Dividends versus Stock Repurchases and Long-Run Stock Returns under Heterogeneous Beliefs

We analyze a firm's choice between dividend payments and stock repurchases under heterogeneous beliefs and the subsequent long-term stock return performance of firms adopting the two forms of payout. Firm insiders, owning a certain fraction of its equity, choose between paying out its cash available through a dividend payment or a stock repurchase, as well as the level of investment in its project. Outsiders have heterogeneous beliefs about project success, and may have beliefs different from firm insiders as well. In equilibrium, the firm distributes value through dividends alone; through a repurchase alone; or through a combination. We characterize the conditions under which each form of payout occurs, as well as the firm's optimal scale of investment. We show that, in some situations, the firm may raise external financing to fund its payout in equilibrium, with the form of external financing (equity or debt) chosen jointly with its method of payout and scale of investment. Finally, we develop a number of new results characterizing a firm's long-run stock returns following dividend payments and stocks repurchases, and show how, consistent with the evidence, positive or negative long-run stock returns following such payouts may arise in equilibrium