Dividend policy, risk and the cross-section of stock returns: Evidence from India

We invoke theories of dividend policy and asset pricing to investigate the impact of dividend changes on stock price risk, stock returns, and the cross-sectional risk-return tradeoff. We use a large sample of Indian firms during the period from 1999 to 2018. We find that favorable dividend changes trigger higher stock returns because they convey new information about firm's future profitability, as posited by the dividend signaling theory. Our analysis also shows that the higher (lower) stock returns following dividend increases (decreases) are more pronounced among stocks with greater information asymmetry. The results reveal a new empirical evidence of the heterogeneity of the risk-return trade-off across firms with different dividend changes. We show that the positive risk-return relation is much more pronounced among dividend-increasing firms, but the risk-return relation is negative among dividend-decreasing firms.