Dividends as Reference Points: A Behavioral Signaling Model

We propose a signaling model in which investors are loss averse to reductions in dividends relative to the reference point set by prior dividends. Managers with strong but unobservable earnings separate themselves by paying high dividends and still retaining enough earnings to be likely to at least match the same dividend next period. The model matches several important features of the data, including equilibrium dividend policies that can follow a Lintner partialadjustment model; a modal dividend change of zero; a stronger market reaction to dividend cuts than dividend increases; and a signaling mechanism that does not involve public destruction of value, a notion that managers reject in surveys. We also find empirical support for some novel predictions