3. Behavioral Finance

Behavioral finance also offers an interesting argument for comparatively high dividend payments: Self control.

Because of lack of self-discipline, people often fail to reach their long-term goals. This applies to personal matters such as losing weight, drinking less, or learning a foreign language, and it applies to financial matters. The extent to which our behavior deviates from the long-term optimal behavior because of lack of self-discipline is the so-called self-control bias. 

 

One way to address this bias is to set strict rules to achieve specific goals. For example:

  • Never take the elevator
  • Do not drink alcohol before 5 pm
  • Bank the wife's salary and spend only from the husband's paycheck (or vice versa)
  • Etc.

 

In the context of such rules, dividends could have a potentially function. For example, a rule to instill self-control could be to only use dividends for consumption and to never touch the invested capital. Because share buybacks (and the extent to which shareholders participate) are more discretionary, they could give investors too much leeway to maintain self-control.