Dividend Payments and Stock Price Crash Risk

Abstract

Using a large sample of U.S. firms over the period of 1991-2011, this study examines whether and how cash dividend payments affect stock price crash risk. We predict and find that dividend payments are negatively associated with stock price crash risk. In addition, we find that the effect of dividend payments on lowering crash risk is more pronounced for firms with higher information asymmetry (proxied by higher market-to-book ratios or positive R&D expenditures) and for those with larger free cash flows. Moreover, we document that dividend payments reduce bad news hoarding (overinvestment) whereas bad news hoarding (overinvestment) leads to crash risk, suggesting that dividend payments (1) enhance financial reporting quality and investment efficiency and (2) mitigate stock price crash risk through two channels: curbing bad news hoarding and curtailing overinvestment. Our main results are robust to various sensitivity checks including controls for endogeneity concerns. Our findings are important to investors, policy makers, and academics, because they (1) suggest that dividend payments are an easily observable indicator that investors can use to assess firms’ financial reporting quality and crash risk and (2) support some policymakers’ proposition that dividends mitigate earnings manipulation and fraud.