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The Role of Earnings Information in Corporate Dividend Decisions

Listed author(s):
  • Jumming Hsu

    (Department of Business Administration, Tunghai University, Taichung, Taiwan)

  • Xu-Ming Wang

    (School of Management, Syracuse University, Syracuse, New York 13244)

  • Chunchi Wu

    (School of Management, Syracuse University, Syracuse, New York 13244)

Registered author(s):

    This paper examines the role of earnings information in the determination of dividend policy. We decompose accounting earnings into permanent and transitory components and postulate that dividend policy is driven by sustainable permanent earnings. Two measures of permanent earnings are proposed. The first is a permanent earnings variable extracted from accounting earnings by a random-level shift ARMA model. The second measure is stock price times cost of capital. These two permanent earnings measures are employed in the Marsh-Merton (1987) model to explain corporate dividend behavior and their performance is compared. A generalized friction method is adopted for empirical estimation to account for stepwise dividend movements over time. Results show that the permanent earnings measure extracted from accounting earnings data explains dividend dynamic behavior better than stock price.

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    File URL: http://dx.doi.org/10.1287/mnsc.44.12.S173
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    Article provided by INFORMS in its journal Management Science.

    Volume (Year): 44 (1998)
    Issue (Month): 12-Part-2 (December)
    Pages: 173-191

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    Handle: RePEc:inm:ormnsc:v:44:y:1998:i:12-part-2:p:s173-s191
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    1. Brown, Lawrence D., 1993. "Earnings forecasting research: its implications for capital markets research," International Journal of Forecasting, Elsevier, vol. 9(3), pages 295-320, November.
    2. Beveridge, Stephen & Nelson, Charles R., 1981. "A new approach to decomposition of economic time series into permanent and transitory components with particular attention to measurement of the `business cycle'," Journal of Monetary Economics, Elsevier, vol. 7(2), pages 151-174.
    3. Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, vol. 40(4), pages 1031-1051, September.
    4. Lee, Cheng F. & Wu, Chunchi & Djarraya, Mohamed, 1987. "A further empirical investigation of the dividend adjustment process," Journal of Econometrics, Elsevier, vol. 35(2-3), pages 267-285, July.
    5. Beaver, William H. & Lambert, Richard A. & Ryan, Stephen G., 1987. "The information content of security prices : A second look," Journal of Accounting and Economics, Elsevier, vol. 9(2), pages 139-157, July.
    6. 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.
    7. Jerry A. Hausman & Andrew W. Lo & A. Craig MacKinlay, 1991. "An Ordered Probit Analysis of Transaction Stock Prices," NBER Working Papers 3888, National Bureau of Economic Research, Inc.
    8. Brown, Lawrence D., 1993. "Reply to commentaries on "Earnings forecasting research: its implications for capital markets research"," International Journal of Forecasting, Elsevier, vol. 9(3), pages 343-344, November.
    9. Bernard, Victor L. & Thomas, Jacob K., 1990. "Evidence that stock prices do not fully reflect the implications of current earnings for future earnings," Journal of Accounting and Economics, Elsevier, vol. 13(4), pages 305-340, December.
    10. Praveen Kumar, 1988. "Shareholder-Manager Conflict and the Information Content of Dividends," Review of Financial Studies, Society for Financial Studies, vol. 1(2), pages 111-136.
    11. Terry A. Marsh and Robert C. Merton., 1986. "Dividend Behavior for the Aggregate Stock Market," Research Program in Finance Working Papers 163, University of California at Berkeley.
    12. 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.
    13. Chen, Chung & Tiao, George C, 1990. "Random Level-Shift Time Series Models, ARIMA Approximations, and Level-Shift Detection," Journal of Business & Economic Statistics, American Statistical Association, vol. 8(1), pages 83-97, January.
    14. Ali, Ashiq & Zarowin, Paul, 1992. "Permanent versus transitory components of annual earnings and estimation error in earnings response coefficients," Journal of Accounting and Economics, Elsevier, vol. 15(2-3), pages 249-264, August.
    15. Brown, Philip, 1993. "Comments on 'Earnings forecasting research: its implications for capital markets research' by L. Brown," International Journal of Forecasting, Elsevier, vol. 9(3), pages 331-335, November.
    16. Watts, Ross, 1973. "The Information Content of Dividends," The Journal of Business, University of Chicago Press, vol. 46(2), pages 191-211, April.
    17. John, Kose & Williams, Joseph, 1985. " Dividends, Dilution, and Taxes: A Signalling Equilibrium," Journal of Finance, American Finance Association, vol. 40(4), pages 1053-1070, September.
    18. Sudipto Bhattacharya, 1979. "Imperfect Information, Dividend Policy, and "The Bird in the Hand" Fallacy," Bell Journal of Economics, The RAND Corporation, vol. 10(1), pages 259-270, Spring.
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