Good Managers Invest More and Pay Less Dividends: A Model Of Dividend Policy

This model explains dividends as a component of a contract set up by an uninformed principal. I start from a well-documented empirical fact that there is a relation between dividends declared and executive compensation. I find that when hidden information is about the productivity of the agent then dividend – conditional on cash available – bears a negative relationship to managerial type. That is, for a given level of available cash, the lower type manager declares a higher dividend than that declared by a manager with higher productivity. The result is robust under different model extensions. I also discuss empirical implications of the model.