Academic journal article IUP Journal of Applied Finance

Semi-Strong Form Efficiency: Market Reaction to Dividend and Earnings Announcements in Malaysian Stock Exchange

Academic journal article IUP Journal of Applied Finance

Semi-Strong Form Efficiency: Market Reaction to Dividend and Earnings Announcements in Malaysian Stock Exchange

Article excerpt

(ProQuest: ... denotes formulae omitted.)

Introduction

Efficient Market Hypothesis (EMH), also called theory of stock market behavior, has inspired a new dimension of research in behavioral finance in the last two-and-a-half decades. Within a short period of time, EMH has emerged as the cornerstone of modern-day finance theory, dominating the mainstream of finance research. Thus, empirical testing of EMH has been conducted overwhelmingly in a variety of ways, utilizing data from different countries, across different time periods and using different event studies.1 Considering the three forms of capital market efficiency, semi-strong form efficiency implies that stock prices are not only reflective of past historical information, but also of all publicly available information on the market. In testing this, Fama (1970) argues that each individual test on semi-strong form efficiency only brings supporting evidence for the model, with the idea that by accumulating such evidence, the validity of the model will be established.

Dividend and earnings announcements are among the two most important signaling devices used by managers to transmit information about firms' future prospects to the public (Lonie et al., 1996). If dividend and earnings news does convey useful information in an efficient capital market, then it is assumed that such news will be reflected in the stock price as soon as they are publicly released in the market. Dividend and earning news is taken by investors as "signals which are emitted by the managers of companies in an uncertain economic environment characterized by informational asymmetry" (Lonie et al., 1996). Isa and Subramaniam (1992) suggested that companies' dividend policies are important; and that decreasing dividends or eliminating planned or unplanned dividend payouts-all together in certain periods signal that a firm is financially distressed. Other general market evidence on corporate event announcement information indicates that when a company announces a major change or unexpected future dividend payments omissions, the immediate market reaction can be sudden and dramatic. In Malaysia, the companies usually announce both earnings and dividends on the same day. For this reason, we examine both the dividend and earnings announcements simultaneously in this study.

Several prior studies provide some evidence of weak and strong form efficiency in the Bursa Malaysia (Malaysian Stock Exchange) (Barnes, 1986; Laurence, 1986; Neoh, 1986; Yong, 1989; Yong 1990; and Kok and Goh, 2000). A recent study by Isa and Yap (2004) on merger announcement provides some evidence of semi-strong form efficiency in the Bursa Malaysia. Hiau et al. (2002) only focused on the effect of dividend announcements on stock prices and do not isolate the effect of dividends information from information contained in earnings. Isa and Subramaniam (1992) considered both the effects of dividends and earnings announcements, whereby the data employed covers a period of seven years from 1978 through 1984. Nasir and Mohamad (1993) examined the semi-strong form efficiency in the Bursa Malaysia using earnings and dividends announcements and concluded that a near semi-strong form efficiency existed in Bursa Malaysia. Monthly returns from 1975 to 1989 were used in their study, while the one by Isa and Subramaniam (1992) used weekly returns to avoid the problem of thin trading in the market. Thin trading is due to the nature of infrequent trading where some stocks are not actively being traded in the market. The problem of thin trading, however, is less critical in recent years, as the volume of shares traded has increased significantly. Average daily trading volume in Bursa Malaysia has risen to 678.8 million lots in 2006, compared to only 42.2 million lots in 1989.2 In this study, a daily returns interval is used to allow us to conduct more powerful tests, since confounding events that may contaminate the stock returns are less likely to exist within the short window (Rees and Lopez, 2002). …

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