The pricing of dividends in equity valuation

This study uses Ohlson's (1995 and 2001) accounting-based equity valuation model to structure tests of four explanations for the anomalously positive pricing of dividends reported by Rees (1997) and Fama and French (1998). First, we find that dividends are not simply a proxy for publicly available information that helps predict future abnormal earnings. Second, although dividends act as if they signal managers' private information about future profitability, they remain positively priced for firms with low incentives to signal. Third, dividends do not signal management's willingness to abstain from incurring agency costs. Fourth, however, controlling for one-year-ahead realized forecast errors yields a pricing of dividends that is very close to that of dividend displacement. After showing that dividends are not simply a proxy for analysts' misforecasting, we conclude that dividends appear to be positively priced because they are a proxy for the mispricing by investors of current earnings or book equity.