Why Firms Begin Paying Dividends: Value, Growth, and Life Cycle Effects

The firm life cycle theory of dividends contends that the optimal dividend policy of a firm depends on the firms stage in its life cycle. The underlying premise is that firms generally follow a life-cycle trajectory from origin to maturity that is associated with a shrinking investment 1 opportunity set, declining growth rate, and decreasing cost of raising external capital. The optimal dividend policy, derived from a trade-off between the costs and benefits of raising capital for new investments, evolves with these life-cycle-related changes. As the firm becomes more mature the optimal payout ratio increases. The empirical evidence generally supports the theory, in that dividend payment propensity is related to life-cycle characteristics dividend payers are mature firms, with a high ratio of earned to contributed capital, while young, highgrowth firms do not pay dividends