| In three essays, I examine how the trading behavior of various investors impact a firm's need to employ dividend changes to signal private information to the market and how a manager's reputational concerns create a desire to smooth dividends. The first essay reviews the relevant dividend signaling literature and indicate the existing gaps in the literature that my dissertation fills. The second essay develops a dividend signaling model in which informed traders have private knowledge about the firm's intrinsic value, while uninformed and liquidity traders do not. This privileged knowledge is not reflected perfectly in the price, however. As the number of informed traders increases, more of their privileged information is reflected in the equilibrium price of the stock, pushing it closer to its intrinsic value. Thus, the greater the number of informed traders who are active in a firm's stock, the less likely it is that the firm needs to signal its intrinsic value. Moreover, the more informed traders active in a firm's stock, the smaller the price reaction to a dividend increase by the firm. Next, I empirically test the model's predictions. The third essay develops and empirically tests a dynamic model of dividend smoothing and signaling. Intertemporal dividend smoothing results from a "signal jamming" problem whereby the manager uses dividends not only to convey information about future cash flows but also to influence perceptions of his abilities. Any excess cash left after the dividend is paid must be carried into the future at a dissipative cost, and any cash shortfall arising from promising too high a dividend must be borrowed at a dissipative cost. Since these costs are higher for low-ability managers, high-ability managers promise a lower dividend when future cash flows are high and a higher dividend when future cash flows are low. Thus, high-ability managers not only credibly signal their type and the firm's future cash flows, but also smooth dividends more than low-ability managers. Empirical results support that firms that smooth more have higher future values, larger price appreciations to unexpected dividend increases, and smaller price declines to unexpected dividend decreases. |
