We show that net equity payouts from the corporate sector play a crucial role in helping individuals manage their consumption path across the business cycle. In particular, we show that, as investors' desire to smooth consumption increases, optimal aggregate dividends become both more volatile and more counter-cyclical to help counterbalance pro-cyclical labor income. These findings are robust to whether or not agency conflicts exist in the economy.
JEL classification codes: E13, E21, G35Keywords: Aggregate dividend policy, Consumption smoothing, Habit formation, Dynamic stochastic general equilibrium models 2
IntroductionThere is a disconnection between microeconomic and macroeconomic models of optimal dividend policy. In the corporate finance literature, equity payout behavior at the individual firm level is either considered irrelevant (Miller and Modigliani, 1961) or depends on a range of company-specific issues including, inter alia, taxation, signalling and agency conflicts. 1 By contrast, in dynamic stochastic general equilibrium (DSGE) models, when the consumption requirement of the representative investor is modelled alongside the optimization problem of the corporate sector, an optimal aggregate dividend policy is frequently found to exist.In many settings, standard DSGE models predict that equity payout behavior at the portfolio level should be highly counter-cyclical; see, for example, the discussions in Liu and Miao (2015), Hirshleifer et al. (2015) and Huang-Meier et al. (2015). This is because, when economic times are good, companies have excellent investment opportunities and therefore wish to retain cash for new projects. Simultaneously, individuals have little requirement for additional revenue as their labor income is highly pro-cyclical. The low demand from households for income from financial assets, and the high demand for new investment from corporations, leads to predicted low dividend payments in economic booms.This theoretical prediction, though, clearly conflicts with observed financial market behavior. Jermann and Quadrini (2012) report a correlation of +41% between gross equity payouts and GDP while Huang-Meier et al. (2015) report a correlation of +50% between real aggregate dividends changes and real GDP growth. Even net dividends, which comprise of gross dividends minus new equity issue and share repurchases, are not highly countercyclical in the manner that is predicted by most DSGE models. 2 To overcome this anomaly, a number of papers force the pro-cyclicality of equity payouts onto their economies by modelling dividends as a levered claim to consumption; see, for example, Bansal and Yaron (2004), Ju and Miao (2012) and Liu and Miao (2015). But this does little to explain the underlying reason for this relationship. Both Hirshleifer et al. 1 Dividend policy work in the corporate finance literature has incorporated different corporate accounting and finance issues, such as taxation (Brennan, 1970; Miller and Scholes, 1978;Poterba and Summers, 1985; and Harr...
