The Impact of Initiating Dividend Payments on Shareholders' Wealth Author(s): Paul Asquith and David W. Mullins, Jr.
Source: The Journal of Business, Vol. 56, No. 1 (Jan., 1983), pp. 77-96 Published by: The University of Chicago Press Stable URL: http://www.jstor.org/stable/2352747 Accessed: 09/09/2009 15:14
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Paul Asquith and David W. Mullins, Jr.
The Impact of Initiating Dividend Payments on Shareholders' Wealth*
This study investigates the impact of dividends on stockholders' wealth by analyzing 168 firms that either pay the first dividend in their corporate history or initiate dividends after a 10-year hiatus. The empirical results exhibit larger positive excess returns than any previous study on dividends. This result does not depend on any other events (such as earnings announcements) and the excess return is positively related to the size of the initial payment. Subsequent dividend increases for the same sample of firms are also investigated. Compared with the initiation of dividends, the results suggest that subsequent increases may produce a larger positive impact on shareholders' wealth. The results also indicate that other studies may have underestimated the effect of dividend increases. The findings for both initial and subsequent dividends are consistent with the view that dividends convey unique, valuable information to investors.
The objective of this study is to add to the understandingof the effect of dividendson shareholders' wealth. The impact of a firm's dividendpolicy on its value is an unresolved issue. In their seminalwork, Millerand Modigliani(1961)demonstrate that, absent imperfections, dividend policy shouldnot affect shareholders'wealth. As Miller and Scholes (1978) subsequently demonstrate, under U.S. tax code this result may survive even if there is differentialtaxation of dividends and capital gains. Dividend irrelevanceis also supportedby the empirical work of Black and Scholes (1974). Alluding to an argumentin paper, Black and Scholes the Miller-Modigliani emphasizethe abilityof firmsto adjustdividends to appeal to tax-inducedinvestor clienteles and argue that this supply effect may account for their finding of no significant relationship between dividendyields and stock returns.
* We wish to thankEugene F. Fama, RobertR. Glauber, JohnV. Lintner,Scott P. Mason, RobertC. Merton,Merton H. Miller, Franco Modigliani,RichardRuback, an anonymous referee, and especially Stewart C. Myers for helpful commentsandsubstantivesuggestions.We wouldalso like to of thankthe participants the MITFinanceWorkshopand the membersof the CRSP Seminaron the Analysis of Security supportwas Generousfinancial Pricesfor theircontributions. provided by the Division of Research, HarvardUniversity GraduateSchool of Business Administration.
(Journal of Business, 1983, vol. 56, no. 1) ? 1983 by The University of Chicago. All rights reserved. 0021-9398/83/5601-0002$01.50 77
Hakansson(1982) demonstratesthat informativedividends improve efficiency when investors are heterogeneous in some respect or financial markets are incomplete.78
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Challengesto the dividend irrelevancepropositionhave focused on imperfections. A positive wealth impactmay also result from a dividendpolicy that communicatesvaluable informationto investors. These results are criticized by Miller and Scholes (1981) and Hess (1981). (1978)and Blume. This position is expressed by Grahamand Dodd (1951). on the other hand. Millerand Rock (1982)show that as a result of information asymmetrybetween investors and managers.e. With a given investment policy and capital structure. if risk (i. Gordon (1959). Capitalasset pricingmodels incorporatingdifferentialpersonal taxes have been developed and/ortested by several researchers including Brennan (1970). A traditionalviewpoint is that investors preferreturnsin the form of dividends. and Friend (1974)and by the empirical results of Elton and Gruber(1970) concerning the exdividendbehavior of stock prices. Finally. and Gordonand Bradford(1979)and is supportedby Long's (1978)examination of the returnson the dual series common stock of one firm.This view is consistent with the results of empirical studies examining firms' dividend policies (Lintner 1956.div-
. a negativewealth impactmay resultfrom other costs associated with paying dividends. Empiricalresults presentedin these papers suggest that. Hess. finds that before-taxexpected returnsare relatedto dividendyields.Ross (1977)and Bhattacharya(1979.The existence of taxinduced clienteles is investigatedby surveys of investors' holdingsby Lewellen et al.Fama and Babiak 1968).The formerauthorsfindno supportfor an after-taxcapitalasset pricingmodel.. before-tax returnsare an increasingfunction of dividend yield. Crockett. In additionto the cost of administering a dividendprogram. possibly because of institutionalconstraints. beta) is held constant. and Blume (1980). Dividends may provide a vehicle for communicatingmanagement'ssuperiorinformation concerning their interpretationof the firm's recent performanceand their assessment of future performance. he concludes that the natureof this relationshipis not consistent with the tax-inducedeffects hypothesized by an after-taxcapital asset pricingmodel. an increase in dividends must be funded with new equity. and this suggests a negativewealth impact. Rosenbergand Marathe(1979). However. A positive wealth impacthas also been suggestedby manyresearchers. 1980). 1980)present asymmetricinformationmodels in and which dividendsserve as signals of the firm'scurrentperformance future prospects. This result can hold even in the presence of deadweight costs associated with dividends.Dividend income is taxed at a higher rate than capital gains. Litzenberger and Ramaswamy(1979. In a general equilibriumanalysis.Brittain1966.the firmmay incurtransactioncosts associatedwith issuing new equity.
Dividend Payments on Shareholders' Wealth
idend changes can result in market price reactions...1 Because his study makes no effort to remove the effect of contemporaneous earningsannouncements. Their study also supports the semistrong form of the efficient capital markethypothesis. There is no leakage of information prior to the dividend announcement.and Charest for in assumedthe announcement apparently date to be mid-month insteadof determining the actual news date. and the full impact of the announcementis concentratedin the 2-day announcementperiod. Our analysis. Laub (1976) and Pettit (1976) challenged Watts's findings. like that of Aharony and Swary.Their analysis focuses on dividendannouncementdates that differfrom earningsannouncement dates by at least 11 days. Kalay (1980) studied dividend reductions and. earnings). and Watts (1976) rebutted these challenges. he could not reject the hypothesis that dividend reductions contain information.g.No adjustment risk is incorporated his analysis of daily excess returns.Charestconcludes that his evidence does not necessarily reveal the presence of informationin dividendannouncements. To identify unexpected dividend increases most studies either assume a naive dividendexpectations model (i. For dividend increases they found a significant averageexcess returnof about 1%over the 2-dayannouncement period. A number of other empirical studies have examined whether dividends containinformation.Aharonyand Swary (1980)documenta small but significantdividend announcementeffect separatefrom the information impact of earnings announcements. uses daily data to allow explicit identificationand control of contemporaneous information. The first is inadequate identificationand control of other simultaneoussources of informationsuch as earnings announcements. consistent with his signalingmodel. They contend that unexpected dividend changes communicate no informationbeyond that reflected in other contemporaneous variables (e. The second source is the difficulty of isolating and controllingfor investors' expectations. Two studies employ daily returndata.ratherthan the precise measurement the information of impact. Charest's interest is primarilythe efficiency of the stock marketwith respect to dividendannouncements.e. The disagreementamong previous empiricalstudies stems from three sources. all of these studies are based primarilyon monthly stock returns. The resultreportedabove is basedon a briefextensionof his monthlyanalysis. any change in dividendsis unexpected)or employ some dividendfore1.Pettit (1972)found that dividendannouncements do convey valuable information. However. Charest(1978)found that the announcementof a dividend increase generates an excess return of about 1%. However.
. This study investigates the mannerin which dividends affect shareholders' wealth. Watts (1973) and Gonedes (1978) came to the opposite conclusion.
Before the initial dividend. stockholders of our sample firms receive returnssolely in the form of capitalgains. Exploringthis relation also helps identifytruly unexpected changes in dividendsand provides additionalinsight into the sources of the wealth effect of dividendsas well as of the abilityof investors to forecast both initialand subsequent dividends. these firmsshould be owned by high tax bracketinvestors.Subsequentchanges in dividends. if initial dividends are largely unanticipated. Compared with subsequent dividend changes. exploredin other studies.If dividendinitiationis unexpected. and the full effects of the dividendchange are not visible in the excess returnon announcementday. the market reaction on announcementday should capturethe full effect. Initiatingdividends may also induce a change in investor clienteles. If so the unexpected portionof a changein dividendsis no longerequal to the entirechange. Thus. A final deficiency in much of the previous empirical work is its failure to relate the wealth effect to the magnitudeof dividends. such as the tax burden associated with dividends and the benefits of establishing a mechanism for communicatingmanagerial information. The result should be a clearer view of the true impact of dividends on shareholders'wealth.The averagemarketresponse to initiationis largerthan the average effect of large subsequentdivi-
. This view implies that hypothesized dividends effects should be most visible at initiation. The theory suggests that the two may be related. The firms in our study paid no dividendseither duringtheir entire corporatehistoriesor for at least 10 years.80
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casting model to capture investors' expectations. The portionof the marketreactionassociated with the expected dividend change is already incorporatedin stock prices on announcementday. not its full impact. In this case the dividendforecastingmodels employed in other studies collapse into the naive expectations model. If tax clienteles are relevant. the dividendannouncementmay induce a changein investorclienteles. We find for our sample that initiatingcash dividends is associated with a significantpositive excess return. The present value of any transactioncosts and other expenses associated with the expected change in clienteles as well as the presentvalue of any tax burden imposed on this new clientele will appear in the market's reaction. Therefore. The excess returnshouldreflectinvestors' estimates of the presentvalue of factors.examiningdividend initiationsallows us to purgeinvestors' expectations that may be incorporatedin subsequent dividends. may be more accuratelyforecast by investors. we believe that the naive model accuratelyreflects investors' expectationsfor initialdividends and that initial dividends are more likely to be unexpected. The marketreactionon announcement day is only for the unexpected portionof the change in dividend.
Ouranalysis supportsthe view that dividends convey to investors valuableinformationin additionto that contained in contemporaneousinformationsources. and no anticipationby investors of the initiationof dividendpayments. Further. the effect of subsequent dividend announcements should reflectonly the communicationof incrementalinformation plus any unexpected changes in the other hypothesized effects. Ourresults also suggest that previous studies may have underestimated wealth effect the of subsequentdividendincreases. Aharonyand Swary 1980). the size of the initialdividendis also larger than subsequent changes..the effect of these announcements should reflect only the unexpected
. an efficient stock market. Assumingrationalinvestor expectations. Issues
The precedingsection suggests a numberof hypotheses concerningthe effect of dividends on shareholders'wealth.If the dividendsare partiallyforecast.g. In addition. Gordon1959)view that investorspreferreturnsin the form of cash dividends. and (3) benefits associated with the traditionalists' (e. subsequentdividendincreasesappearto generateas large or largeran effect on shareholders'wealth. Adjustingfor the magnitudeof dividendchanges. Factors that increase shareholders' wealth include the present values of (1) establishinga mechanism for communicatingmanagerialinformation. Factors which decrease shareholders'wealth include the present values of (1) the additional tax burden associated with receiving dividends now and in the future and the adjustmentcosts incurredby tax-inducedchanges in clienteles and (2) any other costs (e.the benefits of this informationappearto outweigh any costs associated with paying dividends.Dividend Payments on Shareholders' Wealth
dend increases analyzed here and in other studies (Charest 1978. the initiation impact should include the value of the incrementalinformationcommunicatedby the initial dividend..However. If investors anticipatesubsequentdividend announcements. transaction costs associated with issuing new equity) incurredin paying dividends now and in the future.(2) reducinginstitutional constraints on investors. The understatement stems from the failure of previous work to (1) capture accuratelyinvestors' anticipation of dividends and (2) incorporate the magnitudeof dividend increases in their analysis. administrativecosts. The factors responsiblefor changes in stockholders'wealth can be groupedinto those which may have a positive wealth effect and those which may have a negative wealth effect.g.investors' estimatesof the present value of the various hypothesizedeffects should be incorporated into the stock price on the day a firm announces an initial dividend. These present values may already be incorporatedin stock prices when subsequentdividendsare announced.
The thirdissue involves comparinginitialand subsequentdividends. The first issue poses a simple question. Obviously. the stock price should already incorporateinvestors' expectations of the impendingdividend. investors have expectations concerning the frequency of dividend payments. investors' information may be augmented by the informationcontained in a nonconstant series of dividends. that any increase in dividendsis unexpected
. This comparison should provide with insightsinto the variouspresent-valueeffects associated primarily the initiationof dividends. Candidates for the size variable include the change in dividend yield and dividendpayout. As a result. Finally.(3) the comparative effects of initialand subsequentdividends. (2) the relationshipbetween the wealtheffect and the magnitude of dividendsfor both initialand subsequentdividends. Aroundthe time a subsequentdividendannouncement is expected. if dividendssignalvaluableinformation. it is not easy to isolate the separateeffects of the disparate factors presented above. investors' informationsets includes all informationavailable or inferrablefrom a dividend series constant at zero. To provide insight into the effects of dividendswe shall explore four issues: (1) the average effect on shareholders' wealth of both initial and subsequent dividend announcements. Unlike episodic stock repurchaseswith timingat the discretionof management. Several of the hypotheses suggest it shouldbe. If dividend increases are good news and investors anticipate an increase. Which set of factors dominates the announcementeffect? On balance. Subsequentwealth effects should result primarilyfrom the communicationof unexpected incrementalinformationtransmittedthrough an established dividend program. do our sample dividend announcementsincrease shareholders'wealth? The mannerin which the effect is incorporatedin stock prices throughtime also provides a test of the semistrongform of the efficient capital markethypothesis. The second question is whetherthe magnitudeof the wealth effect is relatedto the size of the dividendpayment. we shall examine the possibility of an anticipationeffect. For example. the wealth effect shouldbe relatedto the size of the signal. Once dividend payments are initiated. investors may be more successful in forecastingthe magnitudeand timing of future dividendchanges.and (4) investors' anticipation of initial and subsequent dividends. a positive excess return should be observed only if the actual increase exceeds the expected
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changes in the present values discussed above.
Some previous empirical studies of dividends have assumed the naive expectationsmodel. When the firmpays no dividends. The objective is to compare the effect of establishinga dividendprogram with its use once established.
The models are estimated by regressingdividends in a given period againstpast dividends.It may be possible to gain some insight into investors'estimatesof the likelihoodof dividendinitiation.but we have not pursuedthis resultsprovideinsightinto investors'abilityto anticpossibility. not the full effects of initiation. Standard and Poor's Dividend Record. The dividend is either the first dividend in a firm's corporatehistory or the resumptionof a dividendafter a hiatus of at least 10 years.2
The empiricalresults help clarify the question of the efficacy of the naive model and the validity of findingsbased on it. This statement should be limited. Aharonyand Swary 1980).
III. Neither the exdividend day nor the day the dividend is paid is considered to be an announcementday. Other studies have employed dividend forecasting models to captureinvestors' expectations (e.
. The initial 10-yearscreen used was January1954December 1963. our empirical ipate dividendinitiation.The period studiedextends to 1980. and the announcement ponent. for the initiationof dividends the naive model may be difficultto improve
on.Theirestimateshouldbe reflectedin the preannounceeffect shouldreflectonly the unexpectedcomment stock price.g. The abilityof investors to anticipate initial and subsequent dividends provides evidence of the errorsin the findingsof earlier studies that employ the naive expectations model. Data
This study analyzes a sample of 168 firms that initiate a dividend to common shareholders.Watts 1973). and the
Wall Street Journal. The relation between excess returnsand the magnitudeof dividendchanges provides an insightinto the failureof the naive model.. Thus.As a result. With a variable series of past dividends.Dividend Payments on Shareholders' Wealth
(e.For all firms.However. these models generallycollapse into the naive model. these studies may underestimate the wealth effect of an increase in dividends. and other variables. A dividend announcementdate is the date when news of the forthcoming dividend first appears in the Wall Street Journal. earnings. Lintner 1956. the Center for Research in Security Prices. including Moody's Dividend Record. This requirementguaranteesthe availabilityof data. this initial dividend was paid at least 1 year after the firm was listed on either the NYSE or ASE. and thereforeall first dividendpaymentsin this study occur afterDecember 1963.g.
2. Investors may well expect the firm to initiate dividendssometimein the future. When confronted with a constant past series of dividends. these models may produce forecasts superiorto those implicit in the naive model.. The dividend announcement dates and the amount of dividends paid by these companies were then collected. The set of firmsthat initiateddividendpayments came from several
XRit = the excess
returnto securityi for day t. The daily excess returnfor a security is estimated by
XRit = Rit
E(Rit). The majority of such an-
nouncementsare earnings statements.
where N is the numberof securities with excess returnsduringday t.
E(Rit) = the expected rate of return on security i for day t.This provides on information the dividendhistories of the samplefirmsfor the 3-year period following the initial dividend and also allows a comparisonof initialand subsequentdividends. and earningsper shareinformation was collected for the previousfiscal year to calculatechangesin payout ratios.
IV. Average excess returnsfor each relative day are calculatedby
XRit. The term
E(Rit) is estimated by grouping annually all securities listed on the NYSE and the ASE into 10 equal control portfolios rankedaccording to their Scholes-Williamsbeta estimates. The observed return to the control portfolio which security i is assigned to is then used as the estimate of E(Rit). Each security is therefore assigned to one of 10 portfolios. stock prices were collected for the month end before all dividend announcements to calculatechanges in dividendyield. 114increased their dividend within 3 years. Daily average cumulative excess returns. CERs.
where t = the day measured relative to an event. seven decreased their dividendand the remaining47 kept their dividendat the initiallevel. XRit. Methodology This study uses daily stock returndata to compute excess stockholder returnsand to examine dividend announcementsfor each firm in the data base. The results clearly delineatewhetherthe announcementdate is for that firstor subsequent dividends. all other announcementsthat occurred within ? 10 days from a dividend announcementwere collected from the Wall Street Journal Index. Rit = the returnon securityi duringday t. The excess returnfor each security. Finally. are formed by sum-
. is then calculated as the difference between the actual returnto a security and the returnto its control portfolio. To control for other events.84
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Dividendannouncementdates and dividendamountswere collected not only for the initial dividend but also for the largest dividend increase that occurred during the following 12 quarters. Of the 168initialfirms. The daily returns file of the Center for Research in Security Prices (CRSP)provide the observed returnsfor each securityRit.
( IO)/V (5)
where SXR. day The average2-dayexcess returnsfor the eightare + 4. and + 1.o)=
In addition. If a dividend is announced
before the marketcloses.Since this was not an the customarymethodof announcing initialdividend. and N = the numberof firms in the sample.XR_ I = the excess return to
security i on the day priorto the publisheddividendannouncementin the Wall Street Journal.these eightwere kept separate. the marketwill respond the next day and the announcementday is indeed zero. a t-statistic is calculated for XR(.Table 1 gives the average daily excess returnsand cumulativeexcess returnsfor the 20-day pethe riod surrounding initialdividendfor 160 firms. however. 10) = the standard deviation of the 2-day excess returns. a 2-day average excess return is generated for each dividendannouncementexamined.1. Thus in reality there is a 2-day
announcement "day. A 2-day excess returnis necessary to capturethe entire impactof a dividendannouncement.56 and 1. This 2-day return is calN
culated as XR(_1. and reported the next day.7%on the firstannouncement day. Finally.8%on the second announcement
and t = 0. The t-statisticsare 2.Dividend Payments on Shareholders' Wealth
ming average excess returnsover event time as follows:
3. Results This section examines how shareholders'wealth changes with initial and subsequent dividend announcements.Of these 160combined of their announcement dividendinitiationwith the amountof the dividendand are included in tables 1 and 2.
where the CER is for the period from t
K days until t = L days.1. t = . the news is announcedon the previous
day. Therewere 168firmswhichinitiatedividendsin the sample.3The results for the 2-day announcementperiod are both large and significant. Eight firmsmade a separatedividendinitiationannouncement of followed by a second announcement the amountof the dividend.O)by XRt( 10)= XR( lO)/SXR. If the news is announced after the marketcloses.0) = XR_ I + XRjO.Day t = 0 is the day the news of the dividendis publishedin the Wall Street Journal. In many cases.1. then the market'sresponse to the news actually predatesthe announcementday by one. and XRjO = the excess returnto security i on the day the dividend announcementis published in the Wall Street
rD 00 C O
+ + + + + + + + ++
I ++ u C~~~~~~~
I I +++
I+ + ++
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the result may be due to failure of the naive expectationsmodel ratherthan to an adverse reactionto dividend initiation. For the few sample firmswith negative excess returns.18 +.00 < XR +. Of the 160firms.5 In addition.59.06 -.4 These results are several times larger than either Charest's (1978) averagedaily excess returnof 1%or Aharonyand Swary's (1980)2-day average excess returnof 1%.12 -.8 16.6
Size of Excess Return (XR) XR -. on average.7.5 91.0 98. Most important.04 < XR +.2 1. 5.3 95.12 < XR -.00 +. 114 of these 153 firms increased the dividend at least once duringthe first 12 quartersfollowingthe initialdividend.
.02 .06 + +. 153continuedthe paymentof dividends after the initial dividends for at least 3 years.30
Cumulative Percentage of Firms 0 0 0 .5 8.18 < XR -.4 72.02 < XR ?.the results supportthe hypothesis that any negative wealth effect dividends generate (either throughchanges in tax-inducedclienteles or throughincreasedfuture financingcosts for the firm) is.4 100.4 13.9%and the tstatisticis .0 59.24 -.1 99.02 < XR +.9 15.04 +. All firmsthatreducedividendseliminated thementirelyduring first the 3 years. did not pay only a single dividend. however.04 -.1 18.0
excess returnis +3. The average2-day excess returnfor this announcement date is .6 4.Dividend Payments on Shareholders' Wealth TABLE 2 Cross-sectional Distribution of Excess Returns for 160 Firms on Announcement Date of First Dividend Percentage of Firms 0 0 0 . If this establishmentof a dividend policy is foreseen by investors when an initial dividend is
4.8 3.12 +.4 6. Table 2 shows the cross-sectional distributionof 2-day announcementexcess returnsfor the firms in table 1.18 -.30<XR -.06 <XR + .06 < XR -.3 .12 < XR +. The vast majorityof firms in this sample. All seven firmsthatdid not continuepayingdividendshadan announcement that to effect.24 < XR +.30.02 +.8 3.8 2.18 < XR +.24 +. For almost 70%of the firmsexamined there is a positive marketreaction to the announcementof initial dividend.9 45.30 < XR -.04 < XR -.6 31.1 14.7% and the associated t-statistic is 6. more than offset by the positive value investors place on being paid a dividend.6 3.30 -.24 < XR -. It can be argued that a single dividend payment should not have much impact on tax clienteles or on the future financingneeds of the firm.4.3 13.
In additionthere are other events.and only the results for the first classificationscheme are reportedhere. A separateand more importantissue is whether the strongpositive made available results exhibitedin table 1 are due to other information dividendannouncement. these firmswere classifiedas havingno earnin ings information the period ? 10 days. we checked the Wall any that surrounded diviearningsannouncements Street Journalfor the two quarterly not dend announcement.88
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paid. which contain the informationand which occur duringthe 21-dayperiod surrounding initial dividend announcement. The 2-day
excess returns and associated t-statistics are XR = 4. There is the possibility that the Wall Street Journal may report a dividend announcementbut not an earningsannouncement.
.There were only four quarterlyearningsannouncements reported.Some of the firms have both earnings announcementsand nonearningsevents duringthe 21-dayperiod.9%and -2. For event in this period. To test this possibility.The other scheme segregates any events which occur simultaneously with the dividend announcement. legal actions. 7. such as merger negotiations.and XR = 1. divisional spin-offs.88 for the 88 firms with no other new information.The remainsix firmsthere was only a nonearnings become publicwithinthe 21ing 88 firmshad no importantinformation the day period surrounding announcementof an initial dividend. The 2-day announcementday excess returnsfor these four firms are + 3.7 The excess returnanalysis describedin equations(1)-(5) was redone for each of these three subsamplesand is reportedin table 3.4%. Two classification mentionedabove.7% and t = 5. 3).and one is for an initial of that had separateannouncements initiationand amount(see dividendannouncement n. is to segregateany events which occur within + 10 days of the dividend announcement. Three are for regularinitial dividendannouncements. 6.5% and t =
3. One. there is an earnings announcement within ? 10 days.1%. respectively.There are no importantdifferencesin the results for the two criteria. Thirty-fiveof these earnings announcements occur within ?1 day of the dividendannouncement.4%.This raises the possibilitythat the results in tables 1 and of other thanthe announcement an 2 mightbe the result of information initial dividend. None of the subsequentdividendannouncements have a missing earningsannouncement.08 for the 66 firms with earnings announcements.To test for this. XR = 2. and the announcementof new products. +-7.Since the lack of a reportedquarterly earningsstatementdoes not mean that an earningsreportbecame public in the period + 10 days of the dividendannouncement. to the capitalmarketsat the same time as the Aharonyand Swary's (1980)findingof separateannouncementeffects for earningsand dividends and Pettit's (1972)findingof large dividend both suggest excess returnswhen there is positive earningsinformation that earnings announcements must be separated from dividend announcements.+ 0.6%
schemesare used to eliminatethe influenceof otherevents.6For 66 of our 160 initial dividend announcements. the wealth effect on investors should exceed that associatedwith any single dividend. any other events that occurred within + 10 days of any dividend announcementwere identified.
6 1.07 . Aharony and Swary (1980) examined the differentialeffect of earnings and dividend announcements and demonstratedthat dividend and earnings announcements are not perfect substitutes. There is no subsequent marketreaction after the announcement.7 4. Dodd's and Asquith'sresults show a marketreactionto the announcement a of mergerbid from 20 days before until the actual bid.59 5.79 2.88 3. this absence of prior marketreactionis unusualcomparedwith results of other recent studies using daily data. The market'sreactionto subsequentdividendannouncements also is examined.All firmsare followed for 3 years afterthe initialdividendto determinedividendpolicy.7
t-statistic 6. but are smaller and insignificantfor all other days.8 . Thus.6 1.84 1.78for the six firmswith other news.53 .Although consistent with Aharony and Swary's results.Dividend Payments on Shareholders' Wealth TABLE 3 Two-Day Average Excess Returns and t-Statistics for Initial Dividend Announcements and Subsequent Dividend Increases
Excess Return(%) Initialannouncements: All initialannouncements No other events + 10 days Earningsannouncements+ 10 days Otherevents + 10 days Subsequentincreases: Largestabsoluteincreases Subsequentincrease > initial dividend Subsequentincrease > 100% Largestincrease-no other events Subsequentincrease > initial dividend-no other events Subsequentincrease > 100%-no other events 3.07 1. with many firmsdoing so
.5 1.1 and t = 0.08 1.78 3. The results in this study also support the semistrongform of the efficientmarkethypothesis. an initialdividend announcement results in positive excess returnseven when there is no other informationreleased simultaneously.Ourresults suggest that they may be partial substitutes. such as Dodd (1980) and Asquith (1982).7 1. To the contrary.41
Number of Firms 160 88 66 6 114 37 30 66 16 11
and t = 1. 114 firms increased the dollaramountof their dividendat least once.7 2. 153 of the 160 firms continued to pay dividends over this period. other informationappearsto negate the impact at the dividendannouncementby reducingthe information content of the dividend announcement.There also appearsto be no leakage of informationprior to the dividendannouncement.2 .6 1. t = . The excess returnsin table 1 are largeand significant for the 2-day announcement day. As mentionedabove.These results suggest that the market'spositive reactionto the dividendannouncement not due is to other events.
The 2-day announcementexcess return for this subset is 1. If so.6% and the t-statistic is 1. Eliminatingsubsequentincreases where there are other events during the period + 10 days lowers the average excess returnsand the tstatistics for all three of the subsets. There is of course considerableoverlap between these two samples. there is no control for the size of the dividend. At that time the effects of the expected dividend are already incorporatedin stock
prices. with an average excess returnof 0.the naive expectationsmodel may be a more accurate reflection of investors' expectations at the time of dividend initiation.These had a 2-day excess return of 1.53. Finally. Excess returns and t-statistics are then calculated for several subsets of subsequentdividends.07. the full effects of a dividend increase are no longer reflected in the excess returnon announcementday.90
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several times.84. the past sequence and timing of dividend changes may provide informationthat allows investors to construct a better forecasting model.41. The 37 firms with subsequent dividendchanges absolutelygreaterthanthe initialchangeare reduced to 16. Once a dividend policy is in place. Initial dividends may be largerthan subsequentincreases and thus may explain the largerexcess returns. the expected dividend increase may not be zero as assumed in the naive model. respectively. the size of the dividend is a measure of the magnitudeof the signal. Second.7%and 0.
If dividend increases are expected and received as good news. Presumablyif dividendsare a signalingdevice. the announcementday excess return reported by earlier studies understates the market reaction to an increase in dividends. First.There are 37 subsequentdividend increases where the absolute increase was largerthan the initial dividend.79.2% and a tstatistic of 2. 66 firmshad subsequentdividend increases with no other event information. These results for subsequentdividendincreases are small compared to the initial increase and are comparableto those found by Charest and by Aharonyand Swary. Thirty subsequent increases were greaterthan 100%of the previousperiod's dividend. the expectationsmodel for initialand subsequentdividends may differ.7% and a t-statistic of 1. Thus. and the average excess returnand t-statisticare 0. in interpreting these results to suggest that initiatinga dividendpolicy has a positive present value over and above that observed with subsequentdividend increases. The largestabsolute increases in dividendsduringthe 3 years for all 114firmshad an excess returnof 1. As suggestedearlier. There are only 11 remainingsubsequentincreasesgreaterthan 100% of the currentdividend.however. Studies em-
. There is a problem.8% and a t-statistic of 0.The largest subsequentincrease for these 66 had an average excess return of 1.07.6%and a t-statistic of 3.
This objection.8 This cross-sectional regression equationis
XRETi = a + a (A yield1) +
Ei. For initial dividend payments the average increase in the dividend yield was 3. All of the followingregressionsare estimatedfor both changesin yield and payout ratios.a large number of the sample firms changed certain accounting proceduresduringthe periodstudied.02% and the average increase in the payout ratio is 17.85%.07%and the averageincreasein the payoutratiowas 7.A similarrelationis independently derivedby Millerand Rock (1982) from an assumptionof asymmetricinformation (see their eq.For the largest subsequent increases the average increase in the dividend yield was 1.34%. is supportedby the results. measured either by yield or payout ratio. the market'sreactionto an initialdividend(as measuredby each firm'sexcess return)is regressedagainstthe annualizedchangein yield. The average change in the dividend. Changesin payout ratios may be a better signalingmechanismthan changes in yield. This relationshipholds for the sampleof all initialdividendsandfor the
8. but the results for changesin payoutratios are all consistentwith those reportedwith respect to both sign and significance. The following reported results use only changes in yield.Dividend Payments on Shareholders' Wealth
ploying the naive expectations model for subsequent increases measure only the average reaction to the unexpected portion of the increase.3%. Furthermore. but payoutratiosare unfortunately more subjectto measurement errors. which is less than the full effect of a partiallyforecast dividend increase.Earnings per sharedata are often impreciseand differentfirmsemploy differentaccountingpractices. that initial dividends cannot be compared directly with subsequent increases. To explore the relation between the wealth effect and the size of dividends. There is a positive and significantrelationshipbetween the size of the initialdividend and the size of the firm'sexcess returnon the announcement day.
Table 4 reports the regression results for equation (6).Examining the subset of 14 firms where the subsequentincrease in dividend yield was greaterthan it was for the initialdividend.Becauseof this the R2for the sampleof firmsusing changesin payoutratiosis always less thanthe R2 for the same sampleusingchangesin yields. and A yield = the annualizedchange in yield for firmi as calculatedby the new dividend minusthe old dividenddividedby the firm'sprevious-month-end stock
price. is larger for initial payments than for subsequent ones. Examiningthe magnitudeof initialand subsequentdividend changes illustrates the extent to which expected dividend increases are alreadyincorporated stock prices on announcement in day.
where XRETi = the estimated excess return for firm i on the 2-day announcementday as calculated by equation (4). ).9% and the average excess returnfor initial dividends was 3. Thus it is possible that the averageexcess returnsare largerfor initialdividendsbecause the average change in the yield or payout ratios is larger.the average2-day excess returnfor subsequentincreases was 2.
1.This findingimpliesthat the naive expectationsmodel may be accurate for dividend initiation. If increases are good news and dividend initiation is largely unforecasted. The nonnegative intercept term suggests small that. The excess returnon announcementday then capturesonly the
9.92 TABLE 4
Journal of Business OLS Estimates of Equation (6) for Initial Dividends and Largest Subsequent Dividend Increases ct (%) .94 (4.
.43) 2.-t-statistics are in parentheses. investors were not disappointedby arbitrarily initialdividends.35)
sample where there is no other informationduring the period + 10 days. the regressionsdemonstrate day is at least as large as the dividendyield. Further. on average.98 (-2.71)
R2 . The negative interceptmay reflectinvestors' anticipation of subsequent dividend increases already incorporatedin stock prices. For example. However.22 (4.9 Equation (6) is used also to regress the excess returns associated with subsequent dividend increases against changes in yields. that the excess returnon announcement day Therefore.120 . dividend increases would be expected to produce only positive market reactions. demonstratesthat increases in dividends are good news.149 .26) .34 (. Again. suppose the worst-case investor is subject to a 100%tax on the dividend.1.This suggests that dividendsmay produce net gains even for high tax bracketinvestors. The stock price would decline by the full amountof the dividendon the ex-dividendday.the yields employedin the regressionsare annualized.The interceptis small and insignificantly Finally.with all other investorstax exempt.63) 1.96
All initial dividends Initial dividends-no other events Largest subsequent increases Largest subsequent decreasesno other events
NOTE. dividend.182 . The intercept term should measure the effect of dividend initiationseparatefrom the size of the differentfrom zero.the capitalgainon announcement is at least as largeas any capitalloss on the ex-dividendday.38 (. which captures the effects of an unexpected dividend increase. The interceptfor subsequentdividend increases is negative and the coefficient is much larger. This negative intercept suggests the failureof the naive expectations model for subsequentincreases.43) . the regressions also suggest that the dividend effect may be large enough to offset any investor tax differential.while manyof the dividendswere actuallyquarterlydividends. The positive slope.258
160 88 114 66
(. These results are reportedin table 4.45 (4.27)
-. larger dividends are associated with largerexcess returns.20 (4. An investor would not lose even if the entire dividendis taxed away.37) 2.
then using eq.10 This result supports the proposition that the expectations models for initial and subsequentdividends differ. the negative intercept for subsequentdividendincreases suggests that they are partiallyforecast. If the increase is less than expected. In both instances the a termmeasuresthe market's reactionto the magnitudeof an unexpectedchange in dividends. The intercept is significantfor the sample of subsequentdividendincreases with no other events. initiatingdividends increases shareholders'wealth.11.11 This raises the possibility that the marketreacts less favorably to initial dividends than to subsequent dividend increases. The fitted regressionline should equate zero excess returnswith the expected level of the dividend increase. If all expected subsequentdividendincreasesare not equal. VI. Finally. Previous empiricalmeasures of the market's reaction to dividend increases. 42% are negative. would be reclaimed through a negative excess return.45 a for initialdividends. The same is true of subsequent
10. the negative of the intercept term measures the returnassociated with the expected portion of the dividendincrease. This result is also consistent with signalingtheory in that the market'sreaction is significantlyrelatedto the size of the dividend change. (6) to the subsequentdividendincreases. 11. The a terms in table 4 show that the marketreacts more strongly. Here againthere is an assumptionthat the two samplesare independent each of other. which is incorporatedin stock prices before the dividend announcement. the 2.94 a for subsequentdividendincreases is twice as largeas the 1. In summary. the excess return will be negative. for this sample of firms. (6) as an aggregate functionintroducespossibleproblemsof aggregation.When there are no other events. may understate the real reaction since only the unforecastportion is captured. If the firmannouncedno increase in dividends. rather than its full effects.as measuredby excess returns.to subsequentincreases in dividendsthan to initialdividends. Only if the increase is greaterthan expected will the excess returnbe positive.the regression results supportthe hypothesis that part of the largerexcess returnassociated with initialdividendsis due to the largerincrease in the dividendyield. therefore. Of the excess returnsfor the largest subsequent dividend increases.this return. This possibilityis not dealt with explicitlyhere and thus care shouldbe taken in interpreting stronglythe too applicationof eq. If the model is correctly specified. Conclusions Our results demonstratethat.Dividend Payments on Shareholders' Wealth
unexpected component of the dividend increase.and the t-statisticfor Ho: PI 0 12 is 2.
These results are consistent with the view that dividends convey unique. Finally. Dividend policy has several attractive aspects as an information transmissionmechanism. Pettit 1972. comprehensive signal of management'sinterpretationof the firm's recent performanceand its future prospects. our results as well as those of Aharony and Swary (1980) demonstratethat dividend announcementsconvey information over and above that contained in other announcements. The effects we find are largerthan those presented in other studies and do not appearto be caused by contemporaneousannouncements such as earnings reports.
.Once dividendsare initiated. However. dividend announcements must be backedwith hardcold cash. managers'behavioralso appearsto be consistent with this view.
12. As the study by Vermaelen (1981) demonstrates. the wealth dends effect of subsequent dividend increases appears to be as large if not largerthan the effect of initiation.An advantageof dividendsfor investors is the fixed. Black 1976. valuable informationto investors. Stern 1979). In additionto the credibilityof cash signals. Millerand Modigliani 1961. the timingof stock repurchasesis irregular at the discretionof management.In this case the tax advantageto repurchaseswould likely be removed. As Lintner (1956) and others have documented. they would be essentially equivalentto dividends.A smallerinitiationeffect may result from the negative present value of taxes and/orfinancingcosts.Unlike the detailedfocus of other announcements. shareholdersapparentlyanticipatea periodic signal by management and managementis forced to submit to a periodic review. tax considerations appear to preclude the replacement of a dividendpolicy with repurchasesof equal magnitudeand frequency. and investors should benefit from the regular release of valuable information. The firmmust eithergenerate this cash or convince the capitalmarketsto supplyit.Furthermore. cheaper alternatives exist throughwhich managerscan disseminateinformation(e. dividends can be used as a simple. periodicnatureof announcements. dividends are also highly visible compared with other announcements. Unlike most announcements. As a purely empiricalmatter. They suggest that equally efficacious.S.12 Thus. Incorporating effects of the magnitudeof diviand investors' anticipationof subsequentincreases. Many authorshave dismissed this informationrole as unimportant.g.94
Journal of Business
the dividendincreases. dividend payments are more frequent than repurchases.. These advantages are not unique to dividends but are shared by stock repurchases. tax code. repurchases stock repurchasesmay convey information. Repurchaseswhich are essentiallydividendsare treatedas dividendsfor tax purposesunderU. If repurchaseswere executed with equal frequency. may be more attractive to investors because of the tax treatmentof and capitalgains.
P.J.. Stanley.Dividendinformation. Cambridge.
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direct evidence on the dividend clientele phenomenon.