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5) The Lifecycle Theory :
DeAngelo, DeAngelo and Stulz (2006) note that: “Dividends tend to be paid by mature established firms, plausibly reflecting a financial lifecycle in which young firms face relatively abundant investment opportunities with limited resources so that retention dominates distribution, whereas mature firms are better candidates to pay dividends because they have higher profitability and fewer attractive investment opportunities.”
Also in other works such as Fama and French (2001), Grullon, Michaely and Swaminathan (2002) and DeAngelo and DeAngelo (2006), lifecycle explanations for dividends rely on the trade-off between the advantages and disadvantages of paying dividends, which evolve over time as the firm matures, profits cumulate and investment opportunities decline.
Young firms prefer to retain all internal resources and do not pay dividends, and they also need external (contributed) resources. Larger firms with moderate growth rates payout a small part of their profits and retain the rest, to finance continuing investment and growth. As firms reach a stage where their growth is slow, and investment opportunities are scarce, free cash-flow tends to grow and so payout ratios also increase, both through dividends and share repurchases, thus avoiding the agency problems of retaining excess cash.
Confirming this theory, Fama and French (2001) find that firms with current high profitability and low growth perspectives tend to pay dividends, while low profit/high growth firms tend to retain any profits.
Also, DeAngelo, DeAngelo and Stulz (2006) show that the fraction of firms that pay dividends is high when retained earnings are a large portion of total eq ...