Academic journal article South Asian Journal of Management

Dividend Surprise and Market Reaction Evidence from Dhaka Stock Exchange (DSE)

Academic journal article South Asian Journal of Management

Dividend Surprise and Market Reaction Evidence from Dhaka Stock Exchange (DSE)

Article excerpt

This paper examines the stock market reaction to dividend announcement in the emerging stock market of Bangladesh. A sample of 50 listed companies from different sectors of the Dhaka Stock Exchange (DSE) is examined for a period of four years (2001-2004). The finding shows Average Abnormal Return (AAR) gets a pick one day before the dividend announcement, and after the dividend announcement, it falls sharply. This study reveals that the Cumulative Abnormal Return (CAR) of almost all the companies around the study period, which have increased just before the dividend announcement date, did not sustain in the ex-dividend period. Regression analysis depicts that the overall models considered are statistically significant in most of the cases, which means there is a very strong evidence of sensitivity of dividend declaration on the market. The sensitivity is prominent on the day after or the day before the declaration rather than the declaration day. The findings justify that information leakage is evident before the dividend announcement, and dividend announcement carries some significant information content. Thus, it can be concluded that, during the period under study, dividend had strong impact about signaling the future prospects of the companies under study.

INTRODUCTION

The so called "Dividend Puzzle" (Black 1976) has been the focus of financial economists at least since Modigliani and Miller's seminal work (1958, 1961) which established that, in a frictionless world, when the investment policy of a firm is constant, its dividend payout policy is irrelevant meaning that has no consequence on the shareholder's wealth. Dividend irrelevance is also supported by the empirical work of Black and Scholes (1974), where they argue that there is no significant relationship between dividend yields and stock returns. Nevertheless, dividend policy is considered one of the most crucial issues for management decision, because it serves as a communication tool between management and investors. Investors do not always trust managers to provide unbiased information about their companies' prospects, but dividend signals are relatively reliable (despite hot debates), because they require cash payments and cash cannot be easily manipulated.

Prior empirical research, generally focused on firms listed in developed stock markets, suggests that the announcement of dividend (cash or stock) increases is associated with significantly positive stock market excess returns. However, emerging markets add more to the "dividend puzzle", and recently, attracted researchers trying to explain the dividend policy behavior and its reaction in the market. Empirical studies showed mixed evidence on stock return due to dividend announcement. A number of studies (Michaely et al., 1995) found that there is a positive market reaction to dividend increases (good news announcements) and a negative market reaction to dividend cuts (bad news announcements). Same positive relationship also had been revealed by the works of Gordon (1959), Ogden (1994), Stevens and Jose (1989), Kato and Loewenstein (1995), Ariff and Finn (1986), and Lee (1995). A negative wealth impact is suggested by the facts that dividend income is taxed at a higher rate than capital gains, costs associated with paying dividend, and transaction costs associated with issuing new equity. Easton and Sinclair (1989), DeAngelo et al. (1992), Bernartzietal.(1997), and Jensen and Johnson (1995) documented that dividend cuts are followed by earnings increases.

Moreover, it has been found that signal strength is a function of the amount of information transmitted and large dividend changes are stronger signals than smaller dividend changes (Asquith andMullins, 1983).Famaetai. (1969) and Pettit (1972) have empirically documented that unexpected increases (decreases) in regular cash dividends generally elicit a significantly positive (negative) stock market reaction. Subsequent researches focus on explaining the dividend-increase induced positive stock market reaction. …

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