Mutual benefits of transferring stock risks to dividend policy

Abstract

Purpose – The literature on the relation between dividends and stock risks include mixed results. The related studies have reached either insignificant, or positive, or negative results. The authors offer a mathematical structure that addresses potential mutual benefits of dividends signaling under conditions of stock risks (systematic and unsystematic). The mathematical structure demonstrates explicitly a case of risk transfer. The purpose of this paper is to examine the potential benefits to firms and stockholders when financial managers adjust dividends per share (DPS) using percentage change in the explanatory power of systematic and unsystematic risks. This perspective is derived from a practical consideration that dividends are part of stock returns that can be adjusted to take stock risks into account. Design/methodology/approach – The paper utilizes the specifications of the two-stage (simultaneous) regression and partial adjustment model. The sample includes quarterly data for firms listed in the Dow Jones Industrial Average and NASDAQ for the period December 31, 1989-March 31, 2011. Findings – The authors have reached general results based on hypotheses developed from related literature. The results show that: first, benefits of risk transfer can be realized. That is, firms as well as stockholders achieve benefits when the DPS are adjusted using percentage change in the explanatory power of systematic risk only; second, dividend growth rates are affected positively by changes in systematic risks; third, the highest stock returns in the market are reached with sharp decreases in dividend growth rates; fourth, in the highest returns quartile, firm size and time do not matter but the industry type does; and fifth, the associations between dividend growth rates, systematic, unsystematic risks, and stock returns are intrinsically nonlinear. Originality/value – The study contributes to the literature in terms of first, providing practical insights on the financial strategies that help in the use of dividends to convey the right signals to stockholders, and second, empirically show the potential benefits of adjusting dividends growth rates according to systematic and unsystematic stock risks in a unified mathematical structure that adds to the current literature.