International Review of Financial Analysis 20 (2011) 364374

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International Review of Financial Analysis

Dividend signaling under economic adversity: Evidence from the

London Stock Exchange
Konstantinos Bozos a,, Konstantinos Nikolopoulos b, Ghanamaruthy Ramgandhi c
a
Leeds University Business School, University of Leeds, UK
b
Bangor Business School, Bangor University, Gwynedd, UK
c
Manchester Business School, University of Manchester, UK

a r t i c l e i n f o a b s t r a c t

Article history: The signaling or information content hypothesis is amongst the most prominent theories attempting to explain
Received 12 March 2011 dividend policy decisions. However, no research has, to date, examined the information content of dividends
Received in revised form 6 July 2011 in conjunction with generalized economic adversity. With the majority of the western economies facing
Accepted 30 July 2011
the tough reality of the economic recession since late 2007early 2008, we focus on the possibility of
Available online 6 August 2011
asymmetrical dividend signaling effects between periods of stability and economic adversity. Using data from
JEL classication:
the London Stock Exchange (LSE), where earnings and dividend news are released simultaneously, we test the
G14 dividend signaling hypothesis and the interaction of earnings and dividends under both steady and adverse
G35 economic conditions. We document positive and signicant average abnormal stock price returns around the
G12 dividend/earnings announcements. We also nd a signicant interaction between economic conditions and
the information content of dividends. After testing the dividend signaling hypothesis under both stable and
Keywords: recessionary economic conditions we nd that dividends have less information content than earnings in
Dividend policy periods of growth and stability, but more in periods of economic adversity.
Signaling hypothesis
2011 Elsevier Inc. All rights reserved.
Recession
Economic sentiment
London Stock Exchange

1. Introduction to be one of the most important unsolved problems in nance

Dividend policy has indeed been an intricate dilemma for
practitioners and researchers in the eld: The harder we look at
the dividend picture, the more it seems like a puzzle, with pieces that
just don't t together. (Black, 1976: p.5). Meanwhile, dividend policy
is a most important criterion, which forms the basis for explaining
important nancing decisions like asset pricing, capital structure
and capital budgeting (Allen & Michaely, 1995; Barker, 1999). Over
the past ve decades and since Lintner's (1956) seminal work on
managerial dividend decisions and Miller and Modigliani (1961)
development of the dividend irrelevance proposition, the nance
literature has offered various explanations for this everlasting puzzle,
leading to the development of a number of hypotheses. Nevertheless,
in terms of a widely accepted explanation, the situation has hardly
improved; Allen and Michaely (1995) conclude that more empirical
and theoretical research on the topic is required before we reach a
widespread consensus, whilst dividend policy has been suggested
We thank the anonymous reviewers and Jonathan Batten (the editor) for valuable
comments and suggestions. All errors are our responsibility.
Corresponding author at: Leeds University Business School, The Maurice Keyworth
Building, University of Leeds, LS2 9JT, Leeds, U.K.
E-mail address: kb@lubs.leeds.ac.uk (K. Bozos).
(Bhattacharyya, 2007; Brealey, Myers, & Marcus, 2007).
However, no research has, to date, examined the information
content of dividends in combination with generalized economic
adversity. With the majority of the industrialized economies in
recession since late 2007early 2008, with a number of EU member
states struggling with budget decits and sovereign debt and with
scal consolidation rising as the biggest challenge for most econo-
mies, the outlook for corporate protability in the near future is
also rather bleak. In the absence of a growing economic context, it is
reasonable to conjecture that corporate nancial decisions, manage-
rial objectives and investor behavior might transform, in order to
factor in the economic conditions. Financial markets have not been
unaffected and publicly listed companies across the globe have been
called to continue their role in maximizing shareholder wealth, in a
world that is now completely different from the pre-crisis period.
This study aims to contribute to the existing literature on dividend
signaling in three distinct ways.
Firstly, we examine the dividend signaling hypothesis and the
interaction of earnings and dividends under both steady and adverse
economic conditions. Despite the abundance of research in the eld,
there has been no examination of the phenomenon with particular
focus on the surrounding economic environment. As Frankfurter
and Wood (2002) state: Current models of corporate dividend policy

1057-5219/$ see front matter 2011 Elsevier Inc. All rights reserved.
doi:10.1016/j.irfa.2011.07.003
 K. Bozos et al. / International Review of Financial Analysis 20 (2011) 364374
by and large ignore behavioral and socioeconomic inuences on
managerial and shareholder activities (Frankfurter & Wood, 2002:
p 128). Especially under turbulent economic and market conditions,
as corporate protability and earnings per share experience declines
across the board, certain managers may use dividend policy to remove
information asymmetries, by conveying either reassuring or warning
signals to their shareholders.
With the exception of Lonie, Abeyratna, Power, and Sinclair (1996)
and Gunasekarage and Power (2002, 2006), as the only empirical
studies to have examined the share price reaction to dividend an-
nouncements in the LSE, this paper contributes to a body of literature,
which is unevenly populated by US studies. Similar to past empirical
studies in the US, Germany, Norway and Australia, we exhibit the role
of dividend changes in generating abnormal stock returns, thereby
providing signicant evidence for the dividend signaling (information
content) hypothesis.
Finally, in this study, we examine abnormal price reactions in
conjunction with abnormal volumes; this joint examination of price-
volume effects provides a better picture of how investors and possible
investor clienteles revise their expectations and shift positions based
on the arrival of dividend news. Although similar studies have been
conducted by Richardson, Sefcik, and Thompson (1986) and Gurgul,
Mestel, and Schleicher (2003) for the US and the Austrian markets
respectively, this study is the rst to jointly examine price and volume
reactions to dividend announcements in the UK, whilst our results
are in line with the ndings of the above.
Section 2 presents the theoretical context of dividend policy
decisions, some key empirical contributions to the literature and a
brief overview of the institutional setting of this study. Section 3
describes the data, the research design and the employed method-
ology. In Section 4 we present the empirical results in detail, from the
estimation of market reactions to dividend announcements to the
cross sectional models and the robustness of the results. Finally, in
Section 5, we discuss the study ndings and draw conclusions on their
importance for the theory in the eld and the associated practical
implications.
2. Theoretical and empirical background
A number of alternative theories have been proposed to explain
dividend policy decisions: In response to Miller and Modigliani's (1961)
dividend irrelevance theory, Gordon (1963) and Lintner (1962)
presented arguments for the risk advantages of expected dividends
over expected capital gains and the preference of certain investor
clienteles for a bird-in-the-hand. On the other end the tax-preference
hypothesis suggests that, in the presence of taxation, clienteles that
prefer capital gains to dividends will be formed, hence low payout
companies will be preferred over high-payout ones. Another popular
standpoint emerged from the agency theory and was inspired by the
free cash ow hypothesis (Jensen, 1986): dividend distributions may
act as a device that aligns the interests of the agent with those of the
principal, either by reducing the scope for overinvestment in low-yield
projects, or by imposing discipline to the managers, who will have to
approach the capital market to raise capital for new projects, after the
distribution of free cash ows (Easterbrook, 1984).
However, amongst the most prominent theories attempting
to explain dividend policy decisions is the signaling or information
content hypothesis (Bhattacharya, 1979). As managers hold asymmet-
ric information about the company's nancial condition and future
cash ows, dividend policy can act as a most efcient means of
signaling news to shareholders and other market participants.
Bhattacharya (1979) argued that in an institutional setting where
dividends are taxed, hence dividend signaling is a costly means of
removing information asymmetries, the size of the dividends an-
nounced will depend on how good the news is. Moreover, John and
Williams (1985) and Ofer and Thakor (1987) added to the signaling
365
hypothesis by arguing that dividend changes may signal the manage-
ment's assessment of a company's current or future earnings changes
in the same direction. Therefore, in a market with taxable dividends,
where poorly performing agents cannot imitate such an expensive
signaling behavior, dividends are a reliable information transmission
device to convey information about a rm's real value and economic
prospects (Al-Yahyaee, Pham, & Walter, 2011).
2.1. Wealth effects of dividend announcements and the signaling
hypothesis
Share price reactions to dividend announcements have been
examined in a growing number of studies during the past three
decades, as the best proxy of how investors receive the dividend news
and accordingly revise their expectations. Pettit (1972) was the rst
to empirically study the abnormal returns from dividend announce-
ments for 625 NYSE rms and demonstrate that dividend increases
(cuts) resulted in positive (negative) abnormal returns. Aharony and
Swary (1980) also investigated a sample of 384 U.S. listed companies
and found that for the announcement day (T0) stocks see an average
abnormal return of 0.36% if dividends are increased and 1.13%,
if they are decreased. A number of studies that followed (Aharony,
Falk, & Swary, 1988; Divecha & Morse, 1983; Eddy & Seifert, 1992;
Nissim & Ziv, 2001; WoolRidge, 1982) also found signicant abnor-
mal reactions surrounding dividend announcements. In addition,
the magnitude of dividend change was found to play an important
role in generating share price reactions (Brickley, 1983), yet in some
cases (Lee & Yan, 2003; Wansley, Sirmans, Shilling, & Lee, 1991; Yoon
& Starks, 1995) it has been argued that it is the change in dividend
yield, rather than the change in dividend per se, which causes
abnormal returns on the announcement date.
The information content of dividends has also been examined
extensively for dividend initiations and omissions (Asquith & Mullins,
1983; Gorman, Weigand, & Zwirlein, 1993; John & Lang, 1991; Liu,
Szewczyk, & Zantout, 2008), with most studies reporting that dividend
omissions result in greater market reactions than dividend initiations.
In their sample of 160 rms in the NYSE and the AMEX, Asquith and
Mullins (1983) reported an average two-day abnormal return of 3.7%
and a positive effect of the size of the dividend announced. Along the
same lines, in his study of 492 dividend omissions and 475 reductions,
Christie (1994) found abnormal returns of 4.95% when dividends
were cut by 20% or less and of 8.78% when dividend cuts exceeded
60%. Results also indicated that both the changes in dividends and
dividend yields contributed signicantly to the variation of excess
returns, giving support to the signaling hypothesis. In their simulta-
neous examination amongst the competing explanations for the
information content of dividend change announcements Denis,
Denis, and Sarin (1994) provided support for the cash ow signaling
and the dividend clientele hypotheses but not for the overinvestment
hypothesis.
In the UK Lonie, Abeyratna, Power, and Sinclair (1996) were the
rst to examine the share price reaction to dividend announcements
for a sample of 620 companies listed on the LSE. Their ndings for a
two-day period (T 1, T0) showed signicant cumulative abnormal
returns of 2.03% for dividend increases and 2.15% for dividend
cuts. They also examined the interaction effects from the earnings
and dividends being released simultaneously and concluded that
dividend changes are of less signicance when compared to earnings
changes. Gunasekarage and Power (2002, 2006) also carried out
similar research in the UK and conrmed Lonie, Abeyratna, Power,
and Sinclair's (1996) earlier results.
Empirical studies in other institutional settings have provided
comparable evidence and support for the information content hypothesis,
despite the presence of institutional or regulatory differences. Amihud
and Murgia (1997), who investigated a sample of 200 companies in
the Frankfurt exchange, also found support for the dividend signaling
366 K. Bozos et al. / International Review of Financial Analysis 20 (2011) 364374
theory in line with the US literature, despite the existence of dividend
tax advantages in Germany. In Japan, Harada and Nguyen (2005)
also reported dividend announcements to have information content,
whilst Aono and Iwaisako (2010) provided evidence that dividend
yields can forecast future stock returns. More recently, Al-Yahyaee,
Pham, and Walter (2011) examined companies announcing cash
dividends between 1997 and 2005 in the Omani emerging market,
where dividends and capital gains are exempt from taxation. Their
results also gave support to the signaling hypothesis and were in
contrast with the tax-based signaling models. Hence, empirical ndings
from nancial markets with inexpensive dividends were also in line
with the dividend signaling theory.
2.2. Dividend policy and taxation in the UK
According to Megginson (1997), companies in the UK have
traditionally exhibited high dividend payout levels, compared to the
US. Corporate managers in the UK believe that dividend decisions,
when used to inuence capital structure allow very limited exibility.
Hence, UK rms demonstrate very low levels of integration between
dividend policy and future investment decisions, unlike rms in the
US (Baker, Farrelly, & Edelman, 1985). Dhanani's (2005) survey of
British nancial managers also presented evidence for the signaling
hypothesis, whilst managers were not found to use dividend changes
to either avoid agency conicts or reduce costs due to such conicts.
In the UK there is also support for the tax clientele hypothesis,
which arises from two main facts: dividends are taxed at relatively
high rates 1 (yet still somewhat lower that the US) and institutional
ownership of listed companies is relatively high. In specic, insti-
tutional ownership of listed companies in the LSE had increased from
10% in the 1970s to over 60% by 2006.
Finally, companies in the UK release earnings and dividend news
simultaneously, which leads to a scenario wherein dividend changes
can work in corroboration with earnings news to generate a market
reaction. Yet, despite the complexity in estimating the net contribu-
tion of dividend announcements to market reactions, the UK market
is a most appropriate laboratory for the purposes of this study:
the depth and liquidity in the LSE and the strict investor protection
rules imposed by the FSA, the regulatory body governing the market,
minimize the problem of information leakage, insider trading
and the associated market inefciencies, hence making the tests of
the signaling hypothesis more reliable. Moreover, the UK market's
overreliance on the nancial services sector resulted in the economy
being severely hit by the credit crunch and subsequently the deepest
post-war recession, thus making it an excellent setting for examining
the information content of dividend announcements in adverse eco-
nomic conditions.
2.3. Trading activity surrounding dividend announcements
A well known Wall Street adage suggests: It takes volume to make
prices move. Whilst the share price reaction to an announcement
represents aggregate market expectations, the level of trading activity
surrounding the announcement has been suggested to reect the
heterogeneous expectations of individual investors (Bamber, 1986),
in other words the degree of consensus amongst the market par-
ticipants. Within the premise of dividend policy, an increase in trading
volume around a dividend announcement can also be associated with
portfolio rebalances and clientele shifts, as investors revise their
positions to maximize their own after tax welfare (Richardson, Sefcik,
& Thompson, 1986). However, excess trading volume is typical
around price-sensitive announcements and may also occur as a result
1
In the UK, dividend income is taxed at 32.5% for investors with annual income of
up to or below 37,400 and at 42.5% for investors with annual income of up to or
below 150,000.
of noise traders, who revise their portfolios based on sudden price
shifts (Kim & Verrecchia, 1991).
According to Karpoff (1987) examining the trading volume that
surrounds dividend announcements in conjunction with price reactions
can give a more clear understanding of the strength of the signals
conveyed to the market. Richardson, Sefcik, and Thompson (1986) and
Gurgul, Mestel, and Schleicher (2003) examined the abnormal trading
volume reaction around dividend announcements for the US and the
Austrian market respectively. Both studies employed a variant of the
market volume model and reported signicant excess trading activity.
The results suggested that the examination of trading volume reactions
is helpful in analyzing the information content of dividend announce-
ments as well as the existence of clientele effects.
2.4. The role of earnings performance and the market-wide economic
sentiment
Although no prior research has investigated the dividend puzzle
under generalized adverse economic conditions, a number of studies
have examined dividend policy alongside earnings performance (Chen,
Firth, & Gao, 2002; DeAngelo & DeAngelo, 1990; DeAngelo, DeAngelo, &
Skinner, 1992, 1996; Easton, 1991; Eisdorfer, 2007; Kane, Lee, & Marcus,
1984). The vast majority of these studies reported signicant singular
and interaction (or corroboration) effects, although earnings appeared
to be more closely associated to abnormal returns than dividends.
However, in their examination of 167 loss making rms at the NYSE
DeAngelo, DeAngelo, and Skinner (1992) proposed that the information
content of dividends will vary, depending on the level of earnings.
Their results supported the above notion, as dividend cuts were shown
to have signicant incremental information content in predicting
the future earnings of loss making rms. Most interestingly, in his
examination of nancially distressed rms in the main US markets
between 1976 and 1996 Eisdorfer (2007) exhibited that when rms face
nancial distress, cash ow news has a stronger effect on market value
than news about expected returns.
In addition, a rather scant, yet increasing, body of literature has
dealt with the way that the general investor sentiment inuences
stock market reactions to price-sensitive information disclosures.
In developing and testing their catering theory of dividends Baker
and Wurgler (2004), suggested that managers cater to investors, by
initiating or omitting dividends according to investor demand. Their
empirical results supported that investors prefer dividend payers
when the sentiment about growth is low and non-payers when the
overall sentiment is optimistic. In examining the inuence of investor
sentiment on managers' discretionary disclosure decisions, Brown,
Christensen, Elliott, and Mergenthaler (2011) proposed that during
optimistic periods, investors will evaluate managers' disclosures
less rigorously and during pessimistic periods, they will do so more
meticulously. Their ndings suggested a signicant relationship be-
tween the type and content of earnings disclosures and investor
sentiment, whilst reecting, to some extent, a degree of managerial
opportunism. Along the same lines, Sankaraguruswamy and Mian
(2008) investigated the effect of market-wide optimism or pessimism
on market reactions to rm-specic announcements in the three main
markets of the US and concluded that investors appreciate (penalize)
good (bad) news more during optimistic (pessimistic) periods.
Based on the above theoretical premises and the extant empirical
evidence, we expect to nd signicant abnormal returns surrounding
dividends/earnings announcements at the LSE. Additionally, in line
with Kane, Lee, and Marcus (1984) and Easton (1991) we anticipate
that disclosures about dividends should work independently and
jointly with earnings announcements in forming a signal of the
managers' views about future cash ows. In other words, we expect
the stock market's reaction to concurrent dividend and earnings
announcements, such as the ones in the LSE to be explained by the
changes in dividends and earnings and their interactions. Following
 K. Bozos et al. / International Review of Financial Analysis 20 (2011) 364374
the arguments of DeAngelo, DeAngelo, and Skinner (1992) and
Eisdorfer (2007), we also expect that changes in dividends will be
more informative for loss making rms, than for protable ones.
Finally, in line with the increasing evidence on the role of the broader
economic sentiment (Brown, Christensen, Elliott, and Mergenthaler,
2011), we predict that dividend signaling should be stronger during
pessimistic periods, such as the recent economic downturn, and
weaker during more optimistic periods, such as the one preceding
the year 2008.
3. Data and methods
3.1. Data
We employ a sample of 991 nal dividend announcements of
UK companies listed at the LSE. The sample test period spans over
4 years from January 2006 to June 2010. 2 The companies in the
study are either large or mid-capitalization constituents of the FTSE
350 index. Dividend announcements data were manually collected
from Thomson Reuters Extel cards and veried by data obtained
from DataStream. In line with the relevant empirical literature, and to
prevent the impact from other important nancial news, dividend
announcements with simultaneous events such as equity and bond
issues, mergers and acquisitions, seasonal equity offerings and other
deals were excluded from the dataset. In addition, sample observa-
tions which could not be veried by DataStream data were removed
from the sample. Most UK companies announce dividends twice in
a year one interim dividend payment and one nal payment with
the publication of the annual reports. Following Lonie, Abeyratna,
Power, and Sinclair (1996), DeAngelo and DeAngelo (1990) and
DeAngelo, DeAngelo, and Skinner (1996), we focus on annual (nal)
dividend announcements instead of interim payments. As DeAngelo
and DeAngelo (1990) argue, most of the statistical evidence and
managerial surveys indicate that dividend policy is more often
determined on an end-of-year basis.
Share price data, Earnings per Share (EPS) and daily trading
volume were also retrieved from DataStream. Ownership structure
data (% of closely held shares) was obtained from Thomson ONE
Banker. The above data collection and ltering process resulted in 665
observations in the nal sample. Fig. 1 presents daily prices of the
FTSE350 index from 01/01/2006 to 31/05/2010, along with the 665
dividend/earnings announcements in the dataset. The dashed curve
represents seasonally adjusted monthly prices of the UK Economic
Sentiment Indicator (UK-ESIN). The vertical dashed line marks the
beginning of 2008, following the economic meltdown of the last two
quarters of 2007. 3
In Table 1a we present the frequencies of different types of
dividends and earnings combinations for the 665 announcements in
the sample by period (20062007) and (20082010). There are 312
cases in the pre-recession period and 353 cases in the post recession
sample. The top half presents the frequency of the observations by
the type of dividend change (DIV) and by period. Approximately
8.4% of the announcements involved a decrease in DIV, 9.7% involved
no change and in almost 82% of the cases DIV was increased from
the previous year. 4 The lower half of the table presents frequencies of
2
Listed rms in the LSE adopted IFRS for the rst time in 2005. Hence, as market
reactions to dividend and earnings announcements during 2005 could be contami-
nated by effects due to the transition from UK GAAP to IFRS (i.e. certain disclosures of
EPS under IAS33 were not required by UK FRS14) we exclude all announcements
before 2006.
3 t
Alternative cut-off points were also considered, such as the 9 August 2007, when
the credit crunch supposedly began as short-term money markets froze. However, as
the subsequent empirical results were not different, it was decided that the ofcial
beginning of the scal year 2008 was a more appropriate cut-off point.
4
Although seemingly unbalanced between increased, decreased and unchanged
dividends, such a sample structure is characteristic of the literature (Kane, Lee, &
Marcus, 1984).
367
the cases where EPS is positive/negative, again for each of the two
sub-periods. Evidently, in the case of earnings there is more balance
between increases and decreases, whilst all four quartiles are pop-
ulated satisfactorily. Unsurprisingly, the ratio of positive vs. negative
EPS is higher in the pre recession period 20062008 (222/90) and
lower post-recession (169/184). Overall, 274 observations, or 41% of
the cases in our sample involved a decrease in earnings yield, whilst
395 (or 59%) involved an increase.
In Table 1b, Panel A presents the means of DIV for each of the
sub-samples of the previous table, along with a mean comparison
T-test between the two sub-periods. A direct observation is that, on
average, changes in dividends are more negative for the dividend
decrease cluster and more positive for the dividend increase one.
In both cases, the differences between the two sub-periods are
statistically signicant. Another observation is that, although dividend
increases in Table 1a above are dominant during both periods, average
DIV is smaller both when EPS b 0 and EPS N 0 during 20082010;
hence dividend increases are smaller in size during the recession. In
Panel B we present the means of the changes in earnings per share per
dividend and earnings cluster and per period. It is not surprising that
all differences between the two periods are negative, with average
EPS in the 20082010 period being signicantly lower than the pre-
recession period, virtually across all sub-samples.
3.2. Estimation of abnormal returns
In the next step we estimate abnormal returns around the event
window. Following the norm in event studies we employ the standard
market model of abnormal returns as a benchmark for measuring
the value effect of dividend announcements. Since alternative
benchmarks, namely the Capital Asset Pricing Model and the Market
Adjusted Returns Model, were examined and found to produce
remarkably similar abnormal returns, the single factor market model
was preferred, as it has been argued to generally result in smaller
correlations across unsystematic returns, providing better compliance
with signicance tests (Strong, 1992).
The market model equation assumes a linear relationship between
the returns of a particular security, (Rit) and the FTSE350 returns (Rmt)
over a period of time.
Rit = i + i Rmt + it 1
The values of individual stock returns, Rit are calculated for a
period of 120 trading days before the announcement window (T130,
T 10) and are regressed against the corresponding market returns
Rmt as in the market model Eq. (1). Substituting it = ARit and
rearranging Eq. (1) gives the nal equation for the calculation of the
unsystematic/abnormal returns during the event period (T 10, T+ 10):
AR it = Rit i + i Rmt : 2
Using the above models (1) and (2) we calculate the return
residuals for the period T 10 to T+ 10 for all 665 observations in our
sample. Furthermore, we calculate the Average Abnormal Returns and
Cumulative Abnormal Returns (CARit) and their averages (ACARt):
1 665
AARt = AR 3
665 i = 1 it
T
1 665
CARit = ARit ACARt = CARit : 4
665 i = 1
3.3. Estimation of abnormal volume
To estimate abnormal volume reactions surrounding dividend
announcements, we employ the market adjusted mean model, as
368 K. Bozos et al. / International Review of Financial Analysis 20 (2011) 364374

4,000 200

3,500 175

3,000 150

2,500 125

FTSE 350

UK-ESIN
2,000 100

1,500 75
FTSE 350
1,000 50
Dividend Announcements
500 25
UK-ESIN (Monthly)
0 0
01/2006 01/2007 01/2008 01/2009 01/2010

Fig. 1. Dividend announcements at the LSE (January 2006-May 2010). Notes: the gure presents daily prices of the FTSE350 index from 01/01/2006 to 31/05/2010, along with the
665 dividend/earnings announcements in the dataset. The dashed curve represents seasonally adjusted monthly prices of the UK Economic Sentiment Indicator (UK-ESIN). Vertical
dashed line marks the beginning of 2008.

adopted by Richardson, Sefcik, and Thompson (1986) and Gurgul, content factors. All control variables have been suggested to explain
Mestel, and Schleicher (2003). The market adjusted mean model is dividend policy in the relevant literature.
calculated as shown in the Eq. (5) below: We thus employ CAV(T 5, T 1), the Cumulative Abnormal Volume
Abnormal trading volume, AVit = Actual trading volume during the 5 days preceding the dividend announcement, AVR(T 5,
Expected mean trading volume T 1), the ve day average absolute returns on the stock before the
announcement day, LNPRICE(T), the logarithm of the stock price on
   
Vit 1 Vit the day of the announcement and CHS, the percentage of closely held
AVit = ln ln 5
Vmt n Vmt shares by the management, which are not available for trading by the
public. We employ the ve-day pre-announcement cumulative excess
where, Vit is the trading volume of security i on day t and Vmt is the volume, to control for the possible effect of clientele shifts. The ve-
volume of the market index on the same trading day. Similar to day average returns are chosen as a proxy for share price momentum
the estimation of abnormal returns, cumulative abnormal trading and the percentage of closely held shares is added to control for the
volume (CAV) is also estimated for each of the three dividend change ownership structure. According to Bernard and Thomas (1989), the
clusters namely dividend increase, decrease and unchanged dividend most compelling reason for market inefciencies in response to
announcements for an event period of 6 days (T 5, T0) and a shorter earnings or dividend announcements in a timely manner could be the
period of 2 days (T 1, T0) and the results are tested for statistical high transaction costs involved. Hence, to control for such transaction
signicance. costs in the regression model, we include LNPRICE(T) as a proxy for
direct transaction costs.
3.4. The determinants of abnormal returns The extended cross sectional model is:
 
: : :
We perform a cross sectional analysis to identify the factors that CAR T0; T + 1 = + 1 DIV + 2 EPS + 3 CAV T5 ; T1 6
inuence the observed abnormal returns surrounding dividend
: : :
announcements. The dependent variable the model is the two-day + 4 AVRT5 ; T1 + 5 LNPRICET + 6 CHS + :
cumulative abnormal returns, CAR(T1,T0). This interval not only ex-
hibits signicant departures from zero and allows for potentially slow
market responses, but also facilitates direct comparisons with past Table 1b
Means of dividend/earnings in the study sample (N = 665).
research. The two main explanatory variables are DIV = (Change in
Dividend per Share/Pi), and EPS = (Change in Earnings per Share/Pi), 20062007 20082010 T-test 20062010
where Pi is the security price ten days before the dividend announce- Panel A: DIV (%)
ment (T 10). We also use a range of control variables to control DIV b 0 0.81 1.71 2.36** 1.29
possible market-level, company-level, economy-level and information DIV = 0 0.00 0.00 N/A 0.00
DIV N 0 0.27 0.31 1.47* 0.29
EPS b 0 0.13 0.03 1.36 0.06
EPS N 0 0.19 0.17 0.26 0.18
Table 1a Total 0.17 0.10 1.47* 0.13
Frequencies of dividend/earnings in the study sample (N = 665).
Panel B: EPS (%)
20062007 20082010 Total %
DIV b 0 0.04 14.12 2.61*** 7.58
DIV b 0 26 30 56 8.4% DIV = 0 1.46 5.02 1.41* 4.25
DIV = 0 14 51 65 9.7% DIV N 0 0.45 2.32 3.12*** 0.93
DIV N 0 272 272 544 81.9% EPS b 0 8.76 9.73 0.51 9.41
Total 312 353 665 100.0% EPS N 0 3.94 2.84 2.08** 3.47
EPS b 0 90 184 274 41.0% Total 0.32 3.71 4.46*** 1.81
EPS N 0 222 169 395 59.0%
Notes: Panel A presents the means of DIV for each of two the sub-periods, by DIV
Total 312 353 665 100.0%
cluster. The fourth column presents a mean comparison T-test between the two sub-
Notes: the table presents the frequency of different types of dividends/earnings periods for each cluster. The last column presents grand means for the entire sample
announcements in the sample by period (20052007 and 20082010). The top half and per cluster.
presents the frequency of the observations by the type of dividend change (DIV) and Similarly, Panel B presents the means of EPS per dividend and earnings cluster and per
by period. The lower half of the table presents frequencies of the cases where EPS is period.
positive/negative, again for each of the two sub-periods. *, **, ***: signicant at 95.0%, 99.0%, and 99.5% respectively.
 K. Bozos et al. / International Review of Financial Analysis 20 (2011) 364374 369

The model is estimated using Ordinary Least Squares (OLS) with Table 2
White's estimator for robust standard errors. White's estimator uses Average abnormal returns and average cumulative abnormal returns and volumes.

a heteroscedasticity-consistent parameter covariance matrix which Panel A: Average Abnormal Returns AAR
leads to robust estimation of standard errors, even when the error
Event day All events DIV N 0 DIV b 0 DIV = 0
variance is heteroscedastic (White, 1980).
T 5 0.15 0.20 0.12 0.07
(2.17) (2.87) ( 0.46) ( 0.18)
3.5. The role of the 20072008 economic recession T 4 0.06 0.12 0.32 0.24
(0.74) (1.81) ( 0.63) ( 0.71)
Since late 2007early 2008 the global economic conditions T 3 0.02 0.00 0.02 0.22
changed considerably. In the UK, whilst before 2007 GDP gures (0.28) (0.04) ( 0.06) (0.71)
T 2 0.01 0.10 0.31 0.51
had experienced a rather steady growth, the real GDP growth gures (0.17) (1.46) ( 0.96) ( 2.07)
released in early 2008 indicated an economic slowdown, which was T 1 0.40 0.42 0.45 0.23
followed by a remarkable 4.9% decline in 2009. To examine the role (3.76) (3.81) (0.71) (0.69)
of the recession on the determinants of excess returns surrounding T0 0.36 0.58 1.44 0.11
(2.94) (4.79) ( 2.76) ( 0.19)
dividend and earnings announcements, we take a dual approach.
T+ 1 0.28 0.33 0.25 0.19
First, as a most reliable proxy of the prevailing economic (3.61) (4.41) ( 0.75) (0.50)
sentiment, which also reects upon the behavior and the condence T+ 2 0.20 0.21 0.69 0.29
of the agents within an economy we employ the Economic Sentiment (3.17) (3.13) (2.42) ( 1.30)
Indicator (ESI), as published by the Directorate-General for Economic T+ 3 0.12 0.19 0.41 0.05
(1.80) (2.59) ( 1.67) ( 0.22)
and Financial Affairs (DG ECFIN). The ESI aims to combine business T+ 4 0.10 0.10 0.24 0.02
tendency surveys into a single cyclical composite or condence ( 1.49) ( 1.39) ( 0.95) (0.08)
indicator with a view to reduce the risk of false signals and to provide T+ 5 0.01 0.03 0.07 0.08
a cyclical indicator with better forecasting and tracking qualities ( 0.17) ( 0.37) (0.22) (0.28)
than any of its individual components (European Commission,
Panel B: Average Cumulative Abnormal Returns ACAR
2011). Although some US studies have employed rather composite
investor sentiment indicators (Baker & Wurgler, 2004), recent Event window All events DIV N 0 DIV b 0 DIV = 0

evidence (Lemmon & Portniaguina, 2006) suggests that the increasing T 1, T+ 1 1.04 1.33 1.24 0.30
participation of households in stock markets during the past 25 years (5.26) (7.37) ( 1.41) (0.39)
T 1, T0 0.72 0.99 0.99 0.11
has rendered consumer condence a more reliable proxy of economic
(4.73) (6.08) ( 1.22) (0.16)
activity and investor sentiment. We thus employ the UK ESI (UKESI), T0, T+ 1 0.64 0.91 1.69 0.08
to examine the role of the general economic sentiment on the (3.65) (6.38) ( 2.72) (0.11)
market's reaction to dividend and earnings announcements.
Panel C: Average Cumulative Abnormal Volumes ACAV
Secondly, we estimate the above cross-sectional model for the two
sub-periods January 2006 to December 2007 and January 2008 to Event window All events DIV N 0 DIV b 0 DIV = 0
May 2010, to check the consistency in the results. We therefore devise T 5, T0 0.723 0.694 0.631 1.046
a dummy variable (RECESS), which equals 0 for all announcements (9.47) (8.48) (2.16) (3.74)
before January 2008 and 1 for all observations from January 2008 T 1, T0 0.732 0.729 0.707 0.773
(20.65) (18.76) (6.52) (5.86)
onwards.
Notes: the table presents the Average Abnormal Returns (AARs) for the event period
4. Empirical results (T5 to T+ 5) around the dividend announcement in Panel A, the Average Cumulative
Abnormal Returns (ACAR) for three event windows in Panel B and the Average
Cumulative Abnormal Volumes (ACAV) for another two event windows. The rst
4.1. Share price reactions to dividend announcements column (all events) presents the results for the entire sample of 665 announcements,
whilst the second, third and fourth columns present the estimated abnormal returns for
We begin by presenting the Average Abnormal Returns (AARs) the dividend increase, decrease and unchanged clusters respectively.
Figures in brackets are the two-tailed T-statistic.
for the event period (T 5 to T + 5) around the dividend Signicant at 99.5%.
announcement in Panel A of Table 2. The rst column (all cases) Signicant at 99.0%.
presents the results for the entire sample of 665 announcements, Signicant at 95.0%.
whilst the second, third and fourth columns present the estimated
abnormal returns for the dividend increases, dividend cuts and
unchanged clusters respectively. In the period preceding the
announcement day T0 the AARs are mostly insignicant and appear nouncement information effects have been incorporated in the share
random, with the exception of T 1, where positive abnormal returns prices by this point.
are manifested for the entire sample and the increasing dividend Panel B presents the cumulative abnormal returns (CARs) for three
cluster. On the day of the announcement T0 the AAR for the entire event windows, namely (T 1, T+ 1), (T 1, T0) and (T0, T+ 1). The
sample is 0.36%, and signicant at 99.9%. Unsurprisingly, for the accumulation of abnormal reactions around the event day aims to
increasing dividend cluster the T0 excess return is positive (0.58%) capture the entire information content of the announcement and
and signicant (p b 0.001), whilst for the decreasing dividend allow for slower responses to be incorporated in the next steps of
announcements the average market reaction is negative (1.44%), analysis. CARs in all three windows are positive, ranging from 0.72%
as expected, and also signicant (p b 0.01). Finally, in line with our to 1.04% and highly signicant (p b 0.001). In the three dividend
expectations, the AARs manifested in the unchanged dividend cluster change clusters (positive, negative, unchanged) the signs are again as
are insignicant. expected (+, , 0), but not always signicant, especially for the
The above pattern in AARs continues for all the clusters and the dividend decrease cluster. This suggests that, reactions to dividend
entire sample for another 23 days post-announcement to a smaller decreases are more rapidly averaged out, as the opportunities from
degree, suggesting some slow reactions in the market's adjustment price declines are exploited by market participants. Similar to Pettit
of the full information content. After T+ 3 ARRs do not follow any (1972) and DeAngelo et al. (1996) market reactions to dividend cuts
particular pattern and are insignicant, suggesting that all the an- are more pronounced and sharper than reactions to the dividend
370 K. Bozos et al. / International Review of Financial Analysis 20 (2011) 364374

increases, whilst no changes in dividends result in random and insig- Table 3

nicant market responses. Average cumulative abnormal returns.

All DIV DIV N 0 DIV b 0 DIV = 0

4.2. Volume reactions to dividend announcements Panel A: Average Cumulative Abnormal Returns (ACAR) by earnings and dividends
EPS N 0 1.31 1.43 0.31 0.74
Cumulative abnormal volume (CAV) reactions were estimated (5.82) (6.10) (0.30) (0.69)
using the market adjusted mean model for 6 days (T 5, T0) and a EPS b 0 0.07 0.004 1.75 0.69
( 0.26) (0.01) ( 1.60) (1.11)
shorter period of 2 days (T 1, T0) for all three different dividend
DIFF. 1.38 1.43 2.07 0.05
change clusters. In Panel C of Table 2, the two-day CAV was found to (3.97) (3.78) ( 1.36) ( 0.04)
be 0.729% and 0.707% with a T-statistic of 18.76 and 6.52 for dividend
increase and decrease events respectively. Cumulative excess volume Panel B: Average Cumulative Abnormal Returns (ACAR) by period and dividends
reactions for both clusters are positive and signicant, and the results Recess = 0 0.61 0.59 0.58 0.91
(2.62) (2.40) (0.62) (1.04)
are in line with the ndings in the US and the Austrian stock Recess = 1 0.88 1.22 1.84 0.65
exchanges (Gurgul, Mestel, & Schleicher, 2003; Richardson, Sefcik, & (3.44) (4.44) ( 1.60) (1.00)
Thompson, 1986). DIFF 0.27 0.62 2.42 0.26
The presence of excess volume reactions for the unchanged ( 0.78) ( 1.69) (1.60) (0.19)
dividend cluster CAV(T 1, T0) = 0.773%, (p b 0.001) supports that the
Panel C: Average Cumulative Abnormal Returns (ACAR) by economic sentiment and
investors revise their expectations for neutral dividend announce- dividends
ments too. Yet, in examining this volume reaction alongside abnormal UKESI b 100 1.17 1.45 2.23 1.42
returns for neutral dividends during the same event window, the (3.76) (4.23) ( 1.86) (1.76)
excess volume does not reect on security returns. This discrepancy UKESI N 100 0.53 0.64 0.06 0.03
(2.57) (2.95) ( 0.06) (0.03)
suggests that when investors have heterogeneous expectations, DIFF 0.64 0.81 2.17 1.39
the abnormal share price reaction often gets averaged out (Gurgul, (1.74) (2.06) ( 1.32) (1.28)
Mestel, & Schleicher, 2003). Hence, investors revise their expectations
EPS b 0 EPS N 0 DIFF
in a heterogeneous manner instead of the rather more homogenous
pricevolume reactions within the other two clusters. 5 Panel D: Average Cumulative Abnormal Returns (ACAR) by economic sentiment and
earnings
UKESI b 100 0.49 2.04 1.55
4.3. The determinants of abnormal returns (1.19) (4.46) ( 2.50)
UKESI N 100 0.56 1.07 1.63
Since the focal point of the study is the inuence of economic ( 1.71) (4.14) ( 3.75)
performance on the information content of dividends, before progressing DIFF 1.05 1.31
(2.02) (1.87)
to any cross-sectional examinations, we investigate the behavior of
abnormal returns, under different situations of company-level and Notes: the table presents the Average Cumulative Abnormal Returns (ACAR) for the
window (T1 T0) for each of the three DIV clusters, and for different sample
economy-wide economic activity. Table 3 presents the average CARs,
stratications, based on the level of rm and economy-wide economic performance.
for the two-day event window (T1, T0) for each of the three dividend The values in the cells are the average CARs within each cluster and the gures in
clusters, and for different sample stratications, based on the level of brackets are the T-test results for means. DIFF denotes the differences in means
rm and economy-wide economic performance. Panel A presents mean between each cluster.
CARs grouped by earnings and dividend changes and the results of The gures in brackets are the T-values of the differences.
Signicant at 99.0%.
the T-tests for the differences in the means. CARs are generally higher Signicant at 95.0%.
for earnings increases than for earnings decreases; the differences are Signicant at 90.0%.
signicant for the entire sample and for both the dividend increases and
cuts clusters. In addition, CARs appear to be more pronounced when
dividend and earnings changes are in the same direction, suggesting the
existence of a corroboration effect. presented in Table 4. The mean change in dividend yield is 0.13,
Panel B reports average CARs in the periods before and after the whilst the median is slightly above (0.16). Within our sample of 665
beginning of the recession. CARs are on average more pronounced observations there are values of DIV as low as 5.52 (min) and as
during the recession (20082010), whilst the differences are mar- high as 2.47 (max). For the EPS the mean is 1.81, suggesting a
ginally signicant both for dividend increases and decreases. The slightly negative trend, whilst the median is positive (0.41). This
above nding is conrmed in Panel C with the use of the more robust means that the post-crisis effects on company protability in our
measure of economic sentiment (UKESI). In terms of sign, returns are sample have a greater weight on average: whilst the ratio of
in accordance with our predictions: positive in general for dividend positive/negative EPS values is rather balanced, the negative ones
increases and negative for dividend cuts. In terms of magnitude, are, on average, greater in size. The two extremes are 78.64 (min)
returns are moderated during periods of positive sentiment (UKESI N and 45.08 (max). Mean pre-announcement volume reaction CAV
100) and accentuated during periods of pessimism (UKESI b 100). (T 5, T 1) for all events was 0.723 and the mean of the average
Finally, in Panel D average CARs are signicantly higher for EPS ve-day returns AVR (T 5, T 1) was 0.05%, unsurprisingly close to
increases than for decreases, as expected. Also, CARs are on average zero. Closely held ownership in our sample ranges from 0.01% to
higher for both EPS increases and drops when broader economic 89.85%, with an average of 14.7% and a median of 10.63%. This
sentiment is low. suggests that in approximately half of the cases in the sample,
Summary statistics and pairwise correlations for the dependent closely held ownership is fairly low, in comparison with other EU
and all the explanatory variables in the cross sectional models are markets. The mean value for the Economic Sentiment Indicator in
the UK (UKESI) for the examined period was 97.64, whilst the
median was slightly above 102. In addition, UKESI for the cases in
5
An example for this phenomenon can be an event where a company with our sample spans quite a broad range, from 64.7 to 114.9, suggesting
declining earnings maintains an unchanged dividend rate, in an attempt to signal the
management's optimistic view on the company's future earnings potential. Such news
that the collected data should be very suitable to examine the
which is neither purely good nor bad may result in heterogeneous expectations among phenomenon under conditions of economic growth and adversity
the investors, which in turn will lead to share price reactions being averaged out. alike.
 K. Bozos et al. / International Review of Financial Analysis 20 (2011) 364374 371

Table 4
Explanatory and control variables.

1 2 3 4 5 6 7 8 9

Panel A: correlation matrix of the variables in the cross sectional models

1. CAR(T1, T0) 1.00
2. DIV 0.13 1.00
3. EPS 0.13 0.16 1.00
4. CAV(T 5, T 1) 0.03 0.01 0.01 1.00
5. AVR(T 5, T 1) 0.05 0.19 0.07 0.03 1.00
6. LNPRICE(T) 0.07 0.07 0.00 0.14 0.07 1.00
7. CHS 0.00 0.01 0.02 0.11 0.00 0.01 1.00
8. RECESS 0.03 0.06 0.16 0.08 0.01 0.14 0.00 1.00
9. UKESI 0.03 0.08 0.16 0.07 0.01 0.06 0.03 0.66 1.00

Panel B: summary statistics of the variables in the cross sectional models

Mean 0.72 0.13 1.80 0.72 0.05 6.16 14.7 0.53 98.0
Std. dev. 3.93 0.68 11.90 1.97 0.99 0.84 17.4 0.50 16.0
Median 0.39 0.16 0.40 0.32 0.10 6.19 10.6 1.00 102.0
Min 6.40 5.50 79.00 6.40 3.60 3.37 0.01 0.00 65.0
Max 8.50 2.47 45.10 11.5 2.54 8.64 89.90 1.00 115.0

Notes: the table presents the correlation matrix of all the variables employed in the cross sectional models. CAR(T1, T0) measures the two day (T1,T0) cumulative abnormal returns
from the announcement of dividends. DIV = (Change in Dividend per Share/Pi), and EPS = (Change in Earnings per Share/Pi), where Pi is the security price 10 days before the
dividend announcement (T 10). CAV(T 5, T 1), the Cumulative Abnormal Volume during the 5 days preceding the dividend announcement, AVR(T 5, T 1), the ve day average
absolute returns on the stock before the announcement day. LNPRICE(T) is the logarithm of the stock price on the day of the announcement. CHS is the % of closely held shares by the
management, which are not available for trading by the public. RECESS is a dummy variable, which equals 0 for all announcements before January 2008 and 1 for all announcements
from January 2008 onwards. Finally, (UKESI) is the Economic Sentiment Indicator, as this is disclosed on a monthly basis from ECFIN.
Signicant at 99.5%.
Signicant at 95.0%.

In Table 5, we report the results from the ve initial OLS regression namely DIV and EPS, to test the explanatory power, of dividends
models, which were estimated to examine the signaling hypothesis and earnings respectively. The coefcients of both explanatory
and the information content of dividends and earnings for the entire variables are positive (0.737 and 0.036) and agged as signicant
sample. Model 1 (Main) only includes the two explanatory variables, (p b 0.01). The value of R 2 is 3.26% and in the region of generally

Table 5
Coefcients estimated from least squares regressions of abnormal returns (N = 665).

Model 1 main Model 2 main + CVs Model 3 ESI Model 4 interaction1 Model 5 interaction2

Intercept 0.722 3.289 4.322 5.213 4.864

(4.80) (2.37) (2.67) (2.76) (2.70)
DIV 0.737 0.892 0.682 0.634 0.914
(3.23) (2.99) (2.81) (2.35) (2.95)
EPS 0.036 0.038 0.039 0.041 0.044
(3.01) (2.95) (3.16) (3.31) (3.34)
CAV(T 5, T 1) 0.034 0.039 0.042 0.033
(0.37) (0.48) (0.43) (0.36)
AVR(T 5, T 1) 0.109 0.084 0.147 0.125
(0.54) (0.48) (0.71) (0.62)
LNPRICE(T) 0.426 0.344 0.423 0.399
( 1.94) ( 1.69) ( 1.86) ( 1.81)
CHS 0.004 0.001 0.003 0.006
(0.39) ( 0.08) (0.25) (0.54)
UKESI 0.015 0.019 0.018
( 1.46) ( 1.55) ( 1.55)
DIV UKESI 0.027 0.035
( 2.12) ( 2.64)
EPS UKESI 0.001 0.001
(1.24) (0.77)
DIV EPS 0.019
(1.78)
R2 3.26% 4.04% 3.70% 4.50% 5.18%
F 11.61 4.56 3.96 3.78 5.45

Notes: the table presents the estimated coefcients from an Ordinary Least Squares regression of the following equation:


CAR T0; T + 1 = + 1: DIV + 2: EPS + 3: CAV T5 ; T1 + 4: AVRT5 ; T1 + 5: LNPRICET + 6: CHS + :
CAR(T1, T0) measures the two day (T1, T0) cumulative abnormal returns from the announcement of dividends. DIV = (Change in Dividend per Share/Pi), and EPS = (Change in
Earnings per Share/Pi), where Pi is the security price 10 days before the dividend announcement (T 10). CAV(T 5, T 1) is the Cumulative Abnormal Volume during the 5 days
preceding the dividend announcement, AVR(T 5, T 1), the ve day average absolute returns on the stock before the announcement day. LNPRICE(T) is the logarithm of the stock
price on the day of the announcement. CHS is the % of closely held shares by the management, which are not available for trading by the public. Finally, (UKESI) is the Economic
Sentiment Indicator, as this is disclosed on a monthly basis from ECFIN.
T-test results (two-tail) are presented in brackets ().
F is the Robust F-test of the heteroscedastic Estimators (white).
Signicant at 99.0%.
Signicant at 95.0%.
Signicant at 90.0%.
372 K. Bozos et al. / International Review of Financial Analysis 20 (2011) 364374

reported R 2 values across the empirical literature on the topic (Easton, Table 6
1991; Lonie, Abeyratna, Power, & Sinclair, 1996). The F value is 11.61 Standardized coefcients estimated from least squares regressions of abnormal returns.

and also signicant (p b 0.001), suggesting that the model ts the Panel A: sample stratication by earnings performance
data well enough for the purpose of statistical inferences.
EPS b 0 EPS N 0
Model 2 (Main + CVs) tests the same hypotheses in the presence
DIV 0.121 0.163
of the control variables (CVs) described in Section 3.4. Results are
(1.77) (2.87)
robust, despite most of the CVs not being agged as signicant. In EPS 0.019 0.134
Model 2, apart from the explanatory variables, only the coefcient ( 0.34) (3.31)
of LNPRICE(T), our proxy for transaction costs, is negative (0.344)
and signicant (p b 0.1), as expected. As trading (transaction) costs Control variables set CVS(A) CVS(A)

are directly proportional to the share price and investors in general, N 274 395
display an aversion to high trading costs, market reactions are mod- R2 2.40% 5.59%
F 0.96 3.68
erated by high prices (Bhardwaj & Brooks, 1992; Bhushan, 1994).
The value of R 2 is 4.04% the F value is somewhat lower, (4.56) but still Panel B: sample stratication by economic sentiment
signicant at the 99% level.
UKESI b 100 UKESI N 100
The following two models, Models 3 and 4, test the dividend
signaling hypothesis under generalized economic adversity. For this DIV 0.220 0.092
( 4.64) ( 1.36)
reason we generate the appropriate interaction terms for the in- EPS 0.054 0.135
teraction between the change in dividend and the UK economic sen- ( 0.90) ( 3.54)
timent indicator (DIV UKESI) and the respective interaction term
for changes in EPS and UKESI (EPS UKESI). To avoid collinearity Control variables set CVS() CVS()
between the regressors, we centralize the three variables, before N 227 442
calculating interaction terms. In Model 3 the effect of UKESI is neg- R2 8.25% 3.52%
atively related to CARs, yet marginally insignicant. This however F 5.1 2.94

corroborates the ndings previously reported in Table 4 (Panel C),
that CARs become in general more pronounced as he economic
sentiment drops.
More interestingly in Model 4 the interaction term DIV UKESI is
negative and signicant (p b 0.05), suggesting that, as the economic
sentiment drops, the coefcient of DIV increases. Hence, dividend
changes have a greater (lower) effect on market reactions when the
overall sentiment about the economy is pessimistic (optimistic). This
nding not only gives concrete support to the dividend signaling
hypothesis, but also conrms that in periods of economic adversity,
dividend signaling is stronger. On the other hand the coefcient of
EPS UKESI, the interaction term of Earnings and Economic Sen-
timent, is positive but insignicant.
Finally, in Model 5 we test the interaction (corroboration effect)
of earnings and dividends and nd it also to be signicant, in line
with past studies in the US (Kane, Lee, & Marcus, 1984), Australia
(Easton, 1991) and the UK (Lonie, Abeyratna, Power, & Sinclair, 1996).
The nding is also in line with the results of Table 3 (Panel A), where
CARs are signicant and more pronounced when changes in dividends
and earnings are in the same direction. Of course, the statistical
signicance of the interaction term is reduced by the existence of a
number of contrasting earnings dividend changes in the study
sample; hence the coefcient is only marginally signicant in the full
sample (p b 0.10).
4.4. Robustness tests: dividend signaling and economic adversity
Thus far, our ndings support that rm-level and market-wide
economic adversity inuence the information content of dividends,
effectively rendering dividend signals stronger when protability and
economic sentiment experience declines. To examine how robust
these ndings are and to further scrutinize the dataset, we employ
a number of additional econometric tests, this time by splitting
the study sample into different strata and revisiting the main study
hypotheses.
In Table 6 (Panel A) we present the standardized coefcients from
the OLS regressions of the extended cross sectional model for both
positive and negative changes in EPS:
Panel C: sample stratication by period
Recess = 0 Recess = 1
DIV 0.019 0.218
(0.39) (3.16)
EPS 0.130 0.067
(2.73) (1.44)
Control variables set CVS() CVS()
N 312 353
R2 1.76% 7.99%
F 1.25 4.00
Notes: the table presents the standardized coefcients from Ordinary Least Squares
regressions of the following equation:
CAR(T0,T+ 1) = + 1. DIV + 2.EPS + CVS() + ,
where CVS(A): CAV(T 5, T 1), AVR(T 5, T1), LNPRICE(T), CHS, UKESI.
CVS(B):CAV(T 5, T 1), AVR(T 5, T1), LNPRICE(T), CHS, DIV EPS.
CAR(T1, T0) measures the two day (T1, T0) cumulative abnormal returns from the
announcement of dividends. DIV = (Change in Dividend per Share/Pi), and EPS =
(Change in Earnings per Share/Pi), where Pi is the security price 10 days before the
dividend announcement (T 10). CAV(T 5, T 1) is the Cumulative Abnormal Volume
during the 5 days preceding the dividend announcement, AVR(T 5, T 1), the ve day
average absolute returns on the stock before the announcement day. LNPRICE(T) is the
logarithm of the stock price on the day of the announcement. CHS is the % of closely held
shares by the management, which are not available for trading by the public. RECESS is
a dummy variable, which equals 0 for all announcements before January 2008 and 1 for
all announcements from January 2008 onwards. Finally, (UKESI) is the Economic
Sentiment Indicator, as this is disclosed on a monthly basis from ECFIN.
T-test results (two-tail) are presented in brackets ().
F is the Robust F-test of the heteroscedastic estimators (white).
Signicant at 99.0%.
Signicant at 90.0%.
where CVS is a vector of the control variables: CAV(T5, T1), AVR(T5,
T1), LNPRICE(T), CHS, UKESI. 6 For parsimony reasons we only report
the coefcients of DIV and EPS, whilst the standardized betas allow
the direct comparison of the magnitudes of each effect. The beta of
DIV is signicant in both equations and higher in absolute value than
this of EPS, especially in the declining earnings sample (EPS b 0).
Hence, our prediction that the information content of dividends is

6
To avoid collinearity, due to the existence of only positive (negative) EPS in each
 
: : : of the stratied samples, we exclude the interaction terms from the vector of control
CAR T0; T + 1 = + 1 DIV + 2 EPS + CVS + 7
variables.
 K. Bozos et al. / International Review of Financial Analysis 20 (2011) 364374
more important than that of earnings under conditions of poor
nancial performance is conrmed.
Additionally in Table 6 we report the results from two further sets
of regressions of the extended cross-sectional model. In these two
sets, the vector of the control variables includes CAV(T5, T1), AVR
(T5, T1), LNPRICE(T), CHS and DIV EPS, whilst UKESI and the
other interaction terms are excluded to avoid collinearity between
the regressors. In Panel B, we split our sample between high (N 100)
and low (b 100) values of the economic sentiment indicator (N = 227
and N = 442 respectively) and in Panel C the beginning of 2008 is
the cut-off point between the pre and the post-recession period
(N = 312 and 353). The results from both sets are very similar and
give support to the ndings of the full-sample estimates: On one hand,
in periods of economic stability and/or positive sentiment (such as
the period 20062007 or when UKESI N 0) earnings announcements
contain sufcient information content and EPS changes can act as
reliable proxy for forecasting future cash ows. On the other hand,
in recessionary or otherwise pessimistic periods (such as the period
20082010 or when UKESI b 0), dividend announcements have more
information content and act as a more reliable signal of future cash
ows.
5. Discussion and conclusions
Following the dividend signaling theory our study set out to examine
the signaling effects of dividend announcements in the London Stock
Exchange, with a focus on the possibility of asymmetrical dividend
signaling effects between periods of stability and economic adversity.
By employing standard event study methodology, we found
positive and signicant abnormal returns surrounding the dividend/
earnings announcements, in line with the majority of the existing
literature in the US (Aharony & Swary, 1980; DeAngelo, DeAngelo, &
Skinner, 1996; Pettit, 1972) and the UK 7(Gunasekarage & Power,
2002; Lonie, Abeyratna, Power, & Sinclair, 1996). We also examined
volume reactions and found signicant excess volume activity for all
dividend change clusters, in accordance with the ndings in the US
and Austria (Gurgul, Mestel, & Schleicher, 2003; Richardson, Sefcik,
& Thompson, 1986). This result is original in this study, which, to the
best of our knowledge, is the rst to examine jointly the price and
volume effects from dividend announcements in the UK.
In addition, we observed that abnormal returns are accentuated
in the same direction as the change in dividends, regardless of the
level of earnings and the economic conditions. This nding was
conrmed through a series of OLS regressions and is in line with
Easton's (1991) study in the Australian market, where earnings
and dividend news are released simultaneously as in the UK, but are
also comparable to similar studies in the US and Germany (DeAngelo,
DeAngelo, & Skinner, 1996; Kane, Lee, & Marcus, 1984). In contrast to
Lonie, Abeyratna, Power, and Sinclair (1996)), who did not nd
enough evidence for the information content of dividends in the LSE,
during a six-month period in 1991, we exhibited that both earnings
and dividend changes convey information content; these effects were
robust to the presence of rm and market-level control variables.
Similar to other past empirical studies (Chen, Firth, & Gao, 2002;
Easton, 1991; Kane, Lee, & Marcus, 1984), we also found support
for the corroboration effect of earnings and dividends, which however
is more pronounced when earnings and dividend changes are in the
same direction.
However, perhaps most importantly, the study revealed a sig-
nicant negative interaction between the broader economic senti-
ment and the information content of dividends. DeAngelo, DeAngelo,
and Skinner (1992) supported that dividends should have signicant
7
In specic, Lonie, Abeyratna, Power, and Sinclair (1996) reports an AAR of 0.61%
for dividend increases on the announcement day, which is very close to the 0.58% in
our own results.
373
information content when current earnings are extreme or otherwise
unusual, whilst Eisdorfer (2007) found that cash ow news is more
important for rms in nancial distress. Our results effectively
extend the above ndings beyond the case of extreme earnings
and nancial distress, to the case of generalized economic adversity.
Splitting our study sample into smaller strata of steady and adverse
economic conditions caused the exact same pattern to emerge: in
both the case of decreasing earnings (DIV b 0) and low economic
sentiment (UKESI b 100) dividend changes were more signicant than
earnings changes in explaining CARs.
On the other hand, we found changes in dividends to be less
important in times of economic stability and growth (i.e. when
EPS N 0, UKESI N 100 or during the steady period 20062008). This
gives further support to DeAngelo, DeAngelo, and Skinner (1992), as
there should be little information content in random samples,
because current earnings would seem to be an essentially sufcient
means of forecasting earnings for most rms in most circumstances
(DeAngelo, DeAngelo, & Skinner, 1992 :p.1857). Finally, our results
offer support to the increasing literature on the inuence of the
economic sentiment to share price reactions, especially the ones
surrounding price-sensitive announcements (Baker & Wurgler, 2004;
Brown, Christensen, Elliott, & Mergenthaler, 2011).
Overall, the study ndings are of considerable importance for the
body of research on dividend policy, as they conrm the information
content hypothesis in the LSE, one of the world's most important
capital markets. Even more importantly, the study informs the
literature about the dynamics between corporate protability, payout
systems and investor behavior, by testing an existing theory under the
prism of generalized economic adversity. As an effect, this study adds
to the scarce empirical research on the recent turmoil in the nancial
markets and the subsequent recession, which spread across most
western economies within just a few months. With regard to practical
implications, the study ndings can be a very useful tool for nancial
decision making by top echelons, especially during recessionary
periods, as well as for nancial analysts and market participants alike.
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