Roger C. Kormendi
Published: 1999
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We develop and test a model of corporate dividend policy based on the permanent income hypothesis (PIH) of Friedman (1957). The PIH implies that dividends are non-stationary and that the response of dividends to a change in earnings is positively related to the persistence of the change in earnings. Using a sample of 337 firms over the 40 year period from 1950-1989, we find the data to be strongly consistent with both implications of the PIH. We also find that earnings and dividends are not co-integrated, indicating that factors other than the permanent component of earnings, such as tax policy, clientele effects, transaction costs, etc. may have a significant impact on the long-run behavior of dividends, and implying that a properly specified dividend model relates the changes in dividends to changes in earnings. This contrasts with the implicitly co- integrated (levels) dividend model of Lintner (1956). Thus, we propose a new non co-integrated corporate dividend policy model that unifies the Lintner model with the PIH. Additionally, our evidence on the non-stationarity of dividends has implications for the stock market rationality debate, and the association between dividend changes and earnings persistence is consistent with Miller's )1987) proposition that dividend changes signal earnings persistence.