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Signaling Managerial Optimism through Stock Dividends and Stock Splits: A Reexamination of the Retained Earnings Hypothesis

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  • Crawford, Dean
  • Franz, Diana R.
  • Lobo, Gerald J.

Abstract

The retained earnings hypothesis predicts that stock distributions accounted for by reducing retained earnings are a more credible signal of managerial optimism than stock distributions that do not reduce retained earnings. This study examines the costs of false signaling that are a necessary pre-condition for the hypothesis and finds them to be generally very small, calling the validity of the hypothesis into question for most firms. However, prior studies report broad-based market evidence consistent with the hypothesis. To resolve this apparent inconsistency, the study replicates and extends tests of the retained earnings hypothesis contained in three prior studies, and shows that the findings in support of the retained earnings hypothesis can be attributed to specification and measurement choices that bias the results in favor of the hypothesis. The support for the retained earnings hypothesis is weaker when the sources of the bias are removed. However, some support for the hypothesis remains for a limited set of distributing firms.

Suggested Citation

  • Crawford, Dean & Franz, Diana R. & Lobo, Gerald J., 2005. "Signaling Managerial Optimism through Stock Dividends and Stock Splits: A Reexamination of the Retained Earnings Hypothesis," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 40(3), pages 531-561, September.
    • Handle: RePEc:cup:jfinqa:v:40:y:2005:i:03:p:531-561_00
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    Cited by:

    1. Leo Vashkor Dewri & Md. Rashidul Islam & Fatema-Tuz-Johra & M Mizanur Rahman, 2021. "Measuring Firms Intrinsic Values in an Emerging Economy: Evidence from Bangladesh," Asian Economic and Financial Review, Asian Economic and Social Society, vol. 11(6), pages 429-445, June.
    2. Nan-Ting Kuo, 2013. "Dividend tax signaling and the pricing of future earnings: a case of taxable stock dividends," Review of Quantitative Finance and Accounting, Springer, vol. 40(3), pages 539-570, April.
    3. Imen Ghadhab, 2023. "Bonding, signaling theory and dividend policy: Evidence from multinational firms," Journal of Asset Management, Palgrave Macmillan, vol. 24(1), pages 69-83, February.
    4. Al-Yahyaee, Khamis Hamed, 2014. "Shareholder wealth effects of stock dividends in a unique environment," Journal of International Financial Markets, Institutions and Money, Elsevier, vol. 28(C), pages 66-81.
    5. Khanal, Aditya R. & Mishra, Ashok K., 2017. "Stock price reactions to stock dividend announcements: A case from a sluggish economic period," The North American Journal of Economics and Finance, Elsevier, vol. 42(C), pages 338-345.
    6. Huang, Chin-Sheng & You, Chun-Fan & Lin, Szu-Hsien, 2009. "Cash dividends, stock dividends and subsequent earnings growth," Pacific-Basin Finance Journal, Elsevier, vol. 17(5), pages 594-610, November.
    7. Ming-Hui Wang & Mei-Chu Ke & Day-Yang Liu & Yen-Sheng Huang, 2011. "Dividend Policy And The Life Cycle Hypothesis: Evidence From Taiwan," The International Journal of Business and Finance Research, The Institute for Business and Finance Research, vol. 5(1), pages 33-52.
    8. Heavilin, Jason E. & Songur, Hilmi, 2019. "Stock distributions and the Retained Earnings Hypothesis revisited," Finance Research Letters, Elsevier, vol. 30(C), pages 240-245.
    9. Leledakis, George N. & Papaioannou, George J. & Travlos, Nickolaos G. & Tsangarakis, Nickolaos V., 2009. "Stock splits in a neutral transaction cost environment: Evidence from the Athens Stock Exchange," Journal of Multinational Financial Management, Elsevier, vol. 19(1), pages 12-25, February.
    10. Ken L. Bechmann & Johannes Raaballe, 2007. "The Differences Between Stock Splits and Stock Dividends: Evidence on the Retained Earnings Hypothesis," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 34(3‐4), pages 574-604, April.
    11. Andreas Charitou, 2007. "Discussion of The Differences Between Stock Splits and Stock Dividends: Evidence on the Retained Earnings Hypothesis," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 34(3‐4), pages 605-612, April.
    12. Cahit Adaoglu & Meziane Lasfer, 2011. "Why Do Companies Pay Stock Dividends? The Case of Bonus Distributions in an Inflationary Environment," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 38(5-6), pages 601-627, June.
    13. Walker, Scott, 2021. "Post-split underreaction: The importance of prior split history," International Review of Financial Analysis, Elsevier, vol. 78(C).
    14. Chin-Sheng Huang & Chun-Fan You & Hsiao-Fen Hsiao, 2017. "Dividends and Subsequent Profitability: An Examination of a Dual Dividend Stock Market," Review of Pacific Basin Financial Markets and Policies (RPBFMP), World Scientific Publishing Co. Pte. Ltd., vol. 20(01), pages 1-35, March.

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