Academic journal article Journal of Economics and Finance

On the Financial Characteristics of Firms That Initiated New Dividends during a Period of Economic Recession and Financial Market Turmoil

Academic journal article Journal of Economics and Finance

On the Financial Characteristics of Firms That Initiated New Dividends during a Period of Economic Recession and Financial Market Turmoil

Article excerpt

Abstract

The initiation of new dividends and increases in dividend payout ratios occur infrequently because once initiated it would be expected by most investors that the new dividends will be maintained. Dividend announcements are said to have informational content concerning the value of the firm, and financial signaling theory would lead investors to conclude that the initiation of new dividends is an indication that the firm expects increased cash flows in the future. Thus, unless the initiation is identified beforehand as a special dividend resulting from unanticipated cash inflows, it is difficult to reverse the action without having an adverse effect on the value of the firm. In periods of economic recession and financial turmoil most firms conserve cash and the initiation of new dividends or increases in the dividend payout ratio in such periods are extraordinary and noteworthy. The purpose of this study is to provide a financial analysis of those firms described by Value Line as having initiated or increased the dividend payout ratio in the most recent period of economic recession and financial market turmoil. Specifically, the analysis will test for significant differences in the financial profiles of those firms that initiated new dividends in such a period, and companies selected at random but from the same industries. A unique financial profile is established for the dividend initiating firms, and it is suggested that the profile may be used to identify firms that will initiate new dividends in future periods of economic downturn. As in previous studies of this nature Multiple Discriminant Analysis is used.

Keywords Dividend Initation * Recession * Financial Market Turmoil

JEL codes G 14 32 * 35

1 Introduction

Dividend announcements have been of great interest to investors, investment counselors and financial scholars for years. They are said to have informational content concerning the value of the firm, and the relationship between dividend announcements and the value of the firm has long been established by early studies in finance (Lizenbunger and Ramaswamy 1982; Miller and Scholes 1978; and Venkatesh (1989). Further, models to predict changes in the firm's value as a result of those announcements have been developed by Lintner (1956), Fama and Babiak (1968), and KoIb (1981). Payne et al. (Payne et al., 1992) found a unique profile of financial characteristics for those firms that initiated new dividends. That work however, ignored the macroeconomic background in which those announcements were made. The initiation of new dividends and increases in dividend payout ratios occur infrequently because once initiated it is expected by most investors that the new dividends will be maintained, and financial signaling theory would lead investors to conclude that the initiation of new dividends is an indication that the firm expects increased cash flows in the future. Consequently, announcements of new dividend initiations generally have a positive effect on stock prices. Obviously, dividends do not have to be paid, but unless the initiation is identified beforehand as a special dividend resulting from unanticipated cash inflows, it is difficult to reverse the action without having an adverse effect on the value of the firm. Kohers and Caton (2003) found that dividend omissions have significantly negative effects on firms across industries. Wansley and Lane (1987) found that to the extent that the expectation of maintaining the newly announced is true, the initiation of new dividends add to fixed financial costs and thus, to the financial leverage (financial risk) of the firm.

2 Background

On November 26, 2008 President-Elect Obama while introducing his new team of economic advisors said, 'We are on the precipice of the greatest financial crisis since the great depression of the 1930's.' A few days later the Business Cycles Dating Committee of the National Bureau of Economic Research (NBER) announced that the United States was not only in a recession, but that it had started a year earlier in December 2007. …

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