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Cross-sectional differences in the profits, returns and risk of firms initiating dividends

Listed author(s):
  • Neil L. Fargher
Registered author(s):

    Purpose– The purpose of this paper is to examine cross-sectional differences in the profits, returns and risk of high- and low-market-to-book ratios (M/B) stocks before and after the initiation of regular cash dividend payments. Design/methodology/approach– This study uses parametric and non-parametric statistics and ordinary least squares regression to test for differences in the profits, returns and risk of high- and low-M/B stocks before and after dividend initiation. Findings– Low-M/B stocks display the most positive price reaction to dividend initiation announcements. High-M/B firms have larger profits, cash levels and capital expenditure before and at the time of dividend initiation, but more closely resemble the low-M/B firms in terms of these characteristics within three years following dividend initiation. Excess returns earned by low-M/B firms are related to decreases in systematic risk, while the returns of high-M/B firms are related to their higher profitability. Research limitations/implications– Averaging results from 1965-2000 does not account for possible changes in the information content of dividend initiations over time (as evidenced by steadily declining dividend yields over this period). Practical implications– The findings are consistent with the idea that firms begin paying dividends as they are maturing into a slower growth period, and do not support the idea that dividend initiation signals faster future earnings growth. Originality/value– The analysis adds to the body of knowledge by explicitly conditioning the expectations from various dividend theories based upon individual firms’ growth phase as reflected in their M/B ratios, and suggests that signaling, agency and risk explanations for dividends must be considered jointly with a firm's growth prospects when studying dividend events.

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    Article provided by Emerald Group Publishing in its journal Managerial Finance.

    Volume (Year): 35 (2009)
    Issue (Month): 6 (May)
    Pages: 509-530

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    Handle: RePEc:eme:mfipps:v:35:y:2009:i:6:p:509-530
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    1. Doron Nissim, 2001. "Dividend Changes and Future Profitability," Journal of Finance, American Finance Association, vol. 56(6), pages 2111-2133, December.
    2. Eugene F. Fama & Kenneth R. French, "undated". "Disappearing Dividends: Changing Firm Characteristics or Lower Propensity to Pay?."," CRSP working papers 509, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
    3. Shlomo Benartzi & Roni Michaely & Richard Thaler, "undated". "Do Changes in Dividends Signal the Future or the Past?," CRSP working papers 327, Center for Research in Security Prices, Graduate School of Business, University of Chicago.
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    9. Roni Michaely & Richard H. Thaler & Kent Womack, 1994. "Price Reactions to Dividend Initiations and Omissions: Overreaction or Drift?," NBER Working Papers 4778, National Bureau of Economic Research, Inc.
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    14. DeAngelo, Harry & DeAngelo, Linda & Stulz, Rene M., 2006. "Dividend policy and the earned/contributed capital mix: a test of the life-cycle theory," Journal of Financial Economics, Elsevier, vol. 81(2), pages 227-254, August.
    15. Baker, H Kent & Veit, E Theodore & Powell, Gary E, 2001. "Factors Influencing Dividend Policy Decisions of NASDAQ Firms," The Financial Review, Eastern Finance Association, vol. 36(3), pages 19-37, August.
    16. Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, vol. 40(4), pages 1031-1051, September.
    17. Barber, Brad M. & Lyon, John D., 1996. "Detecting abnormal operating performance: The empirical power and specification of test statistics," Journal of Financial Economics, Elsevier, vol. 41(3), pages 359-399, July.
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    20. Michael Spence, 1973. "Job Market Signaling," The Quarterly Journal of Economics, Oxford University Press, vol. 87(3), pages 355-374.
    21. 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.
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