Academic journal article Irish Journal of Management

A Research Note on the Information Content of Dividends and the Corroboration Effect of Earnings and Dividend Signals: Irish Evidence

Academic journal article Irish Journal of Management

A Research Note on the Information Content of Dividends and the Corroboration Effect of Earnings and Dividend Signals: Irish Evidence

Article excerpt

Introduction

Modigliani and Miller (1958) demonstrated that, under the assumptions of perfect capital markets, rational behaviour and zero taxes, the value of a firm is independent of the firm's dividend payout rate. In a later paper, however, Miller and Modigliani (1961) suggested that dividends may convey information about future earnings if the management of a firm follow a policy of dividend stabilisation and use a change in the dividend payout rate to signal a change in their views about the firm's future profitability.

The first major thrust in the dividend signalling literature set out to empirically test the hypothesis that dividends convey information about future earnings. Studies by Watts (1973), Ezzell (1974), Laub (1976) and Lobo, Nair and Song (1986) provide conflicting empirical evidence on this issue and have been the subject of critical review. Specifically, Taylor (1979) notes that many of the tests performed are counter-intuitive.

A second major thrust in the dividend signalling literature concerns the effect of dividend announcements on abnormal returns to equity (see, for example, Pettit, 1972, 1976; Charest, 1978; Aharony and Swary, 1980; Penman, 1980; Asquith and Mullins, 1983; Dielman and Oppenheimer, 1984; Kalay and Lowenstein, 1985; Easton and Sinclair, 1989). Whilst the results of such studies are conflicting, in general they are supportive of the hypothesis that dividend signals convey information to the market over and above that conveyed by earnings signals.

In the US, Kane, Lee and Marcus (1984) and in Australia, Easton (1991) investigated the hypothesis that, as unexpected earnings and unexpected dividends are noisy signals, investors may be interested in their consistency. They find evidence to support the existence of an interaction effect of earnings and dividend announcements on abnormal returns to equity.

In a UK context, Opong (1993) reported interaction effects between dividend and earnings signals in interim report releases, but Opong (1996) suggests that the interaction effect of preliminary annual dividend and earnings announcement is weak. More recently, Hamill and McCaffrey (2000) investigated interaction effects with respect to dividend initiation announcements in Initial Public Offerings. They report that no evidence of an interaction effect is observed.

This study investigates the hypothesis that dividends have information content and that there is an interaction or corroborative effect between dividend and earnings signals with respect to future earnings. The study is performed on a sample of 25 companies listed in the Irish Stock Market Handbook (1991). Earnings and dividend data is collected for the seven-year period from 1984 to 1990. The results of the study support the contention that dividends have information with respect to future earnings and that there is an interaction effect between earnings and dividend signals on future earnings.

The remainder of this paper is organised as follows:

* A brief review of previous literature.

* An outline of the data, definitions of variables and tests used in the study.

* An evaluation of the results of the study.

* A review of some of the limitations of the study.

* A brief summary of the main results.

Previous Literature

The first major thrust in the dividend signalling literature set out to empirically test the hypothesis that dividends convey information about future earnings. The results of such studies are conflicting but, in general, are supportive of the contention that dividends convey information about future earnings (see, for example, Petit, 1972; Watts, 1973; Lobo, Nair and Song, 1986).

Taylor (1979) considers the empirical work of Watts (1973), Ezzell (1974) and Laub (1976) and notes that, in 19 out of the 20 tests performed, a particular structure of joint forecasting model is employed. …

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