Signaling, Free Cash Flow And "Nonmonotonic" Dividends

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Executive Summary

Why does a firm pay dividends? Miller and Modigliani (1961) show that, under certain conditions, dividend policy is irrelevant to firm value. Since then, many arguments have been proposed to rationalize why dividends matter. Maybe firms pay dividends to attract certain clienteles, or maybe to signal information to the market, or maybe just to return excess cash fairly to all shareholders. As of yet, no single theory is dominant. This is perhaps because there are multiple motivations for paying dividends and there is no single reason that applies to all firms. Though there is little evidence of a clientele effect, the empirical contest between the signaling and excess-cash continues.

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