HD2S
.K414
ALFRED
P.
WORKING PAPER
SLOAN SCHOOL OF MANAGEMENT
EARNINGS INFORMATION CONVEYED BY
DIVIDEND INITIATIONS AND OMISSIONS
by
Paul M. Healy
and
Krishna
October,
1^87
G.
Palepu
WP #1943-87
MASSACHUSETTS
INSTITUTE OF TECHNOLOGY
50 MEMORIAL DRIVE
CAMBRIDGE, MASSACHUSETTS 02139
EARNINGS INFORMATION CONVEYED BY
DIVIDEND INITIATIONS AND OMISSIONS
by
Paul M. Healy
and
Krishna
October,
1987
G.
Palepu
WP #1943-87
EARNINGS INFORMATION CONVEYED BY
DIVIDEND INITIATIONS AND OMISSIONS
Paul
M. Hcaly
Sloan School of Management
Massachusetts Institute of Technology
Krishna
(J.
I'alcpu
Graduate School of Business Administration
Harvard University
September 19R7
We
wish to thank Paul Asquith and David Mullins for making their data available for
The paper
benefited from the
comments of seminar
participants
at
this
University of California
paper
-
Berkeley, Carnegie- Mellon University, University of Chicago, Harvard University, Massachusetts
Institute of
Technology, Northwestern University, University of Oregon, University of
Pennsylvania, University of Rochester, and Stanford University.
Paul Asquith,
Bob Kaplan, Richard
Ross Watts, and the
We
are particularly grateful to
Lcftwich, John long. Stew Myers, Pat O'Brien, Rick Ruback,
referee for their suggestions.
M.I.T.
MOV
LIBRARIES
2 1987
RECEIVED
1
ABSTRACT
This paper examines earnings changes surrounding firms' decisions to initiate or omit
dividend payments.
Firms
changes both before and
that initiate (omit) dividend
after the dividend policy
positively related to the dividend
announcement
announcement of subsequent earnings
change.
return.
positive (negative) earnings
The subsequent
earnings changes arc
Also, the stock price reactions
arc smaller than usual.
(1) dividend initiation/omission decisions reflect
(2) the
payments have
These
at
the
results suggest that:
both past and future earnings performance; and
market interprets the announcement of these decisions as managers' forecasts of future
earnings changes.
I.
INTRODUCTION
This paper examines whether dividend policy changes convey information about future
earnings.
The
topic has been widely discussed in the finance literature.
Modigliani and Miller
(1958) demonstrate that, under conditions of perfect capital markets anil zero taxes, dividends do
not
affect the
content
if
However, they contend
value of the firm.
managers have superior information
to investors
that information to set current dividends (sec Miller
That
is,
a dividend
that dividends
change may indicate a change
in
on the
may have
information
firm's future earnings
and Modigliani (1961) and
and use
l.intncr (1956)).'
management's expectations of future
Dividend changes can thus be thought of as management forecasts of future earnings
earnings
changes substantiated by cash.
The hypothesis on
the information content of dividend changes has been formalized by
Bhattacharya (1979, 1980), John and Williams (1985), Miller and Rock (1985) and Offer and
Thakor
(1987).
In a
Miller and
Rock summarize
this idea as follows:
world of rational expectations, the firm's dividend (or financing) announcements
provide just enough pieces of the firm's sources and uses statements for the market
to
deduce the unobserved
The market's
piece, to wit, the firm's current earnings.
estimate of current earnings contributes in turn to the estimate of the expected
future earnings
Watts (1973),
dividends, examines
earnings; and (2)
on which the
issues:
(1) the relation
abnormal stock returns
decreases in dividends.
market value largely hinges
(p.
1031).
an one of the early empirical studies of the information content of
in
two
firm's
He concludes
for firms that
out, his study has
stock price data,
makes
it
two
announce unexpected increases and
that current dividends provide
earnings and there are no abnormal returns
As Watts points
between unexpected current dividends and future
in
months surrounding
limitations.
difficult to distinguish
First, the
between the
little
information on future
the dividend
announcements.
use of monthly, rather than daily
effect
of dividend and other
Lintner provides empirical evidence that managers consider past as well as future
earnings in setting current dividends.
Gonedes (1978)
also reports similar findings
contemporaneous information
model reduces the power of the
A
They use
Second, the potential noise
releases.
in the
dividend expectation
tests.
recent study by Asquith and Mullins (19R.1) attempts to mitigate the above
daily stork price data to control for other
announcements, such
announcements
as earnings
lhat they believe are least likely to
lie
anticipated,
contemporaneous information
Also, they select a sample of dividend changes
namely dividend
Mullins find that there are significant positive abnormal returns
announcements. Other studies also use
daily data
announcement of unanticipated dividend
While recent studies document
problems
at
Asquith and
initiations
the dividend initiation
and document abnormal returns
at
the
increases and decreases."
a significant stock price reaction to dividend policy changes,
they do not re-examine the relation between dividend policy changes and subsequent earnings,
the second issue analyzed by Watts.
Our
this issue
announcement
inferred
tests differ
The purpose of
from those of Watts
in
this
paper
two ways
returns, rather than unexpected dividends, as a
by the market from dividend announcements; and
policy changes that have been
announcement
returns,
documented
in
(2).
is
(
1)
to provide fresh evidence
we
on
use dividend
measure
ol the
we focus on
information
the
two dividend
the literature as having the largest average
dividend initiations and omissions.
3
These include Aharoncy and Swary (1980), Bricklcy (1983), Kalay and
and Dielman and Oppcnheimer ( 0R4).
1
owenstcin
1
and omissions have on average the largest announcement
imply that they are the largest dollar or percentage dividend
Restricting our analysis to initiations and omissions allows us to examine dividend
While dividend
initiations
returns, this docs not necessarily
changes.
power of our tests
beyond these extreme
policy changes with the largest information content, thereby increasing the
However,
this research design restricts the gencralizabilitv, ol out results
dividend changes
relevant to
all
The reader should therefore be careful not to interpret our findings as
dividend policy changes.
(
1985),
Our sample comprises
after a hiatus
of
at least ten
131 firms that
years and 172 firms that omit dividend
or after continuously paying for
issues.
First,
pay dividends for the
at least
we document changes
after a dividend initiation or
in a firm's
omission.
The
ten years.
return
Finally,
payments
for the
first
lime
designed to examine three
tests are
earnings performance for fi\e years before and
Next, we examine whether subsequent earnings changes
arc related to the information released at the dividend
announcement
lime or resume payments
first
we analyze
announcement,
as
measured by the
the market reaction to earnings
announcements
subsequent to the dividend policy change to assess whether the market anticipates these
earnings from the dividend announcement.
The
results of
our
increases in their annual earnings for as
initiation.
Firms that
tests arc as follows.
many
initiate
as five years before
Firms that omit dividend payments have
dividends have significant
and the year of the dividend
a significant decrease in their
earnings two years before and in the year of the dividend omission
consistent with those reported by
I
intner (1956),
annual
These findings arc
Fama and Habiak (1%S) and Watts
(1972), and
suggest that dividend initiations and omissions can, in part, be predicted by changes in past and
current earnings
to the
Similar to earlier studies,
announcement of
predicted and convey
we
find that there
is
a significant
market reaction
these dividend policy changes, indicating that they cannot be perfectly
new
information.
Tests of the earnings performance subsequent to the dividend policy changes lead to three
conclusions.
for
two years
First, there arc significant increases in
after this event.
omission firms there
is
earnings for firms that initiate dividends
These earnings increases appear
to be
a significant decrease in earnings for only
permanent
1
or dividend
one year following the event
Further, this earnings decrease appears to be temporary since there are significant offsetting
earnings increases in the subsequent two years
Second, earnings changes
in the
year of and
year following a dividend initiation or omission arc positively related to the information that
is
revealed by the dividend
announcement
as
measured by
reaction at the dividend initiation or omission
available prior to the dividend
relation
lie
two day abnormal stock
announcement
I
his relation
is
price
found to
exist
changes and information on future earnings performance
after controlling for prior earnings
is
t
For dividend omissions there
announcements.
is
a negative
between the announcement return and earnings changes three years subsequent
event, consistent with the earnings recovery noted above.
announcements following
price reactions to earnings
significantly less than
at
to the
magnitude of the stock
Finally, the
the dividend initiation or omission are
normal, indicating that these earnings changes
anticipated by the market
that
the date of the dividend
are, at least in part,
announcement
Together, the above three findings indicate that the information conveyed by dividend
initiations
and omissions
announcement of
to the
is
related to earnings
in the
year of ami one year subsequent
these dividend policy changes. This evidence
is
The results arc also consistent with
dividend information hypothesis.
in
changes
making dividend policy decisions managers consider
past, current
I
consistent with the
miner's description that
and future earnings.
Investors therefore interpret dividend initiations and omissions as changes in
managements
forecasts of firms' future earnings.-
One
we examine
bias
is
effect
limitation of our study
firms'
is
that there
is
an ex post selection bias
which have post-dividend earnings
data.
One
I
lie
is
is
organized as follows
In the next section,
research does not address whether investors value dividends per
full
managers consciously use dividends
we
describe the
sc. that is
whether
Also, our results cannot be interpreted
higher payouts arc associated with higher stock prices
as indicating that
However, the
unknown
remainder of the paper
Our
our sample since
possible manifestation of this
the pattern of earnings recovery for the dividend omission firms
of the bias on our resulls
in
as
signals" of future earnings.
data employed in our empirical analysis.
their results
a
summary and
tests
and
discussion of the results
DATA
2.
2.
The paper concludes with
The third section describes the empirical
1
Dividend Initiation lest Sample
Our dividend
initiation
sample comprises the firms used by Asquith and Mullins (1983)
announcements on shareholders' wealth
their study of the effect of initiating dividend
and Mullins define an
resumption of
initiating dividend as the
All
first
and the period studied extends to
at least
one year
after the firm
was
listed
Their
dividend payments
198(1.
on
For
all
either the
Asquith and Mullins' sample of 168 firms
is
initial
in the
New York
ten year screen
initial
after
dividend was paid
or American Stock Exchange.
Moody's
from several sources:
Dividend Record, Standard and Poor's Dividend Record, the Center for Research
Prices,
was
sample therefore occur
sample firms, the
selected
history or the
in a firm's
a dividend after a hiatus of at least ten years.
January 1954 to December 1963.
1963,
dividend
first
Asquith
in
Security
and the Wall Street Journal. The dividend announcement date, defined as the date when
news of the forthcoming dividend
first
appeared
in the
Wall Street Journal, the stock price two
days before the dividend announcement and stock returns for the day before and the day of the
dividend announcement arc collected by Asquith and Mullins for each of the sample firms
For the above 168 firms we
earnings
announcement dates
collect the following additional data:
prior to the dividend initiation
subsequent annual earnings announcement dates.
collected
from the Wall
Street Journal Index.
(2)
dates.
These data
are collected
I)
The
announcement and
'These earnings
six fiscal
year
the five
announcement
dates
arc-
Annual earnings per share before
extraordinary items and discontinued operations reported
announcement
(
at
the
above eleven earning
from the 1984 Compustat Annual
Industrial
and
in
Finns arc included
Research tapes.
in the final
announcement dates and earnings data
Our
and Mullin
sample, 14 arc not
listed
if at
lcasl eight ol ihc
eleven earning
1
;
arc available.
usable sample comprises 131 firms
s
sample
Of
on Oompustat
the 37 firms that arc eliminated from Asquilh
files;
ten
do not have the required number
of Wall Street Journal earnings announcement dates; three have insufficient earnings data before
the dividend
announcement
new
as they were
listings
insufficient earnings data after the dividend initiation
on the NYS1
announcement
oi
AS1
and ten have
;
(eight of these firms
were
acquired, one was involved in an exchange transaction and one was delisted).
We
define the
first fiscal
year earnings announced prior to the dividend initiation
announcement
as earnings for year -1; the
announcement
is
the year
-1
first
annual earnings announced
defined as earnings for year 0.
announcement
The
five
dividend
annual earnings announced prior to
arc defined as earnings for years -6 to -2.
earnings announced subsequent to the year
after the
announcement
Similarly, the four annual
are defined as earnings for years
1
to 4
Since dividend announcements occur throughout the
above include quarterly earnings
One of our
announced
that are
fiscal year,
year
earnings defined
before, as well as after the dividend
compares markcl reactions to annual earnings announcements before
he data
and after the dividend announcements using time-series data for each sample firm
for
each
firm,
imposed
restriction, that at least eight earnings observations arc available
is
primarily to perform this test.
This restricted sample is used in all tests reported in the paper
so that the results are consistent.
However, we also perform all tests other than this market
tests
I
reaction test using available earnings data for the 16R firms
reported
in the
The
results arc similar to those
paper.
As noted above, excluding
bias for our study.
Discussion of the
these
companies from the analysis
effect of this bias on the results
is
creates an ex post survival
deferred to later in
the paper.
B
.
.
....
announcement
announcements is assigned to ycar-1, thcicbv ensuring that all the
years f) to 4 arc announced subsequent to the dividend announcement
Six firms report annual earnings concurrently with the dividend initiation
,ach of these earnings
;
I
earnings assigned to
announcement.
This introduces a potential hias to our findings regarding earnings performance
subsequent to the dividend
To
initiation.
address this problem,
wc perform
additional tests using
quarterly earnings data.
We
announcement date
collect the first quarterly earnings
date from the Wall Street Journal Index
prior to the dividend initiation
Quarterly earnings per share before extraordinary
items and discontinued operations reported on this date, and earnings reported
quarterly
announcements
summed and
are
defined as earnings for year
summed
earnings reported following the dividend date arc
announcement, and earnings
-1
are
for year
announced
arc
strictly
announced
and Poor's Compustat Quarterly Industrial tapes
Quarterly data arc available for 129 of our 131
The
four quarterly
this
procedure.
Defined
this
before the dividend initiation
after the dividend date.
We
use Standard
as the source of quarlcrly earnings data.
test
firms from a search of these tapes
131 dividend initiation firms are in 38 different 2-digit
evidence of industry clustering within the sample
initiating dividends
The
to construct earnings for year 0.
Farnings for year -2 arc also constructed from quarterly data using
way, earnings for years -2 and
-1.
the three prior
at
Table
1
SIC
presents the
by year. The most frequent years of dividend
There
industries.
number of sample
initiation in the
no
is
firms
sample arc
1976 (32 firms) and 1977 (25 firms). 'The dividend initiating year for the remaining 74 firms
in
the sample ranges from 1970 to 1979.
2.2
Dividend Omission Sample
Our
initial
Compustat Annual
Wc
1
dividend omission sample
Industrial
is
identified
by searching the 1984 Standard and Poor's
and Research tapes, and the
CRSP
tapes.
Wc
first list all
the
New
are grateful to the referee for the suggestion leading to this analysis.
Standard and Poors do not construct
information for companies that were delisted,
Quarterly Industrial tape.
we
a
Research tape for quarterly data
searched old copies of the Compustat
To
collect
York and American Stock Exchange firms on
From
period 1969- 1980.
history
(if
this
list
\vc select firms that
they have been listed for
paying dividends for
less
years
at least ten
these tapes which omitted dividends during the
omit dividends for the
first
We
(if
they have been listed for ten years or more). Out
The
thirty firms
date, the date
when news of
announcement date from
the
CRSP
(3) stock returns for the
from the
CRSP
data
files;
(4)
list
of
a dividend
sample thus comprises 210 companies.
above
firms: (1) the dividend
the forthcoming dividend omission
the Wall Street Journal Index; (2) the stock price
Record;
initial
collect the following data for each of the
announcement
in their
than ten years) and firms that omit after continuously
the 240 firms identified from this search, the Wall Street Journal Index does not
omission announcement date for
time
two days before
omission
first
appeared
in
the dividend omission
Daily Master Tape or Standard and Poor's Daily Stock Price
day before and the day of the dividend omission announcement
annual earnings announcement dates and reported earnings per
share before extraordinary items and discontinued operations for years -6 to
4,
using the
procedures described above for the dividend initiation sample.
The
final
sample consists of 172
reasons, 17 firms had missing earnings
firms.
Of
the 38 firms excluded for data availability
announcement dates
in the
Wall Street Journal Index; ten
have insufficient data prior to the dividend omission as they were new
ASF,; and eleven firms have insufficient data after the dividend
listings
announcement
on the
NYSE
or
(four were
acquired, six were delisted and one firm's exchange listing was suspended).
Fifteen firms report annual earnings concurrently with the dividend omission
announcement.
that
all
Each of these earnings announcements is assigned to year- 1, therein ensuring
to 4 arc announced subsequent to the dividend
the earnings assigned to years
announcement
Discussion of the
excluding these firms
is
effect
on our
results of the ex post survival bias that arises
deferred to later in the paper.
from
As noted
for dividend initiations,
our method of aligning annual earnings
relative to the
dividend announcment date leads to a potential bias in our tests of post-omission earnings
correct this problem,
variables for years -2,
we adopt
-1
and
procedure described
in
Section
3.1 to
Quarterly data arc available for 129 of our 172
172 dividend omission firms arc in 42 different 2-digit
evidence of industry clustering within the sample.
The most
omitting dividends by year.
and 1971 (33
construct earnings
using quarterly earnings per share before extraordinary items
and discontinued operations.
The
tlie
Table
1
SIC
test firms.
industries
presents the
number
There
is
no
of sample firms
frequent years of dividend omission are 1970 (50 firms)
The dividend omission years for the remaining S9 firms
firms).
To
in the
sample
range from 1969 to 1980
2.3
Comparison Samples
A matched
evaluating
test firms'
same industry
at
sample of comparison firms
as
Each comparison firm
earnings performance.
its lest
Industry matches are based
firm match.
the date of the dividend initiation or omission
sample
is
required to:
(1)
be
have stock price data on the
listed
on
CRSP
same earnings data requirements
cither the
announcement
New York
Master Tape or
Record two days prior to the dividend
the
collected to provide an earnings
is
initiation or
in
randomly
on the
selected
test firm's
Each firm
in the
for
from the
SIC code
comparison
or American Stock Exchange; (2)
Standard and Poor's Daily Stock
omission by
as the initiation
is
benchmark
its
and omission
match
test
test
firm;
and
1'ricc
(3)
meet
firms
Quarterly data are available for relatively fewer dividend omission firms than for the
initiating sample.
As can be
seen in Table
when
quarterly data available on
occur
in the
I,
Compustat
the omissions arc clustered in the early 1970s,
arc less complete,
whereas the
initiations tend to
mid-1970s.
For test firms currently listed on the Compustat Research tape, we select the
comparison firms from the Research tape This is done to avoid survivorship bias in the
comparison samples. For the remaining test firms we select the comparison firms from the
regular Compustat tape.
We
omission
For
DO
for
dividend initiation
test
tests that require quarterly earnings
101
per share
wc
are able to find data for
omission comparison firms.
TESTS AND RESULTS
The
results of four tests arc reported in this section,
reaction to the
announcement of dividend
initiations
first,
wc
describe the market
Second, wc examine
and omissions.
earnings changes in the five years before and after these dividend events.
between the market reaction
analyzed.
Finally,
announcements
3.1
firms and 171 dividend
firm each in the dividend initiation and omission samples could not
comparison firms and
18 initiating
3.
One
test firms.
he matched.
1
comparison firms
arc able 1o find
is
we
test
to the dividend
is
whether the the market reaction to the subsequent earnings
Market Reaction to Dividend
We
announcements and subsequent earnings changes
than the normal reaction.
less
Third, the relation
Initiations
These
and
tests
results arc described below.
and Omissions
estimate abnormal returns for dividend initiation and omission firms for the period 60
days before to 20 days after the announcement.
market-adjusted returns, that
is,
Abnormal
returns are defined as
the difference between firms' returns and returns
on the
CRSP
equal-weighted market portfolio.
Mean abnormal
are reported in
Table
returns for various holding periods surrounding the dividend
The mean announcement
2.
return (days
-1
and
announcements
0) for the initiation firms
Where possible, SIC matches are based on 4-digit codes Wc arc able to find 122
matches for the initiation sample, and 159 such matches for the omission sample. The
remaining matches are based on 2-digit industry codes.
4-digit
'
The dividend
services, except
motion
initiation firm that
picture, industry.
is
unmatched
is
in the
The dividend omission
amusement and recreation
is unmatched is in
firm that
the apparel and accessory stores industry.
'
The
Abnormal
results reported in
to the definition of
returns were also estimated as risk-adjusted returns from a market
Table 2 and the other
abnormal
tests
returns.
ic
model
reported later in the paper arc not sensitive
is
3.9% and
is
1%
statistically significant at the
level.
There
also evidence that initiating
is
Mean
firms have significant positive returns in the prc-announccmcnt period
-60 to -21, -20 to
1%
level.
-1
These
1
and -10
to -1 are
results are similar to those reported
sample of 168 firms.
1
significant
-1 are
our
1%
respectively,
all
by Asquith and Mullins
significant at the
for their full
8
For the dividend omission
significant at the
3.5%, 1.1% and 4.0%
returns for days
As
level.
mean two day announcement
firms, the
in the case
of dividend initiations,
Mean
pre-announcement returns
-7.0%, -2.7% and -7.0% respectively,
wc
return
is
-9
5%,
find evidence of
returns for days -60 to -21, -20 to -11 and -11 to
all
significant at the
1%
percent level.
Once
again
results are similar to those reported in earlier studies.
The above
findings indicate that investors partially anticipate dividend initiations and
omissions from other information available prior to the announcement of the dividend policy
change.
However, these events
arc not fully anticipated:
the actual
announcement of
the policy
changes conveys information to the market.
3.2
framings Changes Surrounding Dividend Initiations and Omissions
Studies by Ball and
Brown
(1968), Ball and Watts (1972), and Watts and
suggest that annual earnings follow a
random sample of
firms
is
random
walk.
initiations (omissions) arc preceded
by
a
number of
eftwich (1977)
Thus, the average earnings changes
However,
expected to be zero.
I
I
for a
intner (19S6) implies that dividend
years of earnings increases (decreases)
Asquith and Mullins report a two day announcement return of 3.7 percent for the full
Dielman and Oppcnhcimcr report a two day announcement return of 3.5 percent for a
sample of 39 firms that resume cash dividends.
sample.
For example, Dielman and Oppcnhcimcr report
-8.1
a
percent for a sample of 53 firms that omitted cash dividends
1
I
mean two day announcement
return of
Further,
if
dividend policy changes convey information on future earnings, dividend initiations
(omissions) arc expected to he followed by earnings increases (decreases).
To examine whether
we
or omit dividends,
there arc systematic earnings patterns exhibited by firms that initiate
calculate earnings changes for five years before (years -5 to -1), the year
of (year 0) and the four years after (years
results across firms,
two days prior
price
firm
year
in
j
t,
AF: (
AF
where
j
in
we
is
to 4) the dividend policy
announcement,
P:.
To
aggregate
The standardized change
in
earnings for
therefore defined as:
=
(Ejt
jt
-Ejt )/Pj
t
=
-5
4
F:, arc earnings per share before extraordinary items
year
change
express earnings changes in these years as a percentage of the stock
to the dividend
,
1
(1)
and discontinued operations
for firm
t.
Standardized earnings changes are computed for years -5 to 4 for the dividend initiation
and omission firms and
mean and median
addition,
we
for the
same
fiscal
years for the comparison mate
lies
Our
tests
standardized earnings changes for the intiation and omission firms.
examine
In
analyze industry-adjusted standardized earnings changes for these firms, defined as
the difference in standardized earnings changes for the initiation/omission and comparison
firms.
Dividend
initiation results
Mean and median
earnings changes as a percentage of equity price are reported
of Table 3 for the dividend initiating firms for years -5 to
on
4.
we only
require that firms have earnings change data in seven
12
Panel
Panel M reports mdustry-
The number of firms with available earnings change data
since
in
(if
differs across years -5 to 4
the ten years.
A
adjusted
numbers
for these
same
firms are insignificant in years -5 to
1%
initiating firms are
-1.
As
the results in Panel
matched by
mean
4.3% and
is
annouccment, there
B
is
These findings indicate
significant at the
is
a further
5.5%
increase in
indicate, the earnings increases of the
similar earnings increases for the industry
However, the earnings increase
industry factors.
standardized earnings changes for the initiation
In year -1 the
-2.
In year 0, the year of the dividend
level.
standardized earnings.
year
Mean
firms.
comparison firms
in
cannot be attributed to
for initiating firms in year
that dividend initiating firms arc in
growth industries
but have superior earnings performance in the year of the dividend initiation.
One
announcement we
year subsequent to the dividend
earnings change
is
2.2%
(p
=
0.07); the following year the
earnings changes are insignificant in years 3 and
significantly larger than that for the industry'
The
4.
find thai the
mean change
is
mean
3.5% (p=
earnings increase for the
comparison firms only
in
standardized
Mean
0.01).
firms
test
is
year 2
Conclusions from median earnings changes are generally consistent with the above
findings.
For the
test
-5, -4, -2
periods before (years
2) the
firms there are significant median earnings increases in four of the
dividend announcement.
significant in
two of
and
-1),
the year of (year 0) and
two years
after (years
1
and
Median industry-adjusted standardized earnings changes
the years before (years -4 and -3), the year of (year 0) and
arc
two years
following the dividend event.
Thus, firms that
prior to the dividend
initiate
dividends experience earnings growth starling as
announcement.
announcement and two subsequent
The
years.
many
as five years
earnings growth continues in the year of the dividend
These findings arc consistent with the hypothesis thai
The mean earnings change for year 1, reported in Table 3, includes an observation
which has an earnings decline that is 86% of price. This company is Valmac Industries, which
in this year acquired Rite Care Corporation and recorded a large loss on this new business. If
this observation is excluded, the sample mean in year
is significant at the 1% level in both
Panels A and B.
1
1
5
managers consider past and current performance
as well as expectations of future earnings in
the dividend initiation decision.
One
limitatioti
of the above results
is
that they arc based
on earnings data
that arc
reported annually whereas changes in dividend policy arc reported throughout the year.
median number of trading days between the announcement of the dividend
first
subsequent annual earnings announcement date
is
171 trading days.
initiation
earnings in Table 3
announcements
that precede the dividend
To examine
replicate the
strictly
above
whether our
tests
may have been
reported
We
using quarterly earnings.
earnings are created from the four
to the dividend change; year
and year
-1
for quarters -5 to -R.
we
redefine annual earnings so that they are
-1
earnings are constructed
from the four quarterly earnings announced prior to the event; and year
year
quarterly earnings
results arc sensitive to the use of fiscal year earnings data,
announcements subsequent
from announcements
in
fiscal year.
announcement
aligned with the dividend announcements: year
quarterly
and the
This indicates that
dividend initiation announcements occur after approximately one quarter of the
Therefore, part of the year
The
-2 earnings arc created
Realigned earnings changes arc then calculated for
and arc standardized by the stock price two days prior to the dividend
announcement.
Mean and median
values of raw standardized earnings changes
initiation firms are report in Panel
Panel
B
A
of Table
In contrast to the year D earnings in
announced
strictly after the
We
adopt
this
in years -1
and
Industry-adjusted figures are reported
4.
Table
3,
year
(1
earnings
for the
in
in this table are
dividend announcement.
approach since we do not have enough time
estimate firm-specific quarterly earnings expectation models.
unlike annual earnings, quarterly earnings do not follow a
14
scries
observations to
Previous results suggest that,
random walk
(Sec Foster (1977))
Mean
year
standardized earnings changes for the initiation firms arc
These are both
0.
significant at the
1%
one year prior
earnings, the earnings change
in
year
-I
and 4.5%
In contrast to results for fiscal yeai
level.
announcement
to the dividend
earnings change in the event year, indicating that the
5.4%
is
larger
than the
year findings understate earnings
fiscal
changes prior to the dividend initiation and overstate earnings changes subsequent to the event.
The mean
at
the
5%
industry-adjusted standardized earnings change
The mean
level.
for year
is
1.23% and
is
attributable to a small
number of extreme observations
difference for year
1.72% and
is
is
significant at the
the significant annual earnings changes for year
0,
is
2.85%
in vent -I
not significant
in the
5%
in
is
However,
comparison sample:
significant
this finding
the
is
median
These findings indicate that
level
reported
and
Table
3,
cannot be
fully
announced before the dividend announcement.
attributed to quarterly earnings
Dividend omission results
Panel
A
of Table
5 presents
summary
standardi7.cd earnings changes in years -5 to
statistics for the
Panel
4.
B
dividend omission firms
presents the industry-adjusted
standardized earnings changes for the same years.
The
The means
There
is
test firms'
for years -2
mean
and
also a significant
omission.
The
standardized earnings changes are insignificant
-1
arc
-1.2% and -7.7% respectively and
-13.5% mean earnings change
results in Panel
B
in
year
0,
years -5 to
-3.
arc statistically significant
the year of the dividend
indicate that the earnings decline in year -2 could be
However,
attributed to industry-related factors
in years -1
and
earnings declines even after adjusting for industry performance
initiations, dividend
in
the omission firms have
Thus, similar to dividend
omissions follow significant earnings changes
Subsequent to the dividend announcement, the omitting firms experience two years of
significant positive earnings:
6.3%.
in
year
I
and 9.4%
is
in
year 2
The earnings
increases cannot
in
be attributed to industry factors as they
earnings patterns following dividend initiations.
initiation persist for several years
omissions reverse
These
persist in Panel B.
The
results differ
from the
earnings increases prior to a dividend
subsequent, whereas the declines
in
earnings prior to dividend
subsequent years.
in
The above findings indicate that dividend omissions are preceded by declines
However, these declines do not
persist
beyond year
0.
Year
between the announcement of the dividend omission and the
cannot
136 days, about two
is
(The median number of trading
first
subsequent annual earnings
Based on the above
fiscal quarters.)
infer that there arc earnings declines following the dividend omission.
issue further,
Once
we
announcements.
we
To
Year
(-1) earnings
two days prior
are reported in Panel
to the dividend
A
of Table
6.
These values are
after the
in
year
-1
and -6.6%
announcement
in
raw earnings
in
Industry-adjusted numbers are reported in Panel
significant at the
in
year
0.
Since
1%
all
level.
year
I
he
mean
in
years
P>
years
up
anil
The
-1
and
earnings changes here arc announced
to four quarters subsequent to the dividend omission.
16
-1
industry-adjusted changes
dividend omission date, these results indicate that there are significant earnings
declines for
in the
These numbers are standardized by
omission firms have mean standardized earnings changes of -10.3% and -10.0%
-9.0%
explore this
changes are Ihc sum of earnings changes announced
Dividend omission mean and median standardized changes
are
we
redefine annual earnings so that they are strictly aligned with the dividend
four quarters subsequent (prior) to the dividend omission
respectively.
results,
analyze quarterly earnings data around the dividend omission date
again,
the stock price
earnings
earnings include quarterly
earnings announced both before and after the dividend omission.
announcement date
in
In
summary, the above
changes for up to
results indicate that dividend initiating firms
five years prior to
and
in the
have positive earnings
year of the dividend announcement; the
dividend omitting firms exhibit negative earnings changes for up to two years before and the
year of the dividend event.
these firms' industries.
They
These patterns
even
after controlling for the
patterns.
Evidence on the post-announcement earnings patterns
is
earnings for these firms appears to be permanent.
The
the
3.2
wc
find
In contrast, the dividend omission firms have
by these firms before and shortly
after the
post-announcement performance of the omission firms
is
Further, the earnings
omissions announcement appears
One
temporary as indicated by the subsequent earnings recovery.
This issue
initiations,
increased level of
earnings declines only for one year after the dividend announcement.
to be
For
mixed.
announcement
earnings growth for two years after the dividend
decline experienced
performance of
are consistent with the proposition that these dividend decisions
by systematic earnings
are preceded
persist
possible explanation for
the survival bias in our sample.
discussed later in the paper.
is
Relation Between Dividend Information and Earnings Changes
We
next
test
whether the post-announcement earnings changes documented
section are related to the market reaction to the
omission.
If
announcement of the dividend
changes
A
previous
initiation or
dividend policy changes are based on managers' expectations of future earnings,
there will be a positive relation between dividend
changes.
in the
simple regression framework
in years
to 4
is
announcement returns ami subsequent earnings
used to
test this
prediction for fiscal year earnings
and annualized quarterly earnings changes
year earnings are described below.
in
year
Discussion of modifications to these
quarterly earnings arc deferred to the results section.
17
0.
Tests using
tests for
fiscal
annualized
examining the relation between the earnings changes and the market reaction
In
to the
dividend announcement, our tests control for information on future earnings from sources other
than the dividend announcement.
First,
Tables 3 and
dividend initiation and omission firms deviates from a
changes
may
5 indicate that the
random walk
be used to forecast subsequent earnings changes
earnings in year
t-1 is
included as an independent variable
in
earnings time scries of
Therefore, prior earnings
The standardized change
the regression
model
in
for year
to
t
control for this earnings pattern.
The second
to the market
we
source of information on future earnings
between the earnings announcement
omission announcement.
for year
-
1
is
and the dividend
show
Results reported in section 3.1
control for
information released
initiation or
that there arc significant
abnormal
returns prior to the dividend announcements, indicating that information regarding the sample
companies' future performance
is
released during this period.
The market-adjusted return
cumulated from one day subsequent to the earnings announcement
to the dividend date
We
AF,:
is
is
=
B
+ B,DRETj + B 2 AI
;
j
.,
t
+ B PRBTj +
3
the standardized earnings change for firm
PRUT:
is
two days
prior
j
in
year
Uj,
j
=
I
t, t
=
to
4:
N
(2)
as defined in equation (1);
t
the cumulative market-adjusted return from one day
subsequent to the earnings announcement for year
initiation or
\
to
the market-adjusted return for one day before and the day of the dividend initiation
or omission announcement; and
i
1
used to proxy for this information.
(
DRET:
-
estimate the following cross-sectional regression separately for each year
AFj,
where
is
for year
-1
to
two days prior
to the dividend
omission announcement.
.
.
...
This information could be from prior quarterly earnings announcements or anticipation
of the dividend news.
IK
The
primary interest
coefficient of
equation (2)
in
omissions convey information about future earnings,
In addition,
if
earnings changes in year
Dt
earnings, the coefficient
Bi.
If
this coefficient
dividend initiations and
is
positive
can he used to forecast the change
t-1
be non-zero.
will
is
Finally,
Dividend
D-^ will
in
significant
year
information released prior to
if
dividend announcement but after the previous earnings announcement
earnings performance, the coefficient
and
is
t
tin-
related to subsequent
be positive.
initiation results
Equation
(2)
estimated cross-sectionally, using the 131 dividend initiating firms, for each
is
of the five years subsequent to the dividend initiating announcement.
reported in Panel
A
of Table
and
coefficients (Bi) in years
The
7.
1
estimates for the dividend announcement return
are 0.197
and 0.356 and arc
26
levels respectively using a two-tailed test.
This evidence
is
significant at the
year of and the year following the dividend initiation:
dividend initiation implies a
0.2% and 0.36%
a
1%
10% and 5%
consistent with the hypothesis
announcements convey information about
that dividend initiation
These estimates arc
firms' earnings prospects in the
abnormal
price reaction to a
increase in standardized earnings in these years
number of observations used to estimate the regression in each year varies
The number for each year is different from the number of
observations reported by year in Table 3 for two reasons.
First, we use earnings changes in
two successive years in each regression. Second, wc require the annual earnings announcement
The
and
is
actual
reported in Table
7.
date prior to the dividend
reduce the
number of
announcement
to calculate
PRET.
These additional data requirements
usable observations.
z-
White tests for hctcrosccdasticity arc not significant for any of the five regressions
White (19R0) for a description of this test). Belslcy, Kuh and Wclsch diagnostics, which
assess the effect of extreme observations on the regression coefficients, are also examined (see
Rclsley, Kuh and Welsch (19R0) for a description of these diagnostics).
The reported coefficient
estimates do not appear to be influenced by extreme observations.
(see
Since the information hypothesis predicts the sign of the dividend return coefficient to
be positive, a one-tailed
coefficients for years
in the tables are for a
test is
and
1
probably more appropriate.
are significant at the
more conservative
5%
two-tailed
19
level.
test.
Under
a one-tailed test the
The significance
levels reported
.
The
coefficients for year 2 to 4 arc insignificant, indicating that dividend
no information on earnings changes beyond year
The
coefficient estimate for the
10%
significant at the
level in the year
negative and significant at the
1%
change
announcements convey
1
in
earnings in year
The estimated
regression.
fW
t-1,
is
positive arid
coefficient for year 3
Fstimatcs for other years are not significant.
level.
is
Finally,
the coefficient estimates for the market adjusted stock return, cumulated from the earnings
announcement
at
the
1%
in year -1 to the
level in the year
dividend initiation announcement (B^)
regression.
The estimates of R^ arc not
is
0.12 and
is
significant
significant for years
1
to
4.
We
between the earnings change
also replicate the test of the relation
in
year
and the
market reaction to the announcement of the dividend policy change using annualized quarterly
earnings.
for
Fquation
(2) is
estimated cross-scctionally for year
which quarterly earnings data are
return for firm
is
redefined as the market-adjusted
cumulated from one day following the previous quarterly earnings
j
announcement
PRET:
available.
for the 129 initiating test firms
to
two days prior
announcement.
to the dividend
Tabic 8 reports the estimated
regression coefficients.
The
estimate of the dividend
significant at the
5%
level
using a two-tailed
price increase at a dividend initiation
standardized earnings year
information
do not
return coefficient
The
test.
announcement
is
0.31
and
estimate implies that a
associated with a
The earnings change measure for year
the dividend
is
announcement.
is
statistically
1% abnormal
0.3% change
in
corresponds to
Therefore, this finding provides
Quarterly earnings announcements for 16 initiating firms arc reported on the same date
as the dividend
results
0.
strictly released after
27
announcement
announcement. Fquation
from those reported.
(3)
is
estimated after excluding these firms and the
differ
20
further support for the hypothesis that dividend initiations provide information
on subsequent
earnings.
Dividend omission results
The parameters
of regression equation (2) are estimated cross-scctionally using the 172
dividend omitting firms in the sample.
years
These estimates
to 4.
The
and
1
Separate equations arc estimated for each of the
are reported in Panel
B of Table
7.
estimates for Bi, the dividend omission return coefficient, arc 0.42 and 0.39 in years
and are
5%
significant at the
10%
and
levels respectively in a two-tailed test.
findings are consistent with the information hypothesis: the estimates indicate that a
unexpected decline
the omission
in price at
announcement
The
estimate for year 3
is
The
in years 0, 3
the
1%
and
4.
This
,
The estimated
For years
is
1
and
2,
the estimated coefficient
is
The
is
is
not significant
negative anil significant
at
consistent with the turnaround in the earnings performance of the
The
coefficient estimates for the cumulative
market-adjusted return between the earnings announcement
and
the following
coefficients for years 2
the coefficient of the earnings change in year t-1,
dividend omission sample in these years.
2R
announcement and
significant.
estimate for Bt
level.
1%
negative and significant, reflecting the earnings recovery
subsequent to the dividend omission documented above.
and 4 are not
These
accompanied by about a 0.4%
is
decrease in standardized earnings in the year of the dividend
year.
fiscal
actual
reported in Table
number of observations used
The number for each year
7.
observations reported by year in Table
4.
This
is
in
year
-1
and the dividend omission
to estimate the regression in each year vanes
is different from the number of
due to additional dala requirements discussed
earlier.
Once
again,
White hctcrosccdasticity
tests
and
diagnostics indicate that the regressions are well-specified.
21
Bclsley,
Kuh and Welsch
influence
announcement,
years
1
B-^, is
and
0.13 in year
is
significant at the
5%
The estimates of B3 for
level.
to 4 arc insignificant.
Once
again,
we
replicate the test of the relation
between the earnings change
in
year
and the market reaction to the announcement of the dividend policy change using annualized
Equation 2
quarterly earnings.
test
rc-estimatcd cross-scctionally for year
in
firms for which quarterly earnings data are available."
regression coefficients.
and
is
statistically significant.
is
Table 8 reports the estimated
estimate of the dividend announcement return coefficient
The
Since year
omission
for the 129
earnings arc announced
strictly after
is
0.39
the dividend
date, this finding provides further support for the dividend information hypothesis.
In
summary, the
indicate that there
is
results for
both the dividend
a positive relation
announcements and earnings changes
These
year following.
years,
results are
initiation
and the dividend omission sample
between the market reaction
to the dividend
for the year of the dividend policy
change and for one
obtained after controlling for the earnings changes
in prior
and information on future earnings available before the dividend announcement.
consistent with the hypothesis that dividend initiations or omissions convey information
They arc
on
future earnings performance.
3.4
Market Reaction to Earnings Announcements After Dividend Initiations/Omissions
A number
of accounting studies have documented that there
announcement of unexpected
reaction to the
earnings.'
We
is
a significant stock price
use the following model to
Quarterly earnings announcements for 30 omission firms are reported on the same date
as the dividend
results
do not
31
Morse
announcement. Equation
from those reported
(2)
is
estimated after excluding these firms and the
differ
See Ball and
Brown
(1968), Beaver, Clarke and Wright (1979) and Beaver,
(1980).
22
lambcrt and
represent the usual relation between earnings
announcement returns and
the si/e of unexpected
earnings:
ARETj
where ARFTjj
for firm
j
j
+ RijAi
+
;
ej
t
=
-5 to 4.
j
=
1
to
t
j,
N
the market-adjusted return at the lime of the annual earnings
is
year
in
= D
t
and
t
AEu
is
(4)
announcement
unexpected earnings based on a random-walk earnings
expectation model deflated by the firm's equity price two days before the earnings
announcement. The parameters B n and Bj
are
the market reaction to unexpected earnings and
assumed
is
to be firm specific. Bi
is
the elasticity of
expected to be positive, consistent with the
findings of the earlier studies.
The
results presented in the previous section
announcements convey information on subsequent
market to revise
its
show
that dividend initiation or omission
These announcements enable the
earnings.
expectation of earnings and thus reduce
its
measures of unexpected earnings based on a random walk model do not
information
earnings forecasts.
in
therefore, the elasticity of the
model
will
be
To
ARET
jt
less
B
reflect this additional
In years subsequent to the dividend initiation or omission,
market reaction to unexpected earnings based on a random walk
than "normal".
test the
=
However,
forecast errors.
oj
above prediction, we use the following modified form of equation
+ B,jAF jt
+^^D
i
ti
AEjt
=
23
+
e
t
jt
=
-5 to 4,
j
=
1
to
N
(4):
(5)
The
parameters Uq to U4 arc cross-sectional average adjustments to Dj:
five
the elasticity of
,
the market reaction to unexpected earnings, in each of the five years following the dividend
The
initiation or omission.
multiplicative
dummy
variable D.: takes the value
following the dividend initiation or omission, and zero in other years.
announcement
leads the market to revise
its
Uq to
The sample
114 will
in years
in
year
i
the dividend policy
forecast of subsequent earnings,
earnings will be noisier estimates of unexpected earnings
the parameters
If
one
changes
in
to 4 than in -5 to -I,
and
be negative.
distribution of estimated
company-specific coefficients Bq: and Bj:.
t
statistics is
used to
test the significance
For each parameter the following
/.
of the
statistic is
computed.
N
z =
i/v^y^
i=
where
is
t:
is
the
t
statistic for
firm
j
/^kj/(kj-2)
tj
1
associated with the estimate of the parameters B or Di; k:
()
the degrees of freedom in the regression for firm
The
sample.
t
statistic for
firm
Central Limit Theorem, the
variance of N.
The Z
j
is
sum
statistic for
t
test is
used to
test
and
distributed Student
of the standardized
each parameter
the null hypothesis that the parameter (Bq or Bi)
Student
j;
is
is
t
t
N
is
the
number of
firms in the
with variance k:/(k:-2).
statistics is
Under the
normally distributed with a
therefore a standard normal variate under
not significantly different from zero.'
the significance of the parameters that arc
A
assumed constant
across firms (uq to U4).
For a detailed discussion of this test sec Christie (19S6). The test is based on the
sample distribution of the parameter estimates. It is assumed that the parameters arc
independent across firms in the sample.
24
Dividend
initiation results
The parameters of
regression equation (5) are estimated jointly using
ten years for the 131 dividend initiation
coefficients Dq:
and
Bj:,
estimate of U]
The
is
0.0039, and
The sample mean of
test.
is
-0.1280 and
estimates of pj,
of the regression
is
[ij,
distribution of the estimated regression
and the estimated values of the u coefficients arc shown
The sample mean value of Bq
two-tailed
The
test firms.
observations over
tlic
is
which
0.2894 and
is
U4
is
the
5%
are not significantly different
These
level
Tabic
level
1%
also significant at the
statistically significant.
is
1%
statistically significant at the
statistically significant at
M3. and
0.272,
Dj
is
in
using a
zero.
The
level.
using a two-tailed
from
9.
test.
The adjusted
R
results arc consistent with
the hypothesis that the magnitude of the market reaction to the earnings change during the one
year following the dividend initiation
is
than the "normal' market reaction for a given level
less
J
of earnings change.-
Dividend omissions results
The
coefficients of regression equation (5) are estimated for the 172 dividend omission test
firms using ten years' observations.
These
results are reported in
values of Bq and Bi are 0.0038 and 0.2714 respectively.
Table
Both these
The sample mean
10.
values,
which arc very
similar to those obtained for the dividend initiation sample, are statistically significant at the
level.
The
coefficient estimates for
ug to
and -0.1048. The estimates of Ug, Ui,
estimate of
\ia is significant at
the
u.4 arc, respectively, -0.1 148, -0.1 182,
\ij,
5%
and
level
u-^
are significant at the
using a two tailed
test.
1%
These
1%
-0.1323, -0.1 194,
level,
and the
results are
consistent with the hypothesis that the magnitude of the market reaction to the earnings change
during the
five years
following the dividend omission
dividend omission for a given level of earnings.
which
is statistically
•"
An
significant at the
1%
alternate explanation
is
The
is
less
than the market reaction before the
adjusted
R
of the regression
is
0.296,
level.
that there
is
abnormally high noise
to the dividend initiaton, reducing the earnings coefficient in these years.
25
in
earnings subsequent
The
initiation
year
regression results for the dividend omission sample differ from those for the dividend
sample
in
significantly negative for the dividend
This
is
is
|t
significantly negative only in
whereas the estimates of the
for the dividend initiation sample,
omission.
The parameter
one important respect
omission sample
in all five years
|i
parameters arc
following the dividend
noteworthy given that the earnings changes
particularly
omission sample change from negative to positive
after year
(I.
The
for the dividend
negative value of u
in later
years for the dividend omission sample cannot be attributed to information revealed by the
dividend omission announcement.
the market receives
possible explanation for the negative coefficients
more non-accounting information than
showing
a dividend omitting firm starts
earnings announcements
3.5
One
a
turnaround
in its
is
that
usual on the firm's performance once
performance.
If this is
the case,
years arc likely to convey less information than usual.
in these
Sample Selection Bias
Our
tests
use earnings data for a
subsequent to the date of the dividend
requirement
is
initiation firms
violated for
one of
and ten omission
minimum
initiation or
five reasons:
(1)
of two years and a
maximum
omission announcement.
new
listing prior to the
firms); (2) corporate control
-
of five years
This data
dividend date (three
change subsequent to the dividend
date (nine initiation firms and four omission firms); (3) dclistmcnl or suspension from the
exchange subsequent to the dividend date (one
Compustat coverage (14
Wall Street Journal.
sample and
18%
initiation firms- •);
The
of the
initiation firm
and
(5) earnings
and seven omission firms);
announcement dates missing
firms that arc excluded account for 22
initial
(4)
n
n
no
in the
of the original initiating
omission sample.
This requirement
is
imposed
to ensure that
we have
sufficient
observations to estimate
firm-specific coefficients in the regression tests reported in Section 3.4.
No
omission firms are excluded for lack of coverage on Compustat since Compustat was
initial sample
used to generate the
26
The
exclusion of the above companies for data availability reasons leads to a potential
selection bias.
If
the reason for exclusion
is
related to the dividend initiation or
decision, the bias systematically influences the reported results.
initiation firms
if
The most
firms and 17 omitting firms
There
is little
Compustat or the Wall
is
mean
earnings changes for the population.
uncertain.
mean change
mean
in earnings.
frequent reasons for exclusion are that firms arc not covered on Compustat or
have missing earnings annoucement dates
firms
the dividend
the best performing firms are excluded from the omission sample, the sample
earnings decline overstates the population
reasons.
il
which arc excluded are the worst performers, the sample mean earnings increases
surrounding the dividend announcement overstate
Similarly,
For example,
omission
It
in the
(65% and 45%
Wall Street Journal
Twenty-four
initiating
of those excluded respectively) are excluded for these
evidence on the characteristics of firms that arc not covered by
Street Journal.
Therefore, the effect of the bias from excluding these
seems plausible that Compustat and the Wall
that they consider to be of interest to the investment
community.
Street Journal cover firms
If,
for
some
reason, the
worst performing initiating firms and the best performing omitting firms arc considered
uninteresting, then the bias increases the probability of finding results similar to those reported
in the paper.
New
37%
listings prior to,
and acquisitions subsequent
to the dividend date account for .12%
of the firms excluded from the initiation and omission samples respectively.
excluding these firms
is
again uncertain:
newly
listed
in the
omission sample, our
and acquired firms
The one
arc
The
effect
they could cither be performing well or poorly.
poor performers
in the initiation
If
of
the
sample and good performers
results are biased.
systematic bias that can be identified
of dclistments subsequent to the dividend date.
It
is
27
is
for firms that have been excluded because
likely that these firms are
poor
and
Hence, the seven omitting firms (19% of the excluded
performers.
excluded for this reason lead to an understatement of the
The
omissions.
mean
initialing firms)
which arc
earnings decline surrounding
earnings recovery documented for dividend omission firms may, in part, he
Since only one initiating firm
attributed to this bias.
excluded for this reason, the
(3%
of the excluded omitting firms)
of the bias on the initiating sample results
effect
likely to
is
is
be
small
In
summary, the
unavoidable
in studies
effect
which
of the selection bias on our results
rely
on ex post
time-series data,
is
uncertain.
and suggests
This
problem
is
our results be
that
interpreted with caution.
4
SUMMARY AND
The
tests
DISCUSSION
reported in this paper examine whether there arc significant changes in firms'
earnings performance surrounding cither a dividend initiation or omission and,
if
so,
these changes are consistent with the market reaction to the dividend policy changes
examine a sample of
years,
131 firms that
and a sample of 172 firms
paying dividends for
pay dividends
that
at least ten years
for the
first
omit dividends for the
Wc
time or after a hiatus of ten
first
All the dividend policy
whether
time or after continuously
changes examined occur between
1969 and 1980.
The
statistical tests
and
results presented in the
there arc significant earnings increases for as
announcements and
announcements.
many
paper lead to four conclusions.
as five years prior to dividend initiation
significant earnings decreases for
two years prior
Second, firms have earnings increases for the year
a dividend initiation; these increases
First,
appear to be permanent
to dividend omission
of,
and two years following
Firms that omit dividends have
earnings declines for only one year prior to the dividend date; subsequently, the omission firms
experience a recovery in earnings
Third, the abnormal stock price reactions to the dividend
28
initiations or
omissions arc correlated with the firms' earnings changes
year subsequent to the dividend announcements.
for prior earnings
This relation
found to
changes and information available to the slock market
dividend announcement
is
less
for five years following
at
year of and one
exist after controlling
the time of the
Therefore, dividend initiations and omissions seem to provide
incremental information firms' future earnings performance.
earnings changes
is
in the
than usual
in the
Finally, the
market reaction to
year following dividend initiation announcements, and
announcements of dividend omissions. Once
again, this
is
consistent
with the hypothesis that the dividend initiation or omission announcements anticipate subsequent
earnings changes.
The dividend
initiation findings provide strong
support for lintner's (1956) description of
managers' dividend decision-making process, and the dividend information hypothesis proposed by
Modigliani and Miller (1961).
Managers appear
performance when they decide to
initiate
to consider both past and future earnings
Dividend
cash dividends.
initiation decisions arc
therefore interpreted by the market as managers' forecasts of future earnings increases.
dividend omission results are
The
While firms appear to have earnings declines
less conclusive.
surrounding the dividend omission, most of the declines occur before the dividend
announcement.
The subsequent
earnings declines arc short-lived and arc quickly reversed.
There are two caveats to the interpretation of our
post earnings time-series data, the results
Second, while there
is
about future earnings,
to
communicate
One
may have been
results.
First, since
our
tests
use ex
influenced by a sample selection bias
evidence that dividend initiation and omission decisions arc informative
this
docs not necessarily imply that managers make these decisions solely
their earnings forecasts.
possible extension of this paper
is
to
examine earnings changes surrounding unexpected
29
dividend increases and decreases.initiations
large
and omissions.
announcement
As noted
earlier,
our sample comprises only dividend
These arc relatively rare changes
returns, thereby increasing the
a
dividend policy.
power of our
representative of the population of dividend policy changes.
whether our findings can be generalized to
in
It
tests,
they
would be
may
While they have
not be
interesting to
examine
wider class of dividend policy changes.
Ofcr and Siegel (I9R7) examine a sample of unexpected changes
in dividends.
report evidence of revisions in analysts' forecasts of earnings subsequent to these dividend
changes which arc consistend with our findings.
JO
They
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Aharoncy,
and
J.
An
returns:
Swary, 19R0, Quarterly dividend and earnings announcements and stockholders'
I.
empirical analysis, Journal of Finance 31, 1-12
D.W. Mullins, 1983, The impact of initiating dividend payments on shareholders'
Journal of Business 56, 77-96.
Asquith, P. and
wealth,
and P. Brown, 1968, An empirical analysis of accounting income numbers, Journal of
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Ball, R.J.
Some
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Finance 27, 663-682.
Ball, R.J.
Beaver, W.H., R. Clarke, and
W.
time series properties of accounting income, Journal of
Wright, 1979,
The association between unsystematic security returns
Journal of Accounting Research 17, 316-340.
and the magnitude of earnings forecast errors,
Beaver, W.H., R. Lambert, and D. Morse, 1980,
of Accounting and Fconomics
Kuh and
Belsley, D.A., E.
The information content
of security prices, Journal
2, 3-28.
Welscli, 1980, Regression diagnostics, (John Wiley and Sons,
R.F.
New
York).
Bhattacharya,
S.,
1979,
Bell Journal of
Bhattacharya,
S.,
Fconomics
Bricklcy,
J.,
Imperfect information, dividend policy, and 'the bird in the hand' fallacy,
Fconomics
259-270.
10,
1980, Nondissipative signalling structure
1983,
Shareholder wealth, information signaling and the specially designated dividend,
Journal of Financial Fconomics
Christie, A., 1986,
Aggregation of
Diclman, T.E. and
II.
187-209.
An
evaluation of the consistency of evidence on
Unpublished paper, University of Southern California.
An examination of investor behavior during periods of
Journal of Financial and Quantitative Analysis, June, 197-216.
R. Oppcnhcimcr, 1984,
large dividend changes,
II.
12,
test statistics:
contracting and size hypotheses,
Fama, F.F. and
and dividend policy, Quarterly Journal of
95, 1-24
Babiak, 1968, Dividend policy:
Statistical Association, 63,
An
empirical analysis, Journal of the American
1132-1161.
Foster, George, 1977, Quarterly accounting data: Time-series properties and predictive-ability results,
Accounting Review 52,1-21.
Goncdes, N.J., 1978, Corporate signaling, external accounting, and capital market equilibrium:
Evidence on dividends, income and extraordinary items, Journal of Accounting Research
16,
26-79.
John, K. and J. Williams, 1985, Dividends, dilution and taxes:
Finance, September, 1053-1070.
Kalay, A. and U. Lowenstein, 1985,
A
signalling equilibrium,
Predictable events and excess returns:
announcements, Journal of Financial Fconomics
31
14,
423-450.
Journal of
The case of dividend
I
intner,
J.,
taxes.
1956, Distribution of incomes of corporations among dividends, retained earnings, and
American Economic Review, 46, 97-1 13.
Mil, and K. Rock, 1985,
Finance 40, 1031-1051.
Miller,
Ofer,
A
and D.
Sicgel, 1987,
Dividend policy under asymmetric information,
Tests of rational signalling
application to dividend signalling,
models using expectations
The Journal of
data:
An
Journal of Finance, forthcoming.
and W. I hakor, 1985, A theory of price responses to alternative cash disbursement
methods: Stock repurchases and dividends, Unpublished paper, Northwestern University.
Ofer, A.
Watts, R., 1973,
The information content of dividends, Journal of Business 46, 191-21
and R. Leftwich, 1977, The time
Accounting Research 15, 253-271.
Watts, R.
White, llalbcrt, 1980,
A
scries
1.
of annual accounting earnings. Journal of
hctcroscedasticity-consistcnt covariance matrix estimator and a direct
for hetcroscedasticitv,
Fconomctrica 48, 817-838.
52
test
Table
Number
of
sample firms
dividends by year
in
1
and omitting
initiating
the period
1
970-1 979 a b
.
Companies
initiating
Number
Year
dividends
Percent
Companies
omitting
dividends
Number
Percent
1969
1970
1971
1972
1973
1974
1975
1976
1977
1978
1979
1980
131
Total
a
100.0
172
100.0
dividend payments in a firm's history or dividend resumptions after a
Dividend omissions are first time eliminations by firms that paid
dividends continuously throughout their history or for at least ten years.
Dividend
initiations are first
hiatus of at least ten years.
D
To be included in the sample, firms are required to meet the following requirements: (1) be listed
NYSE or ASE; (2) have dividend initiation/omission announcement dates available in the Wall
on the
have stock price data available for two days before the dividend
the CRSP daily Master Tape or Standard and Poor's Daily Stock
Price Record; (4) have stock returns available on the CRSP data files for the day before and the day
the dividend initiation/omission announcement; (5) have annual earnings per share before
extraordinary items and discontinued operations available from the 1984 Compustat for 8 of the 11
years surrounding the dividend initiation/omission announcement date; and (6) have earnings
Street Journal index;
initiation/omission
(3)
announcement on
announcement dates
available
in
the Wall Street Journal Index for these
same
years.
of
Table 2
Abnormal returns
dividend initiating and 172 dividend
omitting firms for selected holding periods surrounding the
public
for
131
announcement date
(t
statistics
in
Dividend
period b
Holding
PD-60
to
PD-20
PD-10
to
to
PD-21
PD-11
PD-1
Dividend
firms
initiating
omitting
PD
to
(4.8)
(-4.0)
1.1
-2.7
(2.7)
(-3.1)
4.0
-7.0
(-8.0)
-9.5
3.9
(-24.8)
(15.4)
PD+1
PD+11
to
PD +10
to
PD+20
firms
-7.0%
3.5%
(10.0)
PD-1
parentheses) 3
1.4
-1 .2
(3.6)
(-1.4)
0.6
-0.5
(1.4)
(-0.5)
a Abnormal returns prior surrounding the dividend announcement are market-adjusted returns using
CRSP equal-weighted market returns. The sample firms initiate/omit dividends in the period 1969 to
1980.
D
PD
is
the date the dividend initiation or omission
is
announced
in
the Wall Street Journal.
Table 3
Summary
for
statistics
dividend
Period relative
to dividend
initiation
Panel A:
Year
Raw
on changes
initiating
firms
earnings per share as a percent of equity price
years surrounding the dividend announcement 3 ^
in
Number
of
firms
earnings changes
-5
in
Student
Mean
Wilcoxon
t
probability
Median
probability
Table 4
Summary
of
statistics
equity
price
on annualized quarterly earnings changes as a percent
dividend initiaition firms in years surrounding the
for
dividend announcements 3
Period relative
to dividend
initiation
Number
of
firms
Student
Mean
'
13
Wilcoxon
t
probability
Median
probability
Panel A: raw earnings changes
Year
-1
129
129
5.44%
0.01
3.73%
0.01
4.51
0.01
3.36
0.01
0.05
1.34%
0.01
1.72
0.03
Panel B: industry-adjusted earnings changes
Year
-11
118
2.85%
3
Earnings changes are estimated using quarterly earnings that are announced in the eight quarters prior to the dividend
announcement and the four quarters subsequent. Changes in earnings per share before extraordinary items and
discontinued operations for each firm are standardized by its stock price two days prior to the dividend announcement.
b
The dividend initiation sample comprises 129 firms that announce dividend initiations in the period 1970 to 1979.
Industry-adjusted earnings changes are available for 118 of these firms. They are defined as the difference in
standardized earnings changes for the initiation firms and for matched comparison firms that are randomly selected
from the
c
same
Student
zero.
The
t
industry.
and Wilcoxon
statistics test
the hypotheses that the
mean and median
probability levels reported are for two-tailed tests of significance.
earnings changes are different from
Table 5
Summary
for
statistics
on changes
dividend omitting firms
Period relative
to dividend
omission
-5
'
Number
of
firms
Panel A: raw earnings changes
Year
in
earnings per share as a percent of equity price
years surrounding the dividend announcement 3 6
in
Student
Mean
Wilcoxon
t
probability
Median
probability
Table 6
Summary
statistics
of equity price
on annualized quarterly earnings changes as a percent
dividend omission firms in years surrounding the
for
dividend announcements 3
Period relative
to dividend
omission
Number
of
firms
Panel A: raw earnings changes
Year
1
Student
Mean
'
6
Wilcoxon
t
probability
Median
probability
Table 7
relation between standardized changes in earnings
announcements of dividend initiations/omissions, and the
dividend announcement return (t statistics in parentheses) 3
Tests
of the
following
AEj, =
Period relative
to dividend
announcement
Panel A: dividend
firms
initiation
1
123
2
123
3
121
4
120
p,DRET j+
161
1
159
2
158
3
152
4
141
[5u
sample
Panel B: dividend omission sample
Year
+
P 2AE j|t .i + p 3 PRET, +
ej,°
Number
of
124
Year
(5
0.029
Pi
Pi
P3
R2
Table 8
Tests of the relation between standardized changes in annualized quarterly
earnings one year following announcements of dividend initiations/omissions,
and the dividend announcement return (t statistics in parentheses) 3
AE j0
= p +
P,DRET
j
+ p 2 AEj,.-, + p 3 PRETj +
eJt °
Number
firms
of
Dividend
p
R2
P3
P2
Pi
sample
initiation
129
0.029
0.315
-0.178
0.123
(2.85)C
(2.49)d
(-2.11)d
(1.98)6
0.086
Dividend omission sample
140
3
The sample comprises 129
announced dividend omissions
-0.079
0.394
(-3.42)C
(2.26)0
firms thai
-0.008
-0.062
(-0.40)
announced dividend
0.032
(-0.51)
initiations in the period
1970
to
1979, and 140 firms that
the period 1969 to 1980. Annualized earnings are estimated using earnings for the
eight quarters prior to the dividend announcement and the four subsequent earnings.
D
AEjt
is
firm
j's
announcement;
change
DRET;
in
is
(omission) announcement;
in
earnings standardized by
its
stock price two days prior to the dividend
the market-adjusted return for firm
and PRETi
is
j
for
one day
to
the market-adjusted return for firm
and the day
j
initiation
from one day following the quarterly
earnings announcement immediately prior to the dividend announcement to two days prior to the dividend date.
c
Significant at the
1%
level using a two-tailed test.
d
Significant at the
5%
level using a two-tailed test.
e
Significant at the
6%
level using a two-tailed test.
(omission)
of the dividend initiation
Table 9
Tests of the relation between unexpected stock returns
earnings announcements and standardized changes in
earnings for years surrounding
initiation
of
at
dividends 3
4
ARET
jt
= p oj
+p AE + I M^D T tAEj t +e
b
jt
jt
Ij
T=0
Po
Mean
0.0039
Z
statistic
t
statistic
0.0003
0.0013
0.1418
0.0194
0.3738
Adj.
a
for
quartile
R2
The
M2
Mi
m
M3
-0.1280
-0.0422
-0.0957
-0.0223
-0.0134
-2.04 s
-0.64
-1.49
-0.45
-0.27
7.26 d
-0.0092
Median
Third
0.2894
10.79 d
quartile
First
Mo
Pi
0.272 d
results for coefficients (3q
131 firms that
initiate
and
dividends
in
(3-|
are for the cross-sectional distribution of time-series regression coefficients
The
the period 1970 to 1979.
coefficients
u.
t (t=0
4)
are
assumed
to
be
constant across firms.
D
ARETij
is
the market-adjusted return for
announcement;
aEjj
is
the change
earnings announcement; and
D^
in
is
a
one day
prior to
earnings per share
dummy
in
and the day
year
t
variable that takes the value
announcement and zero otherwise.
c
Under the
d
Significant at the
1%
level using a two-tailed test.
9
Significant at the
5%
level using a two-tailed test.
null
hypothesis, each Z statistic
of
is
the Wall Street Journal annual earnings
standardized by the stock price two days prior to the
distributed unit normal.
one t years following the dividend
initiation
Table 10
Tests of the relation between unexpected stock returns
earnings announcements and standardized changes in
earnings
for
years surrounding omission
of
at
dividends 3
4
ARET
jt
= p oj
+p AE
lj
jt
+
I
^D Tl AE
jt
+
Ejl
b
T=0
Pfj
Mean
Pi
Ho
Hi
H2
H3
H4
Date D
I
MRn'
Lib-26-67
MIT LIBRARIES
illinium
3
inn
111
111
1
ii
iii
inn
=1060 DOM 134
243