Reinvestment and Global Stock Returns

Abstract

This article examines the relationship between a country’s aggregate dividends and its equity market returns. In many countries, the change in the aggregate dividend payout rate is negatively correlated with returns, and in some countries there is no significant relationship between dividend payout rate changes and equity market returns. However, there are no countries in which the change in the dividend payout rate is significantly positively related to returns and the cross-country relationship between dividend payout rate changes and returns is significantly negative. The implication is that at the country level, dividend payout rate increases represent a decrease in the country’s investment opportunity set and are accordingly interpreted by investors as bad news, as evidenced by the finding that the change in a country’s dividend payout rate is negatively related to changes in analysts’ expectations of long-term earnings growth for that country. Furthermore, dividend payout rate increases lead investors to pay less per unit of future expected earnings, as evidenced by the result that the change in a country’s dividend payout rate is positively correlated with the change in the country’s equity risk premium.

A country’s long-term equity market performance is also related to its dividend payout policy. Specifically, over different holding periods, countries with lower dividend payout rates have higher real long-term returns than countries with higher dividend payout rates, even after allowing for the reinvestment of dividends (either into equity or into TIPS).