N°25-99: Dividend-Price Ratios and Payout Constraints

Common models of stock returns and dividend growth have ignored the constraint that dividend payments can never exceed stock prices. If a statistical process finds itself in such a scenario, it is best interpreted as investment termination. In the simplest canonical model, in which stock returns net of dividend growth rates are matched to their historical means and standard deviations, the termination scenario is triggered between 65% and 80% of the time. Termination also has implications regarding the interpretation of predictive OLS coefficients of dividend-price ratios on stock returns. A second important contribution of our paper is to show multi-stock evidence that hints that very high dividend-price ratios predicted future dividend reductions rather than higher stock returns, contrary to the association within the narrower dividend-price ratio range observed for the overall market. *We thank Mark Garmaise, Valentin Haddad, and seminar participants at USC, UCLA, Amsterdam, and Frankfurt for helpful comments and advice.