What is the dividend puzzle?

Just why do companies pay dividends? That's the question posed by the dividend puzzle. Some theorists are baffled as to why investors need dividends as an incentive to buy shares in a company.

Where have you heard about the dividend puzzle?

The death of dividends has been predicted for years, but they’re still going strong because investors like them. In 1976, American economist Fischer Black wrote a paper entitled The Dividend Puzzle looking at corporate dividend payments. Over 40 years on, there’s still much bemusement among economists over the merits of dividend-paying stocks.

What you need to know about the dividend puzzle.

Much of the puzzle surrounding the popularity of dividends stems from the fact they're taxed twice – they’re paid from after-tax profits and yet most investors still have to pay income tax on dividends. They're also seen to devalue a company. If a business has just paid out millions in dividends, its enterprise value has decreased by the same amount.

The reasons why dividends are popular have been attributed to several factors, not least market uncertainty, but it also has a lot to do with investor psychology. When stock prices fall, dividends serve as a silver lining, and when they rise they’re regarded as a separate gain.

Find out more about the dividend puzzle.

Read our definition of behavioural finance to learn more about investor psychology.