a1 email@example.com, SUNY at Oswego, Oswego, NY 13126
a2 firstname.lastname@example.org, University of Toledo, 2801 W. Bancroft, Toledo, OH 43606
a3 email@example.com, University of Houston, C.T. Bauer College of Business, Houston, TX 77204.
The retained earnings hypothesis predicts that stock distributions accounted for by reducing retained earnings are a more credible signal of managerial optimism than stock distributions that do not reduce retained earnings. This study examines the costs of false signaling that are a necessary pre-condition for the hypothesis and finds them to be generally very small, calling the validity of the hypothesis into question for most firms. However, prior studies report broad-based market evidence consistent with the hypothesis. To resolve this apparent inconsistency, the study replicates and extends tests of the retained earnings hypothesis contained in three prior studies, and shows that the findings in support of the retained earnings hypothesis can be attributed to specification and measurement choices that bias the results in favor of the hypothesis. The support for the retained earnings hypothesis is weaker when the sources of the bias are removed. However, some support for the hypothesis remains for a limited set of distributing firms.