Dividends, Dilution, and Taxes: A Signalling Equilibrium




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    • Graduate School of Business, New York University. We gratefully acknowledge the helpful comments of Mike Brennan, David Emanuel, Mark Grinblatt, Rob Heinkel, Avner Kalay, Shmuel Kandel, Alan Kraus, Uri Lowenstein, Kevin Rock, Steve Ross, Marti Subrahmanyam, and participants in workshops at Baruch, Buffalo, Columbia, Concordia, Dallas, Georgia Tech, Houston, Northwestern, NYU, Ottawa, Stanford, UBC, Wharton, Yale, and the American, European, and Western Finance Associations. Kose John acknowledges support from a Presidential Research Fellowship at NYU and the Batterymarch Fellowship.


A signalling equilibrium with taxable dividends is identified. In this equilibrium, corporate insiders with more valuable private information optimally distribute larger dividends and receive higher prices for their stock whenever the demand for cash by both their firm and its current stockholders exceeds its internal supply of cash. In equilibrium, many firms distribute dividends and simultaneously issue new stock, while other firms pay no dividends. Because dividends reveal all private information not conveyed by corporate audits, current stockholders capture in equilibrium all economic rents net of dissipative signalling costs. Both the announcement effect and the relationship between dividends and cum-dividend market values are derived explicitly.