Dividends, Uncertainty, and Underwriting Costs Under Asymmetric Information

This paper presents a two‐period model in which dividends act as a signal of the stability of the firm's future cash flows. It is demonstrated that firms with more stable future cash flows pay a higher dividend. Dividends are a credible signal because the promise of a higher dividend, ceteris paribus , increases the probability that the firm will have to issue equity and pay underwriting costs. Empirically testable implications of the model relating to the cross‐sectional determinants of the level of dividends are also discussed.