Market Sentiment and Dividend Policy: Cross Sectional Evidence

Abstract

Existing empirical findings on the validity of catering theory of dividend policy are mixed at the aggregate-market level, while there is little cross-sectional evidence based on individual firms, which is necessary for studying investor preferences for dividend policy with greater resolution. To fill this gap in the literature, we provide cross-sectional evidence of the explanatory ability of market sentiment on dividend policy decisions. Sentiment sensitivity of individual stock returns (SS), measured by the slope coefficient in the regression of stock returns on market sentiment index changes, is an important cross-sectional determinant on dividend policy. Our empirical results suggest that: firms with high SS pay lower dividends or have lower propensity to pay than do otherwise identical firms; cumulative abnormal stock returns associated with dividend initiations (omissions) are significantly related to the SS. These results remain quantitatively the same after controlling for firm characteristics and other risk factors. Our paper highlights the importance of investor behavior on dividend decisions.