Momentum, Dividend Policy, and Market Conditions

Non-dividend-paying firms generate higher momentum profit (0.73% per month) than the dividend payers following up markets. Extant literature suggests that the higher momentum profits following up markets can be explain via behavioral or rational asset pricing models. The rational asset pricing models suggest that the higher momentum profits following up markets stem from higher return autocorrelations during these periods since firms are closer to exercising their growth options when prices are rising (Sagi and Seasholes's (2006)). Thus, the higher momentum profit for the non-payers following up markets should be due to higher return autocorrelations for these stocks relative to their dividend-paying counterparts. This suggests higher expected returns for the non-dividend-paying winners relative to their dividend-paying counterparts and lower expected returns for the non-dividend-paying losers relative to their dividend-paying counterparts. While the evidence is consistent with the latter prediction, it is inconsistent with the former prediction. Specifically, the average return of the non-dividend-paying winners (1.85% per month) is not significantly higher than that of their dividend-paying counterparts (1.78%). Consequently, it is hard to explain the evidence via higher return autocorrelations for the non-dividend-paying stocks following up markets. The behavioral models suggest that the higher momentum profits following up markets are due to the price increases during these markets. In particular, the price increases increase aggregate overconfidence and reduce investor risk-aversion during up markets, and these work to increase momentum profits (Cooper, Guitierrez, and Hameed (2004)). Thus, the behavioral models suggest that the higher momentum profits among the non-dividend-paying stocks stem from higher price appreciations among these stocks when the markets are advancing. Consistent with this prediction, the evidence suggests that price appreciations among the non-dividend-paying stocks are higher than those among the dividend payers. This is due to asymmetric valuation of the dividend signal and the fact that growth opportunities are more important for the non-dividend-paying stocks. The evidence is, therefore, more consistent with the behavioral explanation for the higher momentum profit following up markets than the rational asset pricing explanation.