Dividend reductions,the timing of dividend payments and information content

Australian companies pay dividends semi-annually with smaller “interim” payments and larger “final” payments. Interim dividends are declared and paid within a less full information environment than final dividends. We analyze the interactions between the timing of dividends and their information content, controlling for share repurchase and tax effects. Dividend reductions that are not associated with share repurchases are statistically significantly related to future abnormal earnings and provide strong support for the information content of dividend reductions. The percentage of dividend reduction is stronger for interim than for final dividend reductions. The market reaction is negatively related to the reduction in imputation tax credit and reacts more aggressively and negatively to interim as compared to final dividend reductions.     

UK interim and final dividend reductions: a note on price reaction

Price reactions to interim and final dividend reductions are found to be significantly negative and stronger for interim dividend reductions. Although the market reacted negatively around final dividend reduction announcements it bounced back to its prior level within one month of the announcements. The magnitude of price reactions to dividend reductions is found to be statistically related to the size of the dividend reduction, the post-announcement effect from day 2 to day 20, the pre-announcement effect from day ?20 to day ?2, the gearing ratio and the dummy variable interim versus final dividend reduction.     

Operating performance following dividend decreases and omissions

Using quarterly data and benchmarks based on past performance characteristics, I find little evidence that earnings change following 661 dividend decreases and 484 dividend omissions between 1980 and 1998. The exception is that earnings deteriorate during the quarter of dividend omissions, but they recover within a couple of quarters. My results further suggest that the lack of a more pronounced earnings decline is neither attributable to a contemporaneous and confounding increase in share repurchases, to earnings management, nor to improving investment opportunities, and the results are similar for firms that are not predicted to cut dividend payouts based on their financial flexibility. Instead, I find some evidence that the negative stock price reaction reflects the dismal performance during the quarter of the announcement, especially for firms that omit dividends, and that the market interprets the dividend announcements too pessimistically.     

Dividend changes and earnings performance in Japan

This paper tests the dividend-signaling hypothesis using Japanese data. It is found that firms that increase dividends experience earnings growth in the preceding years but earnings declines in the subsequent years. Just the opposite tendency is found for firms that decrease and omit dividends. These results go against the hypothesis. Nevertheless, the event study results show that the market reacts positively (negatively) to the announcements of dividend increases (decreases). Thus, the evidence indicates that managers tend to be overly optimistic or pessimistic about future earnings when changing dividends, and the market tends to overreact to dividend change news.     

Dividends, Asymmetric Information, and Agency Conflicts: Evidence from a Comparison of the Dividend Policies of Japanese and U.S. Firms

We compare dividend policies of U.S. and Japanese firms, partitioning the Japanese data into keiretsu, independent, and hybrid firms. We examine the correlation between dividend changes and stock returns, and the reluctance to change dividends. Results are consistent with the joint hypotheses that Japanese firms, particularly keiretsu-member firms, face less information asymmetry and fewer agency conflicts than U.S. firms, and that information asymmetries and/or agency conflicts affect dividend policy. Japanese firms experience smaller stock price reactions to dividend omissions and initiations, they are less reluctant to omit and cut dividends, and their dividends are more responsive to earnings changes.     

AN ANALYSIS OF SHAREHOLDER REACTION TO DIVIDEND CUTS AND OMISSIONS

In this paper the proposition is tested that stock market reaction to a dividend change is a function of its information content. A multiple regression model is formulated to identify the factors that contribute significantly to the capital loss suffered by shareholders when firms decide to cut/omit dividends. Results indicate that, in conformity with the information content hypothesis, the announcement period capital loss induced by a dividend deduction significantly depends on the percentage change in dividends, the size and risk of the firm, and the price performance of the firm's stock in the immediately preceding period. The results further reveal that (1) simultaneous announcements of poor earnings cause larger capital losses; (2) prior announcements of loss/lower earnings, strikes, etc. attenuate the negative impact of dividend cuts; (3) managerial reassurances that the dividend reduction is growth-motivated produces a weakly favorable effect, and (4) institution of stock dividends concurrently with the dividend cut significantly reduces the negative valuation effect. It is concluded from the evidence that stock market reaction to managerial signals is a function of the perceived costs associated with these signals.     

The Effect of Past Earnings and Dividend Patterns on the Information Content of Dividends When Earnings Are Reduced

This study pursues two objectives: first, to provide evidence on the information content of dividend policy, conditional on past earnings and dividend patterns prior to an annual earnings decline; second, to examine the effect of the magnitude of low earnings realizations on dividend policy when firms have more‐or‐less established dividend payouts. The information content of dividend policy for firms that incur earnings reductions following long patterns of positive earnings and dividends has been examined ( DeAngelo et al., 1992, 1996 ; Charitou, 2000 ). No research has examined the association between the informativeness of dividend policy changes in the event of an earnings drop, relative to varying patterns of past earnings and dividends. Our dataset consists of 4,873 U.S. firm‐year observations over the period 1986–2005. Our evidence supports the hypotheses that, among earnings‐reducing or loss firms, longer patterns of past earnings and dividends: (a) strengthen the information conveyed by dividends regarding future earnings, and (b) enhance the role of the magnitude of low earnings realizations in explaining dividend policy decisions, in that earnings hold more information content that explains the likelihood of dividend cuts the longer the past earnings and dividend patterns. Both results stem from the stylized facts that managers aim to maintain consistency with respect to historic payout policy, being reluctant to proceed with dividend reductions, and that this reluctance is higher the more established is the historic payout policy.     

Dividends and Losses

An annual loss is essentially a necessary condition for dividend reductions in firms with established earnings and dividend records: 50.9% of 167 NYSE firms with losses during 1980–1985 reduced dividends, versus 1.0% of 440 firms without losses. As hypothesized by Miller and Modigliani, dividend reductions depend on whether earnings include unusual items that are likely to temporarily depress income. Dividend reductions are more likely given greater current losses, less negative unusual items, and more persistent earnings difficulties. Dividend policy has information content in that knowledge that a firm has reduced dividends improves the ability of current earnings to predict future earnings.     

When do German firms change their dividends?

Dividends of German firms are often perceived to be more flexible than those of Anglo-American firms. We analyse the decision to change the dividend for 221 German firms over 1984–1993. Consistent with Lintner [Am. Econ. Rev. 46 (1956) 97], net earnings are key determinants of dividend changes. However, our findings also refine those of Lintner [Am. Econ. Rev. 46 (1956) 97] and Miller and Modigliani [J. Bus. 34 (1961) 411]. First, the occurrence of a loss is a key determinant of dividends in addition to the traditional key determinant, the level of net earnings. Second, the majority of dividend cuts or omissions are temporary. This stands in marked contrast with DeAngelo et al. [J. Finance 47 (1992) 1837] who report that US firms are more likely to reduce their dividend when earnings deteriorate on a permanent basis. Finally, we find that firms with a bank as their major shareholder are more willing to omit their dividend than firms controlled by other shareholders.     

Dividend Policy and Financial Distress: An Empirical Investigation of Troubled NYSE Firms

This paper studies the dividend policy adjustments of 80 NYSE firms to protracted financial distress as evidenced by multiple losses during 1980–1985. Almost all sample firms reduced dividends, and more than half apparently faced binding debt covenants in years they did so. Absent binding debt covenants, dividends are cut more often than omitted, suggesting that managerial reluctance is to the omission and not simply the reduction of dividends. Moreover, managers of firms with long dividend histories appear particularly reluctant to omit dividends. Finally, some dividend reductions seem strategically motivated, e.g., designed to enhance the firm's bargaining position with organized labor.     

IMPLICATIONS OF UNSUSTAINABLE DIVIDENDS

In this article, we examine the wealth effects of unsustainable dividend payments and explore the economic forces that may explain why they exist. We find that the larger the dividend–earnings differential, the lower the short- and long-run wealth effects to shareholders. In addition, the dividend–earnings differential increases not only the probability of a subsequent dividend cut over the next four quarters but also the likelihood that the cut will be greater than 5%. Overall, our findings suggest that although investors are not fooled by unsustainable dividend payments, the negative announcement effects are in anticipation of protracted poor performance.     

Stock Return Volatility and Dividend Announcements

This paper is based on models presented in Kim and Verrecchia (1991a, 1991b) relating to share price volatility and the quality of announcements. It investigates the differences in informational quality between dividend cuts and dividend rises, and between interim and final dividend announcements. The results indicate that when dividends are cut, the interim announcement is perceived as being more significant than the final, whereas the reverse is true when dividends are increased. Implied standard deviations suggest that volatility is expected to peak on the day of final announcements. A peak is also expected after interim announcements of a cut in dividend, but not after announcements of an increase.     

The dynamics of dividends,earnings and prices: evidence and implications for dividend smoothing and signaling

This paper examines the dynamic relations among corporate dividends, earnings and prices, and the implications of these relations for dividend signaling and smoothing. A multiple hypotheses testing method is employed to identify causal relations among the three financial variables and to test the empirical implications of dividend smoothing and signaling models. The results show that dynamic relations exist among dividends, earnings and prices. Empirical evidence is consistent with the contention that dividend changes are often driven by both signaling and smoothing motives. Additional tests are developed to differentiate between the dividend signaling and smoothing models. These tests impose restrictions on the dynamics of the financial variables and information signaling. It is found that dividend changes frequently provide information about unexpected changes in future earnings for a little more than a year.     

Option Implied Dividends Predict Dividend Cuts: Evidence from the Financial Crisis

We employ the forward‐looking implied dividend information contained in option prices to predict dividend cuts and omissions during the recent financial crisis. The large number of dividend cuts and omissions during the 2008–09 financial crisis period provides the opportunity to study the predictability of dividend cuts in a controlled environment. Implied dividends and implied volatility, based on put–call parity and computed from put and call option prices, prove to be effective in predicting those cuts, especially compared to only using the equity market and accounting variables conventionally used for this purpose. Options‐derived variables (implied dividends and implied volatility) enhance the ability to identify firms more likely to reduce or omit dividend payments.     

Do Changes in Dividends Signal the Future or the Past?

Many dividend theories imply that changes in dividends have information content about the future earnings of the firm. We investigate this implication and find only limited support for it. Firms that increase dividends in year 0 have experienced significant earnings increases in years ?1 and 0, but show no subsequent unexpected earnings growth. Also, the size of the dividend increase does not predict future earnings. Firms that cut dividends in year 0 have experienced a reduction in earnings in year 0 and in year ?1, but these firms go on to show significant increases in earnings in year 1. However, consistent with Lintner's model on dividend policy, firms that increase dividends are less likely than nonchanging firms to experience a drop in future earnings. Thus, their increase in concurrent earnings can be said to be somewhat “permanent.” In spite of the lack of future earnings growth, firms that increase dividends have significant (though modest) positive excess returns for the following three years.     

The Informativeness of Dividends and Associated Tax Credits

This paper investigates the informativeness of dividends and the associated tax credits with respect to earnings persistence. After confirming that dividend‐paying firms have more persistent earnings than non‐dividend‐paying firms, we show that the taxation status of the dividend is also important. Firms that pay dividends with a full tax credit attached have significantly more persistent earnings than firms that pay dividends which carry no associated tax credit. Consistent with higher levels of tax credits identifying more mature firms, those paying dividends with full tax credits have significantly less persistent losses than firms that pay dividends with only partial tax credits. Further, market pricing tests confirm that the incremental information in dividends and tax credits contributes to reductions in market mispricing of the persistence of earnings and earnings components. Our results are robust to alternative model specifications and controlling for dividend size and firm age.     

Overinvestment,corporate governance,and dividend initiations

Firms with low Tobin's Q and high cash flow have significantly more positive dividend initiation announcement returns than do other firms. I interpret this result as consistent with the hypothesis that reductions in the agency costs of overinvestment at firms with poor investment opportunities and ample cash flow are reflected in higher dividend initiation announcement returns. Further tests, such as examining the impact of governance metrics on initiation announcement returns following the dividend tax cut of 2003 and examining the long-run cash-retention policies of dividend-initiating firms, are consistent with this interpretation. There is also some evidence that is consistent with the cash flow signaling hypothesis, as dividend-initiating firms with low Tobin's Q and low pre-initiation cash flow experience substantial revisions in analysts' earnings forecasts and significantly positive initiation announcement returns.     

What do dividend reductions signal?

Dividend reductions have long been considered a “last resort” action for firm managers. Managerial reluctance to reduce dividends emanates from the view that dividend drops signal managerial pessimism regarding future earnings. Contrary to expectations, studies show that earnings rebound significantly following a dividend reduction; yet investors react negatively to the dividend-drop announcement. We present an explanation for the anomalous behavior of earnings and returns around the time of a dividend drop. Our evidence suggests that a reduction in a firm's established dividend coincides with a decrease in the value of the firm's real options. Earnings rebound following the dividend reduction due to the savings that result as the firm allows growth options to expire; however, announcement period returns suggest that investors recognize the lost value associated with the forthcoming expiration of growth options.     

Dividend Policy in Switzerland

The paper examines dividend policy for a sample of Swiss companies. Several factors that determine cross-sectional variations in dividend policy – such as profitability, growth opportunities, and riskiness – are identified. Price volatility seems to stand out as the most significant factor. Looking at the relationship between dividends and earnings over time, dividend changes are more closely linked to past and current rather than future net income growth. However, they do confirm a persistent shift in the level of earnings. There is also a significant relationship between losses and dividend cuts. These findings suggest that it is the managers’ reluctance to cut dividends that gives informational content to dividend changes.     

Dividend policy of German firms: A panel data analysis of partial adjustment models

German firms pay out a lower proportion of their cash flows, but a higher proportion of their published profits than UK and US firms. We estimate partial adjustment models and report two major findings. First, German firms base their dividend decisions on cash flows rather than published earnings as (i) published earnings do not correctly reflect performance because German firms retain parts of their earnings to build up legal reserves, (ii) German accounting is conservative, (iii) published earnings are subject to more smoothing than cash flows. Second, to the opposite of UK and US firms, German firms have more flexible dividend policies as they are willing to cut the dividend when profitability is only temporarily down.