IDEAS home Printed from https://ideas.repec.org/a/eee/corfin/v16y2010i5p736-747.html
   My bibliography  Save this article

What do dividend reductions signal?

Author

Listed:
  • Jensen, Gerald R.
  • Lundstrum, Leonard L.
  • Miller, Robert E.

Abstract

Dividend reductions have long been considered a "last resort" action for firm managers. Managerial reluctance to reduce dividends emanates from the view that dividend drops signal managerial pessimism regarding future earnings. Contrary to expectations, studies show that earnings rebound significantly following a dividend reduction; yet investors react negatively to the dividend-drop announcement. We present an explanation for the anomalous behavior of earnings and returns around the time of a dividend drop. Our evidence suggests that a reduction in a firm's established dividend coincides with a decrease in the value of the firm's real options. Earnings rebound following the dividend reduction due to the savings that result as the firm allows growth options to expire; however, announcement period returns suggest that investors recognize the lost value associated with the forthcoming expiration of growth options.

Suggested Citation

  • Jensen, Gerald R. & Lundstrum, Leonard L. & Miller, Robert E., 2010. "What do dividend reductions signal?," Journal of Corporate Finance, Elsevier, vol. 16(5), pages 736-747, December.
  • Handle: RePEc:eee:corfin:v:16:y:2010:i:5:p:736-747
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0929-1199(10)00041-6
    Download Restriction: Full text for ScienceDirect subscribers only

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, vol. 40(4), pages 1031-1051, September.
    2. Adam S. Koch & Amy X. Sun, 2004. "Dividend Changes and the Persistence of Past Earnings Changes," Journal of Finance, American Finance Association, vol. 59(5), pages 2093-2116, October.
    3. Kahle, Kathleen M. & Walkling, Ralph A., 1996. "The Impact of Industry Classifications on Financial Research," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(03), pages 309-335, September.
    4. Gerald R. Jensen & James M. Johnson, 1995. "The Dynamics of Corporate Dividend Reductions," Financial Management, Financial Management Association, vol. 24(4), Winter.
    5. Kathleen M. Kahle & Ralph A. Walkling, "undated". "The Impact of Industry Classifications on Financial Research," Research in Financial Economics 9607, Ohio State University.
    6. Christopher W. Anderson & Luis Garcia-Feij√£o, 2006. "Empirical Evidence on Capital Investment, Growth Options, and Security Returns," Journal of Finance, American Finance Association, vol. 61(1), pages 171-194, February.
    7. Healy, Paul M. & Palepu, Krishna G., 1988. "Earnings information conveyed by dividend initiations and omissions," Journal of Financial Economics, Elsevier, vol. 21(2), pages 149-175, September.
    8. Guenther, David A. & Rosman, Andrew J., 1994. "Differences between COMPUSTAT and CRSP SIC codes and related effects on research," Journal of Accounting and Economics, Elsevier, vol. 18(1), pages 115-128, July.
    9. Jonathan B. Berk & Richard C. Green & Vasant Naik, 1999. "Optimal Investment, Growth Options, and Security Returns," Journal of Finance, American Finance Association, vol. 54(5), pages 1553-1607, October.
    10. DeAngelo, Harry & DeAngelo, Linda & Skinner, Douglas J, 1992. " Dividends and Losses," Journal of Finance, American Finance Association, vol. 47(5), pages 1837-1863, December.
    11. Asquith, Paul & Mullins, David W, Jr, 1983. "The Impact of Initiating Dividend Payments on Shareholders' Wealth," The Journal of Business, University of Chicago Press, vol. 56(1), pages 77-96, January.
    12. Brickley, James A., 1983. "Shareholder wealth, information signaling and the specially designated dividend : An empirical study," Journal of Financial Economics, Elsevier, vol. 12(2), pages 187-209, August.
    13. Michaely, Roni & Thaler, Richard H & Womack, Kent L, 1995. " Price Reactions to Dividend Initiations and Omissions: Overreaction or Drift?," Journal of Finance, American Finance Association, vol. 50(2), pages 573-608, June.
    14. Dielman, Terry E. & Oppenheimer, Henry R., 1984. "An Examination of Investor Behavior during Periods of Large Dividend Changes," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 19(02), pages 197-216, June.
    15. Charest, Guy, 1978. "Dividend information, stock returns and market efficiency-II," Journal of Financial Economics, Elsevier, vol. 6(2-3), pages 297-330.
    16. Doron Nissim, 2001. "Dividend Changes and Future Profitability," Journal of Finance, American Finance Association, vol. 56(6), pages 2111-2133, December.
    17. Pettit, R Richardson, 1972. "Dividend Announcements, Security Performance, and Capital Market Efficiency," Journal of Finance, American Finance Association, vol. 27(5), pages 993-1007, December.
    18. Denis, David J. & Kruse, Timothy A., 2000. "Managerial discipline and corporate restructuring following performance declines," Journal of Financial Economics, Elsevier, vol. 55(3), pages 391-424, March.
    19. Benartzi, Shlomo & Michaely, Roni & Thaler, Richard H, 1997. " Do Changes in Dividends Signal the Future or the Past?," Journal of Finance, American Finance Association, vol. 52(3), pages 1007-1034, July.
    20. Michael J. Barclay & Erwan Morellec, 2006. "On the Debt Capacity of Growth Options," The Journal of Business, University of Chicago Press, vol. 79(1), pages 37-60, January.
    21. Merton H. Miller & Franco Modigliani, 1961. "Dividend Policy, Growth, and the Valuation of Shares," The Journal of Business, University of Chicago Press, vol. 34, pages 411-411.
    22. DeAngelo, Harry & DeAngelo, Linda, 1990. " Dividend Policy and Financial Distress: An Empirical Investigation of Troubled NYSE Firms," Journal of Finance, American Finance Association, vol. 45(5), pages 1415-1431, December.
    23. Yoon, Pyung Sig & Starks, Laura T, 1995. "Signaling, Investment Opportunities, and Dividend Announcements," Review of Financial Studies, Society for Financial Studies, vol. 8(4), pages 995-1018.
    24. Gustavo Grullon & Roni Michaely & Shlomo Benartzi & Richard H. Thaler, 2005. "Dividend Changes Do Not Signal Changes in Future Profitability," The Journal of Business, University of Chicago Press, vol. 78(5), pages 1659-1682, September.
    25. Sant, Rajiv & Cowan, Arnold R., 1994. "Do dividends signal earnings? The case of omitted dividends," Journal of Banking & Finance, Elsevier, vol. 18(6), pages 1113-1133, December.
    26. Nance, Deana R & Smith, Clifford W, Jr & Smithson, Charles W, 1993. " On the Determinants of Corporate Hedging," Journal of Finance, American Finance Association, vol. 48(1), pages 267-284, March.
    27. Ilan Cooper, 2006. "Asset Pricing Implications of Nonconvex Adjustment Costs and Irreversibility of Investment," Journal of Finance, American Finance Association, vol. 61(1), pages 139-170, February.
    28. Christie, William G., 1994. "Are Dividend Omissions Truly the Cruelest Cut of All?," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 29(03), pages 459-480, September.
    29. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. De Cesari, Amedeo & Huang-Meier, Winifred, 2015. "Dividend changes and stock price informativeness," Journal of Corporate Finance, Elsevier, vol. 35(C), pages 1-17.
    2. Jie Chen & Wei Song & Marc Goergen, 2018. "Passing the dividend baton: The impact of dividend policy on new CEOs' initial compensation," Working Papers 2018-18, Swansea University, School of Management.
    3. Scott Walker, 2015. "Repeated Dividend Increases: A Collection of Four Essays," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 17.
    4. Chen, Zhijuan & Lin, William T. & Ma, Changfeng & Tsai, Shih-Chuan, 2014. "Liquidity provisions by individual investor trading prior to dividend announcements: Evidence from Taiwan," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 358-374.
    5. Chen, Fan, 2016. "The wealth effects of dividend announcements on bondholders: New evidence from the over-the-counter market," Journal of Economics and Business, Elsevier, vol. 86(C), pages 52-75.
    6. Lee, Bong Soo & Mauck, Nathan, 2016. "Dividend initiations, increases and idiosyncratic volatility," Journal of Corporate Finance, Elsevier, vol. 40(C), pages 47-60.
    7. Balachandran, Balasingham & Krishnamurti, Chandrasekhar & Theobald, Michael & Vidanapathirana, Berty, 2012. "Dividend reductions, the timing of dividend payments and information content," Journal of Corporate Finance, Elsevier, vol. 18(5), pages 1232-1247.
    8. repec:ibn:ijefaa:v:9:y:2017:i:4:p:20-34 is not listed on IDEAS
    9. repec:eee:finmar:v:36:y:2017:i:c:p:40-55 is not listed on IDEAS

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:corfin:v:16:y:2010:i:5:p:736-747. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Dana Niculescu). General contact details of provider: http://www.elsevier.com/locate/jcorpfin .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.