Does Dividend Policy Relate to Cross-Sectional Variation in Information Asymmetry? Evidence From Returns to Insider Trades

Summary

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We examine the relation between dividends and information asymmetry by using insider returns as a proxy for information asymmetry. We find that dividends are negatively related to returns to insider trades across firms. Firms that pay consistently high dividends have lower insider returns than do firms that pay consistently low dividends. These results do not support traditional dividend signaling models. Rather, they are consistent with the proposition that firms with the highest dividends have the lowest levels of information asymmetry.

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Does Dividend Policy Relate to Cross-Sectional Variation in Information Asymmetry? Evidence From Returns to Insider Trades

Why do some firms pay a higher level of dividends than others? Although past research provides us with a greater understanding of dividend policy, there is ample evidence we still have a long way to go (Brav, Graham, Harvey, and Michaely, 2005).

The purpose of our article is to add to earlier research by examining the relation between the level of dividend payout and information asymmetry. To do so, we use returns to insider trades as a proxy for the level of information asymmetry between insiders and outside investors. Examining this question is important because it provides evidence on whether asymmetric information motivates dividend policy.

To date, the evidence on this question is mixed and related mainly to tests of dividend signaling models. Several studies examine short-term stock price reactions to dividend changes and find that stock prices initially react as predicted by dividend signaling models (Aharony and Swary, 1980; Asquith and Mullins, 1983; Healy and Palepu, 1988; and Michaely, Thaler, and Womack, 1995). However, other studies show that stock prices continue to drift for two to three years after the dividend change (Charest, 1978; Michaely, et al. 1995; and Grullon, Michaely, and Swaminathan, 2002), indicating that dividends may contain information, but are not an effective signal. Other studies examine whether dividend changes are positively related to future earnings changes. Again the evidence is mixed. Some studies find evidence supporting a relation (Watts, 1973; Gonedes, 1978; Healy and Palepu, 1988; and Brooks, Charlton, and Hendershott, 1998). Other studies find evidence to the contrary (Penman, 1983; DeAngelo, DeAngelo, and Skinner, 1996; Benartzi, Michaely, and Th...

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