Losses, Dividend Reductions, and Market Reaction Associated with Past Earnings and Dividends Patterns

Abstract

This paper examines investors’ reactions to dividend reductions or omissions conditional on past earnings and dividend patterns for a sample of eighty-two U.S. firms that incurred an annual loss. We document that the market reaction for firms with long patterns of past earnings and dividend payouts is significantly more negative than for firms with less-established past earnings and dividends records. Our results can be explained by the following line of reasoning. First, consistent with DeAngelo, DeAngelo, and Skinner (1992) , a loss following a long stream of earnings and dividend payments represents an unreliable indicator of future earnings. Thus, established firms have higher loss reliability than less-established firms. Second, because current earnings and dividend policy are a substitute source of means of forecasting future earnings, lower loss reliability increases the information content of dividend reductions. Therefore, given the presence of a loss, the longer the stream of prior earnings and dividend payments, (1) the lower the loss reliability and (2) the more reliably dividend cuts are perceived as an indication that earnings difficulties will persist in the future.

Dividend policy and earnings: a study of short- and long-term causality

“…This finding is similar to the findings by Charitou et al (2010Charitou et al ( , 2011, Healy and Palepu (1988), Hsu et al (1998) and Marsh and Merton (1987). On the other hand, for Walt Disney Company (DIS), Home Depot (HD), McDonald's Corporation (MCD) and United Technologies Corporation (UTX), the earnings lead the dividends with lags.…”

“…They are especially unwilling to reduce the dividend amount if they know in advance that the earnings reduction is most likely temporary. Charitou et al (2011) show that dividend reduction announcements by established firms are accompanied by larger negative market reactions than for similar announcements by less-established firms. This finding indicates that investors do take notice of dividend directions and show their viewpoint through the change in the market price of the stock.…”

When no news is good news: failing to increase dividends

“…For instance, DeAngelo et al (1992) note that the negative abnormal returns in response to a dividend cut are greater for firms that also announce a loss when those firms have a prior 10-year track record of dividend payments and positive net income. This result is confirmed in Charitou et al (2011) for firms with a seven-year history of positive earnings and nondecreasing dividends. When these firms both announce a loss and decrease the dividend, abnormal returns are significantly more negative than for firms with shorter histories of positive earnings and nondecreasing dividends.…”

Market response to dividend change announcements: unregulated versus regulated US firms

“…A number of studies have focused on the determinants of the magnitude of market response. These determinants include firm size (Eddy and Seifert, 1988;Bessler and Nohel, 1996;Amihud and Li, 2006), dividend yield (Bajaj and Vijh, 1990;Denis et al, 1994;Amihud and Li, 2006), ownership structure (Grinstein and Michaely, 2005;Puckett and Yan, 2011;Amin et al, 2015), profitability (Amihud and Li, 2006), age (Amihud and Li, 2006;Charitou et al, 2011), magnitude of dividend change (Denis et al, 1994;Black et al, 1995;Yoon and Starks, 1995;Bessler and Nohel, 1996;Bulan, 2010), leverage (Black et al, 1995;Casey et al, 2007) and market direction such as recession (Docking and Koch, 2005). More specifically, the literature reports a negative relationship between the market response and firm size (Amihud and Li, 2006), market-tobook ratio (Casey et al, 2007) and economic recession (Kohers, 1999), and a positive relationship between market response and change in dividend yield, profitability, and information asymmetry (Amihud and Li, 2006), net taxes (Baker and Wurgler, 2004), magnitude of dividend change (Amihud and Li, 2006) and leverage and firm-specific risk (Casey et al, 2007).…”