According to Modigliani and Miller, dividend policy is irrelevant in perfect capital markets. Yet in practice, managers are highly reluctant to cut dividends, even when it would be financially rational to do so. Could we interpret dividend smoothing as a form of implicit signalling? And how does this managerial behavior reconcile with the theoretical irrelevance of payout policy?
Yes, lack of smoothing is usually taken as a bad signal.
Irrelevance only holds in perfect capital markets. The main explanation behind dividend smoothing is agency costs. Intuitively, shareholders do not want the management to have a lot of cash because then they can buy Ferraris, planes, etc.
Irrelevance only holds in perfect capital markets. The main explanation behind dividend smoothing is agency costs. Intuitively, shareholders do not want the management to have a lot of cash because then they can buy Ferraris, planes, etc.