What Is Dividend Signaling?

The dividend signal theory is also called the signaling hypothesis, or the information content of dividend hypothesis. This theory starts from the assumption that investors and management authorities who relax the MM theory have the same information assumption. In a perfect market, there is an information asymmetry between the management and the company's external investors, and management has more internal information about the prospects of the company.

Dividend signal theory

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Although the research on dividend signal theory has made breakthrough progress, it is not perfect, and the empirical results are also inconsistent. In general, the following flaws still exist:

(1) The market reacts positively to the increase in dividends and negatively to the decrease in dividends. This phenomenon can be explained not only by signal theory, but also by other theories such as agency cost theory.

(2) Signal theory is difficult to effectively explain and predict the differences in dividends in different industries and countries. For example, why do companies in the U.S., U.K., and Canada pay higher dividends than Japan and Germany without showing stronger profitability?

(3) Signal theory cannot explain why companies do not use other equivalent and lower cost means to convey information.

(4) At the same time that the market has become more and more efficient and information means have been greatly improved, why is the payment of dividends a constant signal means?

(5) More importantly, in high-growth industries and enterprises, the dividend payment rate is generally very low, but according to the signal theory, the opposite interpretation and prediction will be made.