The Impact of Unrealized Fair Value Adjustments on Dividend Policy

Abstract

We examine the impact of unrealized fair value adjustments on dividend policy. Dividend payouts should include only persistent income [Lintner, J. (1956). Distribution of incomes of corporations among dividends, retained earnings and taxes. American Economic Review, 46(2), 97–113]. In our institutional setting, however, regulators recommend the non-distribution of any income from fair value adjustments, which suggests that they interpret them as transitory. We empirically demonstrate that fair value adjustments on investment property are persistent, while those on financial securities are transitory. We further show that only fair value adjustments from investment properties are distributed. We argue that managers perceive the persistence of the two fair value components correctly, and by doing so, they distribute income consistent with the Lintner framework rather than on regulatory recommendations. Finally, by focusing on managerial optimism, debt contracting, and insider ownership, we demonstrate the conditions under which firms choose to deviate from regulator recommendations and to distribute fair value profits.