Dividend Policy, Production, and Stock Returns

Abstract

We propose an asset pricing model in a production economy where cash flows are determined by firms' dividend and investment decisions. Managers choose extensive and intensive margins in payout policy while facing non-convex costs as firm cash holdings grow. Differences in the timing of dividend payments by younger growing firms and older mature firms help explain the value and size premiums. Quantitative analysis shows that model-implied dividend policies and investments are consistent with the data, and interactions among productivity shocks, investment, and dividend policies help explain cross-sectional stock returns. We also provide empirical support for the model's testable implications.