Many dividends theories imply that a change in the dividends signals to the market that a firm is now processing future expectations which can then cause stock price movements. This study investigates market reactions to regular cash dividend distributions for the period 2010 – 2016 on USA markets. In particular, this paper studies the effect of dividend announcements on both stock price and trading volume in high growth and low growth industries. Research results indicate that in low growth industries, the stock price moves significantly upward after increasing dividends. Moreover, the market absorbs the negative news of decreasing dividends which can still result in positive abnormal return. High growth industries experience higher price volatility and negative abnormal return after decreasing their dividends payout. The trading volume is significantly high around the announcements dates for both high and low growth industries. These results are consistent with the theory as dividend announcements convey information that significantly impacts share prices.
The principal finance goal of managers is to maximize the value of the firm and the shareholder’s investment value. Mangers take different investment and financing decisions to maximize the shareholder’s value. One of these decisions is distributing dividends to shareholders as a reward for their investments with an implied intention to reduce agency problem (Jensen and Meckling, 1976). Assuming that mangers have inside information about the firm’s future prospective, they may use various ways to signal information to the market. Dividends and earnings announcements are the most important devices to signal a change in the mangers expectations about the firm’s future prospective (Ahorny and Swary, 1980).
The effect of a firm’s dividend policy on stock returns is important to corporate managements, investors and to economists who try to understand the function of financial capitals markets. Asquith and Mullins (1983) find a significant positive abnormal return after the initial announcement of dividends. Dielman and Oppenheimer (1984) documented increase (decrease) of abnormal return after unanticipated dividend increase (decrease) announcements.
This paper examines whether the information revealed by dividend change announcements affect the valuation and abnormal return of high and low growth industries. Research that examines the dividend change impact in a corporate market value has not previously studied the growth of the industries1. Many well-published papers examine the stock market reaction around dividend announcements. However, the basic hypothesis for this paper is documenting that high growth industries have more stock price volatility. Also, this paper hypothesizes that abnormal return decreases (increases) after announcing dividend decreases (increases) in high growth industry. Moreover, following a dividend increase, low growth industry shows a higher increase in abnormal return than high growth industry. Finally, we expect low growth industries tend to maintain positive abnormal return when dividends are announced.
The remainder of the paper proceeds as follows. In Section II literature review, Section III Data, sample selection and methodology. In Section IV results and discussion. Finally, section V conclusion.
II. Literature review:
Dividends and Abnormal Returns:
There have been a large number of studies documenting the statistically significant stock price reaction following dividends changes. The abnormal return direction and magnitude are positively related to the degree and size of the dividends changes (Pettit (1972), (1976), Dielman and Oppenheimer (1984). Studies has also find that a significant abnormal return increase for the companies that initiate dividends for the first time and significant decrease for the companies that omitted dividends after previously paying them (Mitra & Owers 1995).
Lintner (1956) and Carroll (1995) find a positive relationship between unexpected dividends changes and abnormal returns. One explanation for that is that the changes in dividends signal cash flow and earnings changes in future. Kim and Verrecchia (1991a, 1991b, 1992) provide analysis of the trading behavior around expected events. Kim and Verrecchia’s model predicts an increase in stock price volatility and the trading volume during the announcement period. Quarterly dividend announcements contain useful information beyond quarterly earnings numbers and if these announcements convey useful information it will reflect immediately in the stock price. (Healy and Palepu, 1988). (Grullon, Michaely, Benartzi and Thaler, 2005) support these findings with empirical methods showing that dividend changes are negatively correlated with future changes in earnings and result in decreasing abnormal return. Pettit (1972) argues that dividends announcements convey more information than earnings numbers. Academicians like Ariff and Finn (1986), Stevens and Jose (1989), Lee (1995) find above market return following the cash dividends announcements. On the other hand, Sinclair and Easton (1989) find a negative market return following the cash dividends announcements. The positive relationship between the market return and dividends announcement is interpreted as the information effect of dividends, while the negative relationship between the market return and the dividends announcement is interpreted as the income tax effect. Gordon (1963) argues that shareholders prefer cash dividends rather than capital gain to reduce the risk in the future dividends stream and prefer a high dividends policy than uncertain future investment. Miller and Rock (1985) argue that it’s unwise for bad expectation firms to pay high level dividends, and only good expectation firms without uncertain long-term operations can pay high level dividends.
Behbahani and Rezvani (2016) find a negative and significant relationship between growth opportunities and cumulative abnormal return. They argue that, capital markets evaluate the performance and financial situations of firms with high growth opportunities helps for avoiding investors withdrawing confidence. Skinner (1994, 1997) find that firms with high growth opportunities frequently preannounced negative earnings news. This is consistent with Gulen and Schill (2009) finding that there is a strong negative relationship between high growth firms and stock return while they document a return premium of 20% per year.
In this paper, event study methodology is used to assess the impact of the dividends announcement on the abnormal return for high growth vs. low growth industries. The data used is from Center for Research in Security Prices (CRSP) daily stock file, and Compustat. A sample of 420 industrial firms listed in both New York Stock Exchange and NASDAQ. Each firm has met the following criteria:
1. Quarterly dividends per share for only regular cash dividends.
2. The distribution doesn’t include initiation or omission dividends.
3. Daily rates of return and declaration dates were available in CRSP for the period of 1/1/2010 – 12/31/2016.
4. The study used only USA firms excluding all the financial firms (SIC codes 6000 – 6999) and utilities firms (SIC code 4900 – 4949).
To empirically examine the abnormal return to quarterly dividends changes, a measure of unexpected dividends change must be derived. In common with other studies2 the expectation naïve model has been used in this study which assumes that the current dividends for quarter (q) is expected to be equal to the previous dividends for same quarter (q-1), that is:
1. E (Djq) = Djq-1
2. E (Djq) = Djq-4
Where E (Djq) = expected dividends per share for the j company in quarter q, and
Djq. = actual dividends per share announced by j company in quarter q
The first model says that expected dividend is equal to the last quarter’s dividend. This model has been used in previous studies (I.e. Aharony and Swary (1980) and Firth (1996)). This model is used for firms that pay equal amounts of dividends each quarter. The second model measures the expected dividends for the current quarter as equal the actual dividends paid four quarters ago. This model is more appropriate if firms vary dividends payment over the quarters. A dividends announcement is considered a positive event if Djq > E (Djq), neutral if Djq = E (Djq) and negative if Djq
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