Stock Liquidity and Firm Cash Dividend Policy
Date Issued
2008
Date
2008
Author(s)
Lee, Tzu-Ying
Abstract
Miller and Modigliani (1961) advanced the dividend irrelevance proposition－in perfect capital markets populated by rational investors. First, because investors with liquidity needs can create homemade dividends at no cost by selling an appropriate amount of their holdings in the firm; therefore, they are not concerned about the payout policy. As a result, investors should be indifferent between receiving a dollar of dividends and selling a dollar’s worth of their investment. Second, a firm’s value is solely a function of the firm profitability or firm’s investment opportunities and is independent of payout policy. The following years, a large body of literature examines the importance that managers and investors attach to dividend policy in light of the irrelevance proposition. The starting point of these studies is to question some of the assumptions that define the perfect capital markets, especially the assumption of “trading is frictionless”, analyzed by Miller and Modigliani. In actuality, trading friction is pervasive throughout financial markets. According to the points of view above, Banerjee, Gatchev, and Spindit (2007) advanced the “liquidity hypothesis of dividend.” It says when trading friction exists in financial markets, an immediate implication of Miller and Modigliani (1961) is that, other things equal, firms with more (less) liquid stocks will have lower (higher) incentives to distribute cash dividends to shareholders. The main purpose of this study is to providing evidence of a link between firm dividend policy and stock liquidity and examining the “liquidity hypothesis of dividend” in Taiwan capital markets. This study covers 384 TSEC firms for the period 2001 to 2007. And I choose three measures of trading activity, share turnover, traded dollar volume in the stock, and Martin index, as proxies of liquidity. The result shows that there is a strong empirical relation between the dividend policy of the firm and the liquidity of its common stock, and these results persist throughout the examined period and remain after we control for the ability of firms to pay dividends. Also, I find that dividend payments are more sensitive to liquidity for the portfolio of firms that are more likely to pay based on firm characteristics.
Subjects
Liquidity
Cash dividend policy
Panel data
Fixed effects model
Logistic regression model
Type
thesis
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