What is Dividend Premium?

Abstract: Defined by Baker and Wurgler (2004a), dividend premium is the difference between the average market-to-book ratio of dividend payers and non-payers. We study what dividend premium is by examining two explanations, agency explanation and signaling explanation. Using U.S. industrial firms from 1962 to 2004, we find evidence consistent with the agency theory that dividend premium is higher when the need to mitigate the agency problem is greater. In particular, dividend premium is positively related to the difference in cash holdings at the beginning of the year between dividend payers and nonpayers, and is negatively related to the difference in future profitability between dividend payers and nonpayers. In other words, investors value dividend payers with a higher premium when dividend payers have more cash and fewer profitable future investment projects than nonpayers. 1