The Dividend Disconnect

Abstract

Many individual investors, mutual funds, and institutions trade as if dividends and capital gains are disconnected attributes, not fully appreciating that dividends result in price decreases. Behavioral trading patterns (e.g., the disposition effect) are driven by price changes instead of total returns. Investors rarely reinvest dividends, and trade as if dividends are a separate, stable income stream. Analysts fail to account for the effect of dividends on price, leading to optimistic price forecasts for dividend-paying stocks. Demand for dividends is systematically higher in periods of low interest rates and poor market performance, leading to lower returns for dividendpaying stocks.The humble dividend is reclaiming its rightful place as the arbiter of stock-market value . . . To investors desperate for income, the argument for buying equities is, well, duh. Who wouldn't want a higher income? Shares might swing around, but corporate managers go out of their way to preserve the dividend.

Stock Market Returns and Consumption

“…6 In particular, dividend income changes are significantly more persistent than changes in capital gains, and, as long as households consider capital gains and dividend income as separate sources of income, this can rationalize an MPC out of dividend income that is significantly larger than MPC out of capital gains. This interpretation is consistent with the free dividend fallacy identified by Hartzmark and Solomon (2017), that investors view capital gains and dividend income as separate attributes of a stock.…”

“…The findings on the differential MPC out of capital gains and dividend income complement the evidence presented in Hartzmark and Solomon (2017). They show that, in contrast to Miller and Modigliani (1961), investors do not fully appreciate that dividends come at the expense of price decreases and behave as if they were separate disconnected attributes of a stock.…”

“…Our findings are most closely related to Baker, Nagel and Wurgler (2007) and Hartzmark and Solomon (2017). Baker et al (2007) exploit cross-sectional variation in households' consumption, capital gains and dividend income in CEX, in addition to using data from a large discount brokerage on households' net withdrawals, capital gains and dividend income.…”

“…For instance, they tend to hold high dividend-yield stocks longer, even when their prices change, and rarely reinvest the dividends into the same stocks paying them. Hartzmark and Solomon (2017) suggest that this dividend fallacy could be driven by the way stock prices are reported. 9 Our results show that this fallacy translates in differential consumption responses, which suggests that it might have aggregate effects on the real economy.…”

Capital Redeployment in the Equity Market

“…This paper is also related to a literature on how investors use dividends. The fact that exposures to dividends is a persistent characteristic of money management funds complements the dividend disconnect phenomenon, which describes the tendency of investorsmutual funds and otherwiseto treat dividend returns differently than price returns, documented in (Hartzmark and Solomon 2017).…”