Dividend announcement effects

9 Oct 2018

A team of accounting researchers at LMU and Cologne University develop a model that predicts how investors react to different combinations of earnings and dividend announcements.

Julia Nasev (Professor of Accounting at LMU), Carsten Homburg (Professor of Controlling at Cologne University) and Dr. Christian Müller (Cologne University) examine how investors react to earnings and dividend announcements by listed firms. The study will appear in Contemporary Accounting Research, one of the leading international journals in accounting.

Earnings and dividend announcements are among the most important performance indicators available to investors. From the investor’s point of view, companies that report a quarterly earnings increase and then announce a dividend hike are generally profitable investments. From the company’s point of view, however, dividend announcements are an expensive signal, since they require a cash outflow. In addition, investors tend to respond negatively to reductions of the dividend.

The study examines how much importance investors place on the dividend as a signal of a company’s future performance. Investors are likely to have less confidence in the future performance of firms that have reported disappointing earnings in the past. Conversely, strong growth in earnings in the past will increase investors’ expectations. The study documents that investors tend to react particularly strongly to the announcement of a dividend increase if their prior earnings expectation was neither especially high nor low. In the first case, there is a discrepancy between investors’ expectations and the dividend signal; in the second case, the dividend announcement provides little new information. This logic holds as long as the dividend change is not very high relative to the earnings change and, hence, the signal associated with the dividend is not very strong. As the dividend signal gets very strong, investors tend to ignore their expectations and react strongly even if the discrepancy between their expectations and the dividend signal is large.

The results of the study could for example help investors to better interpret information implied in dividend announcements. (Contemporary Accounting Research 2018)

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