A TEST OF THE EASTERBROOK HYPOTHESIS REGARDING DIVIDEND PAYMENTS AND AGENCY COSTS

Easterbrook (1984) argues that dividend payments may be an ambiguous signal unless the market can distinguish growing firms from disinvesting firms. Shares of growing firms that announce both financing and dividend increases are predicted to rise more in value than shares of firms announcing a dividend increase alone. We examine the relation between prior financing activity and the market response to initial dividends and find evidence consistent with the Easterbrook agency cost model.