise. The total payout aggregates all dividends paid and the amount
repurchased during the year, scaled by total assets.
We report the time-series characteristics of repurchase and payout measures in Table VI,
Panel A. We see that the proportion of repurchasing firms increases from 1983 to 1990, declines
afterward, and then peaks again toward the end of the technology bubble. The proportion of firms

Table VI. Summary Statistics of Repurchase and Payout Policies

The sample period is from 1983 to 2003. We obtain accounting information from Compustat, dividend/repurchase information from CRSP, and analyst forecasts from IBES. We define repurchasing firms as
those firms that make nontrivial repurchases in year t and nonrepurchasing firms as those firms that make
no repurchases in year t. The repurchase amount is the ratio of the product of the split-adjusted change in
shares outstanding and the average of the split-adjusted stock price at the beginning and the end of the year,
normalized by total assets. Payout firms are firms that either pay dividends or make repurchases or both in
year t and nonpayout firms are those that make no payout in year t. We define total payout as the ratio of
the sum of the dividend payout and repurchase amount in year t to total assets.
Panel A. Time-Series Characteristics of Repurchase and Payout Policies
Year

(1)
Proportion of
Repurchasing
Firms

(2)
Repurchase
Amount

(3)
Proportion of
Payout
Firms

(4)
Total
Payout

1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003

0.121
0.283
0.210
0.252
0.259
0.377
0.271
0.333
0.193
0.172
0.166
0.186
0.214
0.211
0.240
0.297
0.259
0.307
0.208
0.209
0.202

0.262
1.053
0.779
1.179
1.418
2.096
1.111
1.441
0.696
1.709
0.724
0.775
0.969
0.938
1.458
1.569
1.339
2.322
0.957
0.972
0.833

0.817
0.808
0.743
0.712
0.701
0.712
0.652
0.651
0.599
0.602
0.552
0.503
0.495
0.453
0.452
0.457
0.440
0.464
0.400
0.432
0.425

2.381
2.901
2.466
2.701
2.883
3.557
2.446
2.777
1.996
3.031
1.894
1.816
1.914
1.806
2.267
2.156
1.889
2.937
1.515
1.507
1.402

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691

Table VI. Summary Statistics of Repurchase and Payout Policies (Continued)

Panel B. Measures of Firms Information Environment Grouped by Repurchasing or Not,
and Paying Out or Not
Mean

Median

Standard
Deviation

25th
Percentile

75th
Percentile

Forecast error
Repurchasing firms
Nonrepurchasing Firms
Difference
p-value

0.174
0.231
0.057
<0.001

0.553
0.641

0.010
0.014

0.029
0.042

0.090
0.139

Payout firms
Nonpayout firms
Difference
p-value
Repurchasing firms
Nonrepurchasing firms
Difference
p-value
Payout firms
Nonpayout firms
Difference
p-value

0.176
0.268
0.092
<0.001
0.107
0.150
0.043
<0.001
0.114
0.171
0.058
<0.001

0.547
0.700

0.011
0.016

0.031
0.051

0.096
0.170

0.305
0.370

0.010
0.013

0.025
0.107

0.069
0.106

0.309
0.405

0.012
0.014

0.029
0.038

0.076
0.129

making cash payouts shows a steady decline over the sample period, with a slight rebound in
2002. There is no systematic pattern in the amount of repurchases or total payouts. When we
compare the repurchase amount in Column (2) of Table VI, Panel A with the dividend payout in
Column (4) of Table I, we see that the repurchase amount is lower than the amount of dividends in
the beginning of the sample period. Since the mid-1990s, the amount of repurchases significantly
exceeds that of dividends.
Panel B shows summary statistics for our two measures of asymmetric information across
repurchasing and nonrepurchasing firms, and across payout and nonpayout firms. We note that
both measures are significantly lower for repurchasing firms and those with nontrivial payouts
than for their respective counterparts.
Table VII presents the determinants of repurchases and total payouts. The model specification
is identical to Equation (1) except that the left-hand-side variables are: repurchase dummy,
repurchase amount, payout dummy, and total payout. We report only those results that include
both asymmetric information measures. Results with one measure at a time are similar.
We find that larger, more profitable firms with lower growth potential and lower risk are more
likely to repurchase shares or to pay out cash. There is a very weak negative relation between
asymmetric information and repurchases. This relation is at the 10% level of significance and only
between the dispersion in earnings forecasts and the likelihood of making a repurchase. When
we compare Columns (1) and (2) of Table VII to Column (4) of Panels A and D in Table III, we
conclude that the overall relation between asymmetric information and payout policy is weaker
for repurchases than for dividends.
Given that the signaling theory predicts a stronger relation between asymmetric information
and dividend policy, the findings in this table strengthen our evidence on the lack of support for
the signaling theory of dividends. We find that the larger negative impact on dividends happens
precisely where the signaling theory suggests the more positive one should be.

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Financial Management

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Table VII. Explaining Repurchase and Payout Policies

The sample period is from 1983 to 2003. We obtain accounting information from Compustat, dividend/repurchase information from CRSP, and analyst forecasts from IBES. We define profitability as
earnings before extraordinary items (data 18) + interest expense (data 15) + income statement deferred
taxes (data 50, if available)/total assets (data 6). The market-to-book (M/B) ratio is the ratio of the market
value of total assets to the book value of total assets. Asset growth is the rate of growth of total assets.
Firm size is the NYSE market capitalization percentile. Firm risk is the standard deviation of residuals
from the market model measured in percentages. We define forecast error as the absolute value of the
difference between mean analyst earnings forecasts and actual earnings, divided by the absolute value of
actual earnings. We define forecast dispersion as the standard deviation of analyst earnings forecast scaled
by the absolute value of the mean earnings forecast. The dependent variable in Column (1) is the repurchase
dummy, set equal to one for firm i in year t if the annual amount of repurchases is positive, and zero
otherwise. The dependent variable in Column (2), repurchase amount, is the product of the split-adjusted
change in shares outstanding and the average of the split-adjusted stock price at the beginning and the end
of the year, normalized by total assets. The dependent variable in Column (3) is the payout dummy, set equal
to one for firm i in year t if the annual amount of payout is positive, and zero otherwise. We define the
dependent variable in Column (4), total payout, as the ratio of the sum of the dividend payout and repurchase
amount to total assets. The estimation includes industry and year dummies. We base the reported p-values
on White (1980) heteroskedasticity-consistent standard errors adjusted to account for possible correlation
within a (firm) cluster.

Profitability
M/B ratio
Asset growth
Firm size
Firm risk
Forecast error
Forecast dispersion
Intercept
Number of observations
Pseudo/adjusted R2

(1)
Decision to
Repurchase

(2)
Repurchase
Amount

(3)
Decision to
Pay Out

(4)
Total
Payout

2.574
[<0.001]
0.125
[<0.001]
1.914
[<0.001]
0.202
[0.054]
0.424
[<0.001]
0.005
[0.884]
0.114
[0.085]
1.626
[<0.001]
22,413
0.118

1.780
[<0.001]
0.249
[0.023]
0.151
[0.035]
0.411
[0.138]
0.285
[<0.001]
0.054
[0.619]
0.117
[0.269]
0.121
[0.592]
22,413
0.008

2.259
[<0.001]
0.364
[<0.001]
0.960
[<0.001]
1.396
[<0.001]
1.111
[<0.001]
0.028
[0.384]
0.114
[0.066]
3.917
[<0.001]
22,413
0.363

2.335
[<0.001]
0.318
[0.006]
0.194
[0.061]
0.678
[0.028]
0.648
[<0.001]
0.033
[0.763]
0.278
[0.013]
1.951
[<0.001]
22,413
0.026

Columns (3) and (4) of Table VII show that there is a negative relation between asymmetric
information and total payouts. Again, our findings are not consistent with the signaling theory.

V. Conclusion
In this paper, we analyze the relation between firm dividend policy and the quality of its information environment. Our measures are analyst earnings forecast errors and forecast dispersion.

Li & Zhao

Asymmetric Information and Dividend Policy

693

Prior research shows that forecast errors and dispersion are positively correlated with the extent
of information asymmetry that firms face. We conjecture that if the signaling theory of dividends
is an accurate description of reality, then firms dividend policies should be positively associated
with analyst earnings forecast errors and forecast dispersion.
Using a CRSP/Compustat/IBES combined sample over 1983-2003 and controlling for firm
characteristics, we find that, ceteris paribus, firms more subject to the problem of information
asymmetry are less likely to make dividend payments, to initiate dividends, and to increase
dividends, and that these firms also distribute smaller amounts. Our conclusions are not driven
by sample selection criteria, and they hold after we control for contemporaneous repurchasing
activities, the presence of monitoring institutional investors, and catering incentives. Therefore,
our evidence casts doubt on the validity of the dividend signaling models.
We find a weak negative relation between repurchases and measures of information asymmetry.
This finding further strengthens our evidence on the lack of support for the signaling theory of
dividends. 

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