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We investigate the relation between dividend changes and future profitability, measured in terms of either future earnings or future abnormal earnings. Supporting quot;the information content of dividends hypothesis,quot; we find that dividend changes provide information about the level of profitability in subsequent years, incremental to market and accounting data. We also document that dividend changes are positively related to earnings changes in each of the two years after the dividend change.
One of the most important predictions of the dividend-signaling hypothesis is that dividend changes are positively correlated with future changes in profitability and earnings. Contrary to this prediction, we show that after controlling for the well-known non-linear patterns in the behavior of earnings, dividend changes contain no information about future earnings changes. We also show that dividend changes are negatively correlated with future changes in profitability (return on assets). Finally, we investigate the out-of-sample forecasting ability of dividend changes. We find that models that include dividend changes do not outperform those that do not include dividend changes. In fact, our evidence indicates that investors are better off not using dividend changes in their earnings forecasting models.
We present fresh evidence on the validity of the dividend signaling hypothesis (DSH), by using a new testing approach. We test the unambiguous prediction from the DSH that the association between current dividend changes and future profitability is stronger for firms with higher marginal net benefits from signaling. Using a simple dividend signaling model, we derive three empirically identifiable drivers of the marginal net benefit of signaling: cash flow predictability, market-to-book, and past equity returns. Our empirical tests support the DSH. There is a significant association between current dividend changes and future earnings performance for firms with low cash flow predictability, low market-to-book ratio, and low past equity returns. But, as predicted by the DSH, the association is much weaker for firms with high cash flow predictability, high book-to-market, and high past equity returns. There is also evidence that the marginal signaling benefits at the firm-level are influenced by aggregate factors: the information content of dividend changes is time-varying, increasing (decreasing) in booms (recessions) and in periods of high (low) aggregate stock market performance.
This thesis examines the relation between dividend changes and future profitability in respect of the degree of information asymmetry faced by U.S. firms during 1990 to 2013. As the information asymmetry is the theoretical incentive for firms to signal via dividends, firms with a high level of information asymmetry should be those that have the most incentives in taking such action. Contrary to this prediction, no conclusive evidence is found to support such hypothesis. Specifically, the results tend towards suggesting no evidence of dividend signaling. Additionally, the lack of the significance when testing the difference between high and low asymmetry firms greatly indicates that the difference in the level of asymmetry faced by firms has no impact on their decision to use dividend signaling. Hence, the findings of this thesis taken together suggest that dividends contain no information of future profitability, and plausibly that dividends are not the common means of signaling.
We examine whether the market interprets changes in dividends as a signal about the persistence of past earnings changes. Prior to observing this signal, investors may believe that past earnings changes are not necessarily indicative of future earnings levels. We empirically investigate whether a change in dividends alters investors' assessments about the valuation implications of past earnings. Results confirm the hypothesis that changes in dividends cause investors to revise their expectations about the persistence of past earnings changes. This effect varies predictably with the magnitude of the dividend change and the sign of the past earnings change.
We observe significant valuation revisions around divined changes. The price reaction to dividend initiations and omissions are more compared to the dividend increase/decrease sample. We analyze the relationship between dividend changes and future profitability/earnings using categorical analysis and regression analysis. There is a strong relationship between the dividend changes and earnings/profitability changes for the corresponding year. Dividend initiating (omitting) firms have large increase (decrease) in profitability in the year of change compared to dividend increasing (decreasing) firms. We found that dividend changes provide information about the level and change in profitability in the immediately succeeding year, but not thereafter. The availability of financial results for the next quarter/half year may discount the signaling argument as a valid explanation. Generally positive dividend changes are associated with somewhat permanent increase in earnings in the year of announcements.
The stylized facts that firms pay and investors react to dividends disregard dividend neutrality. Taking on the perspective that informational asymmetries are the central determinant for dividend value relevance, Christian Müller assumes that firm’s dividend decision conveys useful information to investors. He shows that investors use dividend changes to revise their a priori expectations about the persistence of a current earnings change. While his theoretical and empirical analyses generally imply that dividend changes constitute informative, but imperfect information signals, he further identifies situations in which they are substantial to investors. Christian Müller’s research comprehensively examines the informational role of dividend policy and provides new insights to the corresponding Bayesian investor learning process.