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A tax-based signaling cost structure is developed in an intertemporal model with risk neutrality, and comparative statics connect dividend signaling incentives to key parameters such as tax rates and the interest rate.",{"@graph":14,"@context":72},[15,34,55],{"@type":16,"itemListElement":17},"BreadcrumbList",[18,23,27,31],{"item":19,"name":20,"@type":21,"position":22},"https://docshare.wps.com","Home","ListItem",1,{"item":24,"name":25,"@type":21,"position":26},"https://docshare.wps.com/document/","Document",2,{"item":28,"name":29,"@type":21,"position":30},"https://docshare.wps.com/document/research-report/","Research & 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assumption about outside investors in this paper?","Question",{"text":62,"@type":63},"Outside investors have imperfect information about firms’ profitability, so they cannot distinguish expected cash flows across firms a priori.","Answer",{"name":65,"@type":60,"acceptedAnswer":66},"Why do cash dividends function as signals in the model?",{"text":67,"@type":63},"Dividends are taxed at a higher ordinary income rate than capital gains, creating signaling costs that make dividend payments convey information about expected cash flows.",{"name":69,"@type":60,"acceptedAnswer":70},"What comparative static result is derived regarding dividend payout?",{"text":71,"@type":63},"The equilibrium dividend proportion relative to expected earnings increases when shareholders’ planning horizons are shorter, reflecting how quickly wealth must be 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BusinessUniversity of Chicago  \nThis paper assumes that outside investors have imperfect information aboutfirms'profitability and that cash dividends are taxed at a higher rate thancapital gains.It is shown that under these conditions,such dividends functionas a signal ofexpected cash flows.By structuring the model so that finite-livedinvestors turn over continuing projects to succeeding generations of investors,we derive a comparative static result that relates the equilibrium level of dividendpayout to the length of investors'planning horizons.  \n## 1.Introduction\n\n■ This article develops a model in which cash dividends function as a signalof expected cash flows of firms in an imperfect-information setting.We assumethat the productive assets in which agents invest stay in place longer than theagents live and that ownership of the assets is transferred,over time,to otheragents.The latter are a priori imperfectly informed about the profitability ofassets held by different firms.The major signaling costs that lead dividendsto function as signals arise because dividends are taxed at the ordinary incometax rate,whereas capital gains are taxed at a lower rate.Within this framework,this paper explains why firms may pay dividends despite the tax disadvantageof doing so.  \nRecently,Leland and Pyle(1977)and Ross(1977)have used the paradigmof Spence's signaling model(1974)to examine financial market phenomenarelated to unsystematic risk borne by entrepreneurs and firm debt-equity choicedecisions,respectively.In its spirit and cost structure,our model is closelyrelated to the Ross model(1977).The essential contributions of our model arethe following.First,we develop a tax-based signaling cost structure foundedon the observation that signaling equilibria are feasible,even if signaling costelements that are negatively related to true expected cash flows are small,provided there are other signaling costs that are not related to true cash flowlevels.Second,we develop the model in an intertemporal setting that allows  \n260 /THE BELL JOURNAL OF ECONOMICS  \nus to identify the relative weights placed on the benefits (increase in value)andcosts of signaling with dividends.Our model suggests an interesting comparativestatic result concerning the shareholders'planning horizon;namely,the shorterthe horizons over which shareholders have to realize their wealth,the higher isthe equilibrium proportion of dividends to expected earnings.1 Other compara-tive static properties of the dividend-signaling equilibrium,with respect to majorvariables like the personal income tax rate and the rate of interest,are also devel-oped and are shown to be in accord with the empirical results of Brittain(1966).  \nTo keep the analysis manageable,and to highlight the essential character-istics,we employ two major analytical simplifications.First,we assume that thevaluation of cash flow streams is done in a risk-neutral world.Second,we allowthe \"urgency”of the agents'need to realize their wealth to be parameterizedby the length of the planning horizons over which they maximize expected dis-counted realized wealth,with no detailed consideration of the intertemporalpattern of asset disposal.These assumptions are further discussed below,afterthe basic model is developed.The general structure of the dividend-signalingmodel and the conditions for the existence of dividend-signaling equilibria aredeveloped in Section 2.In Section 3 we analyze an example with uniformlydistributed cash flows to facilitate discussion of comparative static propertiesand issues related to multiperiod planning horizons and dynamic learning pos-sibilities.Section 4 contains the concluding remarks and suggestions for furtherresearch.  \n## 2.Dividends as signals\n\n■ In this section we outline the nature of the dividend-signaling model and thesignaling cost structure.The model applies to a se","cbCaigVh1c75Q2vO","https://ap.wps.com/l/cbCaigVh1c75Q2vO","pdf",341474,12,"English","# 1. Introduction\n# 2. Dividends as signals","[{\"question\":\"What is the central assumption about outside investors in this paper?\",\"answer\":\"Outside investors have imperfect information about firms’ profitability, so they cannot distinguish expected cash flows across firms a priori.\"},{\"question\":\"Why do cash dividends function as signals in the model?\",\"answer\":\"Dividends are taxed at a higher ordinary income rate than capital gains, creating signaling costs that make dividend payments convey information about expected cash flows.\"},{\"question\":\"What comparative static result is derived regarding dividend payout?\",\"answer\":\"The equilibrium dividend proportion relative to expected earnings increases when shareholders’ planning horizons are shorter, reflecting how quickly wealth must be realized.\"}]","Imperfect information, dividend policy, and \"the bird in the hand\" fallacy | PDF",1792357997]