Academic journal article Financial Management

Information Associated with Dividend Initiations: Firm-Specific or Industry-Wide?

Academic journal article Financial Management

Information Associated with Dividend Initiations: Firm-Specific or Industry-Wide?

Article excerpt

Unexpected changes in dividend policy are associated with stock price reactions in the same direction (see Aharony and Swary, 1980; and Kalay and Lowenstein, 1985). A widely accepted explanation for this well-established empirical finding, which was first suggested by Miller and Modigliani (1961), emphasizes the role of information asymmetry. Because managers are better informed than the market about the future prospects of their firms, their actions may convey new information to investors. An unexpected increase (decrease) in dividends conveys positive (negative) news about the profitability of the firm.(1)

Asquith and Mullins (1983) argue that initial dividends are probably more unexpected than are subsequent dividend changes. If dividend initiation is not anticipated, the market reaction on the announcement day should capture the full effect of the dividend change. Therefore, the impacts of dividend changes should be most evident at initiation. Consistent with this reasoning, Asquith and Mullins (1983) and Richardson, Sefcik, and Thompson (1986) find large, significantly positive two-day abnormal returns in response to dividend initiation announcements.

The purpose of our paper is to test for intra-industry information effects of dividend initiation announcements. Information spillovers are important for at least two reasons. First, examination of intra-industry effects adds to our understanding of the nature of the information conveyed by a dividend initiation announcement. Specifically, the absence of an information spillover suggests that the information is firm-specific. The presence of an intra-industry effect suggests that the information contains an industrywide component.

Second, the direction of the intra-industry effect indicates whether the information contains industrywide favorable news, or unfavorable news for nonannouncing firms about the competitive structure of the industry. Although the extant literature includes research on the intra-industry effects of a number of corporate events, no study has investigated the intraindustry effects of dividend initiations.(2)

We measure intra-industry effects in two ways. First, we examine the stock price reaction of rival firms, matched by four-digit Standard Industry Classification (SIC) code. As discussed in the next section, competing hypotheses suggest that rivals' stock prices can react positively, negatively, or not at all to the announcement of a dividend initiation. Second, our research explores whether analysts revise their earnings forecasts for rival firms in response to a dividend-initiation announcement. Many studies have examined forecast revisions, but few have used changes in earnings forecasts to assess intra-industry effects. As with stock price reactions, earnings forecast revisions for rival firms can be positive, negative, or zero.

We find no evidence of either significant stock price reactions or significant revisions of earnings forecasts for rivals. These findings are quite robust. For example, they are not sensitive to the manner in which we form portfolios of rival firms. We estimate the abnormal returns of rivals using different estimation periods (pre- and post-event) and different market indices (value-weighted and equally weighted). The results are nearly identical. We confirm the lack of significance of the abnormal returns using three different test statistics. We examine revisions of earnings forecasts by using both unadjusted and adjusted revisions, and we assess their significance with both parametric and non-parametric tests. The results are broadly consistent. In short, no discernible intraindustry effect is associated with a dividend initiation. This finding is consistent with the notion that a dividend initiation is a firm-specific event and carries no implications for the initiating firm's competitors.

The paper proceeds as follows. In the next section, we review relevant literature and discuss intra-industry effects in greater detail. …

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