Dividends drive discipline and provide continuous feedback
Legendary professor Ben Graham spoke for higher dividends in order to keep management focused on getting high rates of return from their current businesses rather than chasing the next dream acquisition. The list of shareholder value destroying acquisitions over the past twenty years is extensive. According to the National Bureau of Economic Research the aggregate losses on acquiring public firms over the last 20 years was a staggering $257 billion.*
Dividend payments can act as a useful identifier of companies that are disciplined and efficient in their capital allocation and cash flow management. Dividends offer a view of management's confidence in the business through the eyeglass of the amount paid out. Boards will not declare or increase dividends if they have low confidence in the company's prospects going forward, since the market induced penalty for cutting a dividend can be very high.
The mere fact that the company has excess cash to pay out suggests a certain financial strength. There is a simple folk truth that "you can't fake cash."
* Do Shareholders of Acquiring Firms Gain from Acquisitions? (NBER Working Paper No. 9523), co-authors Sara Moeller, Frederik Schlingmann, and Rene Stulz, August 2003.