Market movements and the excess cash theory

• We analyze the effects of the market's outlook on dividend payers and non-payers.
• Dividend payers outperform non-payers when the market's outlook declines.
• Non-payers outperform the payers when the market's outlook improves.
• The difference in returns increases with excess cash in both down and up markets.
• We provide new evidence that supports the excess cash theory of dividends.

This study examines the effects of changes in the market's outlook for investment on the returns of dividend payers and non-payers to test the excess cash theory for dividends. When the market's outlook declines, the adverse effect is stronger for non-payers than payers and the difference concentrates among firms with high excess cash. When the outlook improves, the positive effect is stronger for non-payers than payers and the difference also concentrates among firms with high excess cash. These results support the theory that a dividend payment is a signal that the firm will not overinvest.