Ambiguity, Risk, and Payout Policy

Richard Herron and Yehuda Izhakian

Abstract

We study the effect of ambiguity---Knightian uncertainty---on dividend payout policy. We find that firm-level risk decreases and delays dividends. In contrast, firm-level ambiguity increases and accelerates dividends. These findings can be explained by the attractiveness of investment opportunities, which potentially increases in risk and leaves less capital for dividend payout. In contrast, ambiguity leads investors to overweight the likelihoods of bad outcomes and underweight the likelihoods of good outcomes so that the attractiveness of investment opportunities decreases in ambiguity. Consistent with this positive effect of ambiguity on dividends, we find that dividend initiation announcement returns increase in ambiguity.