Dividends, Return and Consumption

Abstract

Based on empirical evidence, households consume dividends from common stock at a much higher rate than the rise in its price. This pattern is consistent with consumption from durable, predictable, and permanent sources of income as compared with non-durable income. Such a separate tracking of dividends and capital gains is not consistent with the notion of return as the combination of both: price appears to convey performance as compared to return. Empirical studies show that dividend yield predicts return in the short and the long horizons, particularly when the effects of repurchase activities as well as cash flow transfers to equity holders are included. The various empirical findings show, in part, that the market price of the stock does not decline as a result of the payment of cash dividend by as much as the elegant hypothesis of Miller and Modigliani implies. Behavioral finance provides some explanations in this regard as investors appear to view dividends as given, and place it in a mental account separate from the rise in price of the stock and not as an integral part of return.