The Effect of Dividend Changes on Stock and Bond Prices

This study examines stock and bond price reactions to dividend changes. The positive stock market response to dividend increases has several potential explanations, two of the more commonly discussed being information content and wealth redistribution between stockholders and bondholders. The evidence presented supports the wealth redistribution hypothesis but does not rule out the information content hypothesis. Typically we find that the bond price reaction to announcements of large dividend changes is opposite to the stock price reaction. Our results differ from those of Handjinicolaou and Kalay.     

Dividend Changes and Security Prices

This paper analyzes the effect of unexpected dividend changes on the values of common stock, preferred stock, and bonds. Two potential effects are identified: a wealth transfer effect and a signalling effect. Previous studies have shown that positive (negative) dividend change announcements produce positive (negative) common stock price changes. Whereas these findings have been attributed to the signalling aspect of dividends, they are also consistent with the wealth transfer hypothesis. Based on the announcement day returns of common and preferred stock and bond holders, it is demonstrated that the primary factor influencing security returns in response to dividend changes is market signalling. A wealth transfer effect is not necessarily ruled out, but if it exists it is dominated by the signalling effect.     

Dividend signaling under economic adversity: Evidence from the London Stock Exchange

The signaling or information content hypothesis is amongst the most prominent theories attempting to explain dividend policy decisions. However, no research has, to date, examined the information content of dividends in conjunction with generalized economic adversity. With the majority of the western economies facing the tough reality of the economic recession since late 2007–early 2008, we focus on the possibility of asymmetrical dividend signaling effects between periods of stability and economic adversity. Using data from the London Stock Exchange (LSE), where earnings and dividend news are released simultaneously, we test the dividend signaling hypothesis and the interaction of earnings and dividends under both steady and adverse economic conditions. We document positive and significant average abnormal stock price returns around the dividend/earnings announcements. We also find a significant interaction between economic conditions and the information content of dividends. After testing the dividend signaling hypothesis under both stable and recessionary economic conditions we find that dividends have less information content than earnings in periods of growth and stability, but more in periods of economic adversity.     

The informational content of the timing of dividend announcements

This paper contains a test of a new aspect of the informational content of dividend; namely, is there information in the timing of the announcements? The empirical evidence indicates that the market expects ‘bad news’ to be delivered late and that these expectations are confirmed. Mean excess returns of stock prices around late announcements are, depending on the assumed returns generating process, either significantly negative or insignificant while significantly positive around the entire population of announcements. Moreover, the proportion and magnitude of dividend reductions associated with late announcements are significantly larger than in the complete universe of announcements.     

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.     

Corporate Dividends and Seasoned Equity Issues: An Empirical Investigation

This paper investigates whether managers rely on dividends to obtain a higher price in a stock offering and whether the stock price reaction to dividend and offering announcements justifies such a coordination. The evidence does not support either conjecture. Issuing firms are not more likely to pay or increase dividends than nonissuing forms. Moreover, there is little evidence that firms time stock offering announcements right after dividend declarations to benefit from the attendant information disclosure. The analysis of dividend and stock offering announcement effects suggests few if any benefits from linking dividend and stock offering announcements.     

Regular Dividend Announcements and Future Unexpected Earnings: An Empirical Analysis

Previous studies have interpreted stock price reaction to dividend announcements as being consistent with the hypothesis that any changes are forecasts of future corporate profits. Recent studies seem to provide evidence to this effect. This study provides additional empirical evidence pertaining to the issue of whether quarterly cash dividend announcements convey useful information about a firm's future profitability, beyond that contained in contemporaneous quarterly earnings announcements. The association between unexpected changes in quarterly dividends and unexpected accounting earnings in subsequent quarters is examined, after controlling for information contained in past and current earnings series. The results, based on a large sample of regular quarterly cash dividend changes, indicate that firms that increased (decreased) their dividends realized, on average, greater (smaller) unexpected accounting earnings in subsequent periods than firms that did not change their dividends.     

THE RELATION AMONG DIVIDEND POLICY,FIRM SIZE,AND THE INFORMATION CONTENT OF EARNINGS ANNOUNCEMENTS

In this paper we investigate the role of dividends in explaining the size effect. The previous literature concludes that before the firm's earnings announcement, small firm stock prices impound less information than large firm stock prices. This size effect is evidenced by the greater market reaction to small firm earnings announcements than to large firm earnings announcements. We find that if the dividend announcement precedes the earnings announcement, no size effect exists. The implication is that the information conveyed by dividend announcements includes the information conveyed to investors in large firms by other information sources. However, if the firm does not pay dividends or if the firm's earnings announcement precedes its dividend announcement, the size effect exists. The implication is that dividends do not completely explain the size effect. That is, there are information sources other than dividends that are exclusively available to investors in large firms, and the information provided by these sources is reflected in the stock price of large firms before the earnings announcement.     

A Test of the Relative Pricing Effects of Dividends and Earnings: Evidence from Simultaneous Announcements in Japan

We study the pricing effects of dividend and earnings announcements by taking advantage of the unique setting in Japan where managers simultaneously announce the current year's dividends and earnings as well as forecasts of next year's dividends and earnings. Defining surprises as deviations from analysts' forecasts, we find that share price reactions are significantly affected by earnings surprises, especially management forecasts of next year's earnings. The information content of dividends is marginal and is restricted to announcements of next year's dividends. Consistent with Modigliani and Miller's dividend irrelevance proposition, current dividend surprises have no material impact on stock prices in Japan.     

The information content of cash dividend announcements in a unique environment

Due to its distinctive institutional background, Oman offers a valuable opportunity to examine stock price reactions to dividend announcements. In Oman, (1) there are no taxes on dividends and capital gains, (2) there is a high concentration of share ownership, (3) there is low corporate transparency, and (4) firms frequently change their dividends. Our results show that announcements of dividend increases are associated with increased stock prices, while announcements of dividend decreases cause decreases in stock prices. Firms that do not change their dividends experience insignificant negative returns. These results contradict tax-based signaling models, which argue that higher taxes on dividends relative to capital gains are a necessary condition for dividends to be informative.     

AN EXAMINATION OF MARKET REACTION TO SUBSTANTIAL SHIFTS IN DIVIDEND POLICY

This study provides further empirical evidence on the informational content of dividends hypothesis. To reduce the misclassification of unfavorable and favorable dividend announcements, which can result when small dividend changes are included, the analysis is restricted to cases where a substantial shift in dividend policy has occurred. Specifically, the authors examine the aggregate market response to announcements of (1) omitted dividends, (2) dividend decreases of at least 25 percent, (3) dividend increases of at least 25 percent, and (4) initial dividend payments. The results indicate that announcements of dividend omissions and large decreases have a pronounced downward impact on stock prices even though the market has anticipated the forthcoming news to a large degree. Similarly, the market reaction to initial dividend declarations is found to be substantial and much greater than previously found for favorable dividend classifications in general.     

THE EFFECTS OF THE ANNOUNCEMENTS OF DIVIDEND INCREASES ON STOCK RETURN VOLATILITY: THE EVIDENCE FROM THE OPTIONS MARKET

This paper examines the impact of the announcements of dividend increases on the volatility of underlying stock returns implied by option prices, and analyses whether the impact is related to the label associated with the dividend increase. The results suggest that the announcements of labelled dividend increases are accompanied by a decrease in implied volatility, while the announcements of unlabelled increases in dividends are associated with no change in implied volatility. These results are consistent with the hypothesis that signal implicit in the announcements of dividend increases provides noisy information about the firm's volatility.     

STOCK DIVIDENDS AS SIGNALS

This study analyzes stock dividends as signals from managers. It is argued that in the presence of information asymmetries between managers and investors, stock dividends provide a relatively inexpensive and unambiguous signalling device. Based on an examination of the daily returns around 317 stock dividend announcements, it is concluded that these announcements are interpreted by investors as signals from managers. Further analysis also indicates that stock dividend size is positively related to announcement day returns.     

Signalling power of special dividends in an imputation environment

The present study examines the impact of the announcement of special dividends for a sample of Australian companies over the period July 1989 to June 2002. The risk‐adjusted price reaction to special dividend announcements from the day before the announcement to the day after the announcement (day ?1 to day 1) is positive and statistically significant, averaging 3.67 per cent. Initial special dividend announcements (4.68 per cent) led to stronger price reaction than special dividend announcements that follow an earlier special dividend (1.51 per cent) in the previous year. The magnitude of price reactions to special dividend announcements is statistically related to the size of the special dividend, the existence of prior special dividend announcements, abnormal cash flow for the year ended after the special dividend announcement, the existence of dividend reinvestment plans (DRP) versus non‐DRP, and a preannouncement effect. Finally, we found strong support for the information content/signalling hypothesis for special dividend announcements that do not participate in DRP and limited support for those associated with DRP.     

THE INFORMATION CONTENT OF DIVIDEND CHANGES

In this study, the open empirical question as to whether or not dividends contain information is investigated. The study involves 200 stocks and 376 dividend announcements over the 1971 to 1977 period; measures of unexpected dividends are related to measures of abnormal returns for dividend changing stocks. This study is important for three reasons:

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Informed Options Trading Prior to Dividend Change Announcements

This paper investigates the information content of options trading prior to dividend change announcements. I find a positive (negative) relation between pre‐announcement abnormal implied volatility (IV) spread (abnormal IV skew) and cumulative abnormal stock returns around dividend change announcements. The predictive power of informed options trading is stronger for announcements of dividend reduction and when the options market is more liquid relative to the stock market and weaker when information has already been incorporated in the stock market. The predictability of informed options trading is robust to a placebo test and alternative measures of informed options trading. Overall results suggest that informed options trading predicts dividend change announcement returns.     

The valuation effects of stock splits and stock dividends

This study presents evidence which indicates that stock prices, on average, react positively to stock dividend and stock split announcements that are uncontaminated by other contemporaneous firm-specific announcements. In addition, it documents significantly positive excess returns on and around the ex-dates of stock dividends and splits. Both announcement and ex-date returns were found to be larger for stock dividends than for stock splits. While the announcement returns cannot be explained by forecasts of imminent increases in cash dividends, the paper offers several signalling based explanations for them. These are consistent with a cross-sectional analysis of the announcement period returns.     

THE EFFECT OF INSTITUTIONAL INTEREST ON THE INFORMATION CONTENT OF DIVIDEND-CHANGE ANNOUNCEMENTS

We test the hypothesis that the information content of dividend-change announcements, as reflected in stock prices, is directly related to the degree of pre-announcement information asymmetry in the stock. The dividend-change announcements include initiations, large increases, large decreases, and omissions. Information asymmetry is proxied by the proportion of stock held by institutions. Consistent with the hypothesis, we document a significantly positive relation between the absolute values of the announcement-period excess returns and the degree of pre-announcement information asymmetry in the stock. This finding appears to hold for all types of dividend changes except dividend omissions.     

Shareholder wealth,information signaling and the specially designated dividend: An empirical study

This paper examines common stock returns and dividend and earnings patterns surrounding specially designated dividends labeled by management as ‘extra’, ‘special’ or ‘year-end’ and compares them to those surrounding regular (unlabeled) dividend increases. The results support the notion that management uses the labeling of dividend increases to convey information to the market about the future potential of the firm. Unlabeled increases appear to contain the most positive information. Contrary to the sometimes suggested view, specially designated dividends appear to convey positive information about future dividends and earnings beyond that relating to the current period.     

The Effects of Cash,Debt, and Insiders on Open Market Share Repurchases

The findings of the authors' recent study suggest, on balance, that stock repurchases function much like tax‐efficient special dividends, increasing when free cash flow is large and when debt levels are low, but not replacing regularly scheduled dividends. Repurchasing companies experience median event returns of about 2% around the repurchase announcements, with a related mean effect of roughly 3%. Companies with greater free cash flow and less debt are more likely than otherwise comparable companies to repurchase their shares. Furthermore, repurchasing companies that exhibit substandard preannouncement stock price returns and seek to buy back higher percentages of shares tend to elicit more positive stock price reactions. At the same time, the study provides some evidence that corporate managers attempt to use their inside information to profit from buybacks. For example, managing insiders in repurchasing firms decrease their selling activity and increase their buying activity two weeks before repurchase announcements to a greater extent than non‐managing insiders. But perhaps the most remarkable finding from this part of the study is how little insiders as a group seem to profit from their short‐term trading behavior—a finding that suggests that the market appears to anticipate much of this behavior.