Dividend payments and excess cash: an experimental analysis

Zi Tingting Jia and Matthew McMahon

Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), 2019, vol. 83, issue C

Abstract: There is an observed positive correlation between the size of firms’ dividends and the amount of cash they keep on hand. We specify a new channel of precautionary cash holdings as related to dividend-smoothing, which predicts that increased dividends should cause firms to keep more cash on hand. In the reverse direction, theory’s predictions depend on the source of the increased cash on hand. General dividend-smoothing theory predicts that temporary increases in cash due to natural market fluctuations should not affect dividends. If the increased cash is due to a permanent increase in profitability, both the marginal benefit and the marginal cost of paying dividends also increase, and the net effect is unclear. Theory’s predictions of causality cannot be tested empirically using observed firm data, however, due to an underlying endogeneity issue. We instead turn to a laboratory experiment to determine causality. In the lab, we separately and exogenously vary each relevant variable to test each theoretical hypothesis. Increased dividends lead to increased cash on hand. One-time increases in firms’ cash on hand, representing natural market fluctuations, do not affect firms’ dividends. Increases in cash on hand due to a permanent increase in firm profitability, however, cause dividends to decrease.

Keywords: Dividends; Cash on hand; Precautionary cash holdings; Principal-Agent problem; Behavioral finance; Experiment (search for similar items in EconPapers)
JEL-codes: C91 G35 G40 (search for similar items in EconPapers)
Date: 2019
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (3)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:soceco:v:83:y:2019:i:c:s2214804319300552

DOI: 10.1016/j.socec.2019.101458

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