Special Dividends and the Evolution of Dividend Signaling

Abstract

This paper documents that (1) special dividends were once commonly paid by NYSE firms, but are now a rare phenomenon; (2) firms typically paid specials almost as predictably as they paid regulars; and (3) despite the dramatic decline in specials as a whole, the incidence of very large specials increased in recent years. Most plausibly, small specials disappeared because their predictability made them close substitutes for regular dividend signals, while large specials survived because their sheer size automatically differentiates them from regulars. Firms that stop paying specials substitute into more frequent regular increases but do not alter the pattern of total dividends (per the Lintner (1956) model). Firms that reduce specials tend to increase regulars, effectively making the two types of dividends closer substitutes (and this tendency is more pronounced in recent years). The stock market typically reacts favorably to the declaration of a special, but does not systematically differentiate between special increases and decreases to a still-positive level. The latter regularities give managers incentives to pay specials more frequently than they otherwise would which, in turn, makes specials more closely resemble regulars. Firms that continue to pay specials have lower institutional ownership, suggesting that the long-term trend to a more sophisticated stockholder clientele contributed to the demise of poorly differentiated dividend signals. Finally, special dividends were not displaced by stock repurchases, indicating that most specials failed to survive on their own accord and not because managers discovered the tax advantages of repurchases.