An Empirical Analysis of the Dynamic Relation among Investment, Earnings and Dividends

The authors use a firm-level vector autoregression (VAR) framework to examine the firm-level dynamics among investment, earnings and dividends. The firm-level VAR yields Granger causality results, impulse response functions, and variance decompositions characterizing the dynamics of these three variables at the firm level. For the average firm in our sample, Miller and Modigliani (1961) dividend policy irrelevance is not supported, even in the long-run; the shocks to dividends do have long-run consequences for investment and vice versa. Dividend changes are an ineffective signal of future earnings in both the short and long term. The cost of an increased dividend is on average an immediate decrease of $3 in investment for every dollar increase in dividends and the effect is persistent up to six years after the increase in dividends