This is not because book values correctly reflect the true economic value of the company, but simply that book values are a pretty good measure of the extent to which values will not be upset by financial distress when borrowing. But markets are not frictionless, and there is the possibility that shareholders may prefer one dividend policy to another because of real frictions that are experienced. There is also the dividend clientele effect. Shareholders may prefer one dividend policy to another because of the real frictions that are experienced. Information is not costless and freely available to everyone.
Dividend policy plays an important role as a signalling device.
Thus, simply paying out residual earnings year by year is inadvisable because such a policy would in most cases cause the dividend rate to fluctuate wildly and thus reduce its information value. In order for dividend changes to serve as an effective signalling mechanism, a company must prevent its dividend rate from fluctuating wildly from one period to the next. A company can smooth its dividends over time by building cash surpluses during periods of lower capital expenditure requirements and then drawing down these cash balances during periods of higher capital expenditure requirements. But we are really interested in how it applies to the dividend decision. One effect on the dividend a company declares might be that the debt the company has issued has a legal restriction on the amount of dividend that a company is allowed to pay.