Dividend smoothing and predictability

Abstract

The relative predictability of returns and dividends is a central issue since it forms the paradigm to interpret asset price variation. A little studied question is how dividend smoothing, as a choice of corporate policy, a ects predictability. We show that, even if dividends are supposed to be predictable without smoothing, dividend smoothing can bury this predictability. Since aggregate dividends are dramatically more smoothed in the postwar period than before, the lack of dividend growth predictability in the postwar period does not necessarily mean that there is no cash ow news in stock price variations; rather, a more plausible interpretation is that dividends are smoothed. Using two alternative measures that are less subject to dividend smoothing {net payout and earnings { we reach the consistent conclusion that cash ow news plays a more important role than discount rate news in price variations in the postwar period.