Seeking Safety in Hard Times: Dividends and Insecurity

Abstract

This paper examines the existence of pro-dividend fads and, if such fads exist, their effect on stock valuations. Building upon the notion that investors are more likely to invest in assets they perceive to be safe (e.g., dividend paying stocks) especially when they feel financially insecure, we find that investors value dividend paying stocks more highly than non-dividend paying stocks when investors’ perceptions of their financial well-being are low. Furthermore, in times when investors perceive their well-being to be low, capital markets react more favorably to dividend initiations and increases than in times when well-being is perceived to be high. Our results cannot be explained by alterations in investment opportunities, free cash flow, firm risk, signaling, taxes, or time-varying risk-aversion. Collectively, these findings point to the presence of time-varying pro-dividend fads that influence stock prices.