Voluntary Disclosure and Dividend Policy

We study whether managers can achieve more flexibility in setting dividend payouts by communicating effectively with the investors. We propose that managers could potentially alleviate market frictions by voluntarily disclosing more information to investors. Since better communication helps reduce adverse selection costs and improves shareholder monitoring, we hypothesize the following: 1) dividend payouts should be negatively related to disclosure quality; 2) firms with better disclosure should be more likely to follow a residual dividend policy and demonstrate a higher dividend to investment sensitivity; 3) firms with better disclosure are also more likely to cut dividends in response to negative cash flow shocks or a surge in growth prospects. Using AIMR analyst disclosure ratings to proxy for voluntary disclosure quality, we test our hypotheses and find support for the first two hypotheses, but there is no evidence that disclosure quality impacts the likelihood of cutting dividends. Our work complements Fama and French (2002) by showing that voluntary disclosure affects long-term dividend payment level but does not make dividends an appealing source of funds in the short run. 1