Dividend catering and the information content of dividend changes

This paper reexamines the information content of dividend changes by taking into account the catering incentives of dividends. Dividend premium is defined to measure the irrationality of investors who are willing to pay a premium for dividend paying firms regardless of their earnings prospects. We find that investors' preference for dividends outweighs signaling in firms' dividend payout decision. Managers signal by changing dividends only when the market appreciates the changes. Specifically, during periods in which investors' preference for dividend is stable, the signaling hypothesis is supported if market dividend premium is negative and firms decrease their dividend payout, and if market dividend premium is positive and firms increase their dividend payout. When the market dividend preference fluctuates, on the other hand, the signaling hypothesis is valid only if the dividend premium is positive and firms increase their dividend payout.