Incentive Compensation and the Stock Price Response to Dividend Increase Announcements

Robert L Lippert, Terry Nixon and Eugene A Pilotte

The Financial Review, 2000, vol. 35, issue 4, 69-93

Abstract: Linking executive compensation to stock price performance is predicted to decrease the usual positive price response to dividend increases for two reasons. One, increasing pay-performance sensitivity (PPS) exacerbates managers' optimistic bias regarding future firm performance, reducing the credibility of dividend signals. Two, increasing pay-performance sensitivity reduces the need for dividends as a means of reducing agency costs. Consistent with behavioral and agency theories of corporate finance, we find that price response does decrease as pay-performance sensitivity increases and that this effect is concentrated in firms with low market-to-book ratios. Additional findings are most consistent with the agency cost explanation. Copyright 2000 by MIT Press.

Date: 2000
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