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Can dividend omission signal positive price reaction?
Heesoo Kim 10621377
Finance and Organization
Abstract
Dividend signaling theory suggests that dividend policy reflects the managers’ views on firm’s future prospect. This article investigates whether positive stock price reaction can be attained after the dividend omission announcement. Using a sample of 358 cash dividend omission announcements over the 2009 to 2013 period, this study reports that firms with relatively intensive expenditure on research and development (R&D) and high return on asset (ROA) can obtain significantly positive abnormal return after the omission announcement.1
I. Introduction
The effect of a firm’s dividend policy on its value is one of the debatable topics in the field of corporate policies. Does management’s decision about profit distribution have impact on the current or future stock price? If so, how does it function? In order to answer these questions, a number of empirical studies have been conducted. Miller and Modigliani (1961) insist that the level of dividends do not have impact on the value of the firm under the perfect capital markets with no existence of taxes. With Modigliani-Miller Theorem (M&M), they find that market value of the firm is independent from the method how it finances its investments or allocates dividends (Miller and Modigliani, 1961). Black and Scholes (1974) also support this argument with their empirical result. They do not find significant relationship between a change in dividend policy and the company’s
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2 share price.
However, we do not live in the perfect capital markets. One of the market imperfections is that investors do not have access to same information as the firm managers do. With asymmetric information, managers have more and crucial information about the future prospects of the firm than investors do. Miller and Modigliani (1961) state that dividend policy may convey private information from the managers if they consider that information while setting the level of dividends. This idea refers to dividend signaling theory. It means that increase (decrease) in the level of dividends reflects managers’ positive (negative) views of the firm’s future earnings prospects.
The general objective of this article is to add to the understanding of the impact of dividends on shareholders’ wealth. Especially, this paper will investigate whether positive price reaction can be acquired after dividend omission announcements. Theoretically, it is stylized fact that dividend cuts bring negative future firm value in short term. However, the company’s stock return increases when the company has positive net present value investment opportunities and this may be predicted at the time of thedividend announcement. Also, the firm’s share price depends on its financial situation such as profitability or the level of leverage. Can companies with good reasons of omitting dividends do deliver this information to investors and signal positive price reaction? Bulan et al. (2007) state that good omitters have distinctive characteristics at the time of dividend omission announcements. Those firms have stronger financial fundamentals with higher profitability or lower debt overhang compared to other firms. In the case of good omitting firms, negative effect from dividend omission and positive effect from financial features will conflict to each other. If they successfully deliver the good reasons of omission to investors, negative effect will be mitigated or even positive price reaction can be accomplished after the announcement. If they cannot do so, stock returns will be decreased as usual. Liang et al. (2011) find that investors do not always perceive dividend omissions negatively. Their study observes dividend omission announcements over the period from 1982 to 2005 and shows that firms experience abnormal returns with -6.4% in average after the announcement in short run.
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Nonetheless, companies with higher investment intensity compared to other firms do not undergo significant negative price reaction (Liang et al., 2011). Therefore, this paper will also find whether dividend omissions can bring positive price response under specific circumstance.
In order to observe the effect, this paper will conduct an event study by measuring post-announcement abnormal return with the market model. Dataset of cash dividend omission announcements during the period from 2009 to 2013 are obtained from the Center for Research in Security Prices (CRSP) for firms which are listed on the New York Stock Exchange (NYSE), American Stock Exchange (AMEX) and National Association of Securities Dealers Automated Quotation System (NASDAQ). In specific, this paper will look how stock returns react to sub-samples with four different financial features. Firstly, companies will be categorized as the level of expenditure on research and development (R&D) compared to their total cash flow. Secondly, they will be classified by financial profitability which is measured by return on assets (ROA). Thirdly, firms will be characterized as their debt-to-equity ratio (D/E). Lastly, they will be ordered by relative market value. Theoretical backgrounds of these four criteria will be discussed in the next section.
The outline of this paper is as follows. The next section will introduce related literature of dividend signaling theory. After that, the selection of dataset and methodology will be discussed. Consequently, the fourth section will present the empirical results of the article. Eventually, the last section will conclude the paper.
II. Related Literature
Why do firms pay dividends? As Miller and Modigliani (1961) state that the level of dividends is irrelevant to the firm’s value, many researchers have studied about the reason why companies pay dividends for their investors. Conventionally, it was considered that firms pay dividends in order to fulfill the monetary needs of their stockholders (Allen and Michaely, 2003).
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Nevertheless, the opinion has diverged as time has passed. DeAngelo and DeAngelo (2006) insist that the ideal dividend policy is influenced by the need to payout the company’s free cash flow. Then, which firms pay dividends? Theoretically, payout policy is a trade-off between retaining firm’s earnings and distributing them. Fama and French (2001) demonstrate that higher profitability and lower growth rates are two essential features of dividend-paying enterprises. The propensity of the firms paying dividends is high when they are financially stable and matured because they possess higher profitability and less abundant investment opportunities (DeAngelo et al., 2006). On the other hand, young companies are more likely to keep their earnings and not payout dividends because they have more desirable investment projects without enough financial resources.
Dividend signaling theory has provided a place for debate for a long time. In order to validate the theory, a number of empirical studies have been conducted. According to Hearly and Palepu (1988), firms which initiate (omit) their dividend payments attain significantly positive (negative) changes in their stock price for at least one year after the announcements. They conclude that empirical results are consistent with the dividend signaling theory which refers that earning performances can be anticipated by the changes in the company’s dividend policy (Hearly and Palepu, 1988). Additionally, Michaely et al. (1995) demonstrate that especially short run market reactions after cash dividend changes are consistent with dividend signaling theory. Over the period from 1964 to 1988, firms which initiated their cash dividend payments underwent an increase in stock price about 3.4% (Michaely et al., 1995). On the other hand, share price of companies which omitted paying cash dividend in that period dropped around 7%. Furthermore, Michaely et al. (1995) show that stock price reacts more sensitively after dividend omissions rather than dividend initiations in short run.
On the other hand, not every empirical result is consistent with dividend signaling theory. Watts (1973) tests the hypothesis that dividends deliver valuable contents to investors regarding the firm’s future profitability. However, he concludes that changes in dividends only contain trivial
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information about the company’s afterward earnings (Watts, 1973). Moreover, DeAngelo et al. (1996) identify that there is no evidence that the dividend policy performs as a reliable signal for investors. As possible reasons, they mention that managers tend to be over-optimistic about their future incomes and make only small cash payout while increasing the magnitude of dividends (DeAngelo et al., 1996). Specifically, Boehme and Sorescu (2002) investigate the long-run stock price reactions after the announcements of dividend initiations and continuations during the period from 1927 to 1998. According to their study, there is no drift in post-announcement abnormal share price before 1964. However, Boehme and Sorescu (2002) report significant abnormal stock return changes after 1964 but this evidence is only applicable for small firms and for Fama-French calendar time portfolios which are equally weighted by market capitalization. In the result, researchers conclude that price drift found by Michaely et al. (1995) is confined and may be the product of chance (Boehme and Sorescu, 2002).
As conflicting results of many articles show, the effect of dividend policy on the firm value is a topic of ongoing debate. At the center of this issue, there is a question that exactly what type of valuable information managers want to communicate with their investors. The answer for this question is provided by cash flow signaling hypothesis model by Bhattacharya (1979), Miller and John and Williams (1985) and Rock (1985). Bhattacharya (1979) presents that managers’ decision on the level of dividend signal the expected cash flow in the near future. Additionally, John and Williams (1985) identify a dividend signaling equilibrium with dividends and its properties. In the equilibrium, the firm’s managers with private information will signal with dividends whenever the supply of cash within the firm is less than sum of the demand of cash by both the firm and its shareholders (John and Williams, 1985). All of these researchers insist that the managers are trying to signal their own information about their upcoming cash flows to individuals outside the firm. Therefore, the corporation’s dividend policy is a tool to communicate about the firm’s cash flows.
More empirical studies can support the argument that signaling with dividend changes is related to the firm’s investment opportunities. Lang and Litzenberger (1989) argue that a significant
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change in share price can be found only when investors’ beliefs about the magnitude of the company’s future investment are changed after the announcement. In addition, Yoon and Starks (1995) investigate the shareholders’ wealth effect after the dividend announcements. They report that information regarding the firm’s future investment policies is not discovered when the firm announces new dividend policy. Rather than that, dividend changes can reflect the given investment opportunities at the time of announcements (Yoon and Starks, 1995).
Nonetheless, dividend increase (decrease) does not always mean optimism (pessimism) about the company’s future cash flow. They can be conducted in different ways. For instance, if the company increases or initiates dividend payments for investors, it may signal that the managers are optimistic about the firm’s future cash flow. Nevertheless, it can forecast a lack of beneficial future investment opportunities at the same time. Contrariwise, if the firm decreases or omits the level of dividends, it may convey private information that it has new positive net present value investment opportunities in the future. In this case, dividend omissions can lead to positive share price response, not negative one. Therefore, firms can use dividend omissions for good cause that it may develop its future financial flexibility by allowing them to invest in positive net present value projects (Bulan and Subramanian, 2008). This is not consistent with dividend signaling theory but it happens in real life.
For example, British insurance group Royal & Sun Alliance officially announced that it would reduce its dividend amount by up to 10% (Cave, 2001). Numbers of investors were confused because companies usually cut dividend payments as a last resort when they have financial problems. However, Royal & Sun Alliance had attained one of the highest profits among Financial Times Stock Exchange 100 (FTSE 100) Share Index. According to Cave (2001), Bob Mendelsohn, chief executive officer, explained that they have a business case to invest their capital and therefore cut dividend payments. After the dividend reduction announcement, stock price of Royal & Sun Alliance surprisingly increased by 5%. This result is not consistent with dividend signaling theory. This case shows that cutting the dividend can also forecast firm’s positive future prospect. Thus, investors have
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to interpret what kind of asymmetric information that managers are willing to share by changing the level of dividends.
The objective of this study is to find which financial features may bring positive stock price reaction after the dividend omission announcement. Generally, four criteria are used to distinguish sub-samples. Firstly, companies are categorized according to their amount of expenditure on research and development (R&D) compared to their total cash flow. Ambarish et al. (1987) state that managers can signal firm’s future prospect by using both dividends and investments. They show that the post-announcement impact of dividends depend on the level of investment of the company (Ambarish et al., 1987). According to Liang et al. (2008), firms with heavier spending on research and development are less negatively affected by the dividend omission announcement. The reason why companies with high investment intensity suffer less than others is the upper level of research and development expenditure increases both credibility and predictability for future earnings (Liang et al., 2008). Additionally, Yoon and Starks (1995) suggest that the change in dividend policy reflects the change in investment opportunities in the future. Therefore, it is expected that there is positive correlation between post-announcement price reaction and the level of investment intensity of the firm.
Secondly, firms are classified as level of return on assets (ROA). In the study of Bulan et al. (2007), they find that nearly 35% of whole dividend omissions actually have positive influence on the firm’s future operation. Among those good omitters, many companies have higher financial profitability before the announcement, which can be measured by return on assets (Bulan et al., 2007). Investors will trust the firm with stronger fundamentals and react less sensitively to the announcement even though it may convey negative signal. Hence, this paper will investigate whether profitable firms can attain positive price response even after the omission announcement.
Thirdly, firms are categorized as debt-to-equity ratio. Debt signaling theory states that the issuance of debt can be used as a signal of the stock’s positive future performance (Davidson et al., 1995). When a firm decides to increase its leverage, it also takes responsibility of paying interests on
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the debt at the same time. By doing so, the company can send a signal to investors about their future financial stability. If the dividend-omitting firm has relatively high level of debt, negative signal from dividends and positive signal from debt confront each other. Which effect will nullify the other? According to Rees (1997), it is found that dividends have more powerful influence on firm’s value compared to debts. Therefore, this study will have a look how debt signaling and dividend signaling are related to each other.
Lastly, enterprises are classified as their relative market value compared to others. Ghosh and Woolridge (1988) state that the firm’s wealth loss after the dividend omission announcement is related to the size and risk of the company. In addition, Christie (1994) suggests that the firms with high ratio of market value to the mean market value can possess positive abnormal return after the cash dividend omission announcement. As larger companies’ financial data are more publicly available to the public, information asymmetry can be reduced and the managers can deliver more accurate information (Christie, 1994). Therefore, it is expected that companies with relatively high market value will suffer less than others after the dividend omission announcements. With these four standards, this paper will investigate when companies can attain increase in stock return after the dividend omissions.
III. Methodology and Data
i. Methodology
Overall, this article will conduct an event study in order to assess the effect of a specific event of the firm on its value by using financial market data. Event studies are valuable and frequently held in economics and finance because stock prices are sensitively and directly react to the relevant events in the rational marketplace (MacKinlay, 1997).
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This paper will focus on the event of the dividend omission announcements in New York Stock Exchange (NYSE), American Stock Exchange (AMEX), and National Association of Securities Dealers Automated Quotation System (NASDAQ) during the period from January 2009 to December 2013. Secondly, the event window – the period over which the specific event affects the company’s stock prices – has to be defined. In this article, the event window is set as 31-day window (from 15 days prior to 15 days after the dividend omission announcement). Consequently, the abnormal return has to be measured in order to assess the event’s influence on the firm’s value. The abnormal return is the difference between the actual return of the security and the expected return during the event window (MacKinlay, 1997). The expected return is the normal return without existence of the event. In mathematical formula, the abnormal return of the security i at time t is
𝐴𝑅𝑖𝑡 = 𝑅𝑖𝑡 − 𝐸(𝑅𝑖𝑡|𝑋𝑡)
where 𝐴𝑅𝑖𝑡, 𝑅𝑖𝑡, and 𝐸(𝑅𝑖𝑡|𝑋𝑡) are the abnormal, actual, and expected returns at time t. In order to estimate the expected returns, 𝑋𝑡 is needed which is the conditioned information in the normal return model. This paper chooses the market model in which 𝑋𝑡 equals the market return. Within the market model, the market return and the security return constantly have a linear relationship. For the stock i, the market model is defined as
𝑅𝑖𝑡 = 𝛼𝑖+ 𝛽𝑖𝑅𝑚𝑡+ 𝜀𝑖𝑡
𝐸(𝜀𝑖𝑡) = 0 and 𝑉𝑎𝑟(𝜀𝑖𝑡) = 𝜎𝜀𝑖 2
where 𝑅𝑖𝑡 and 𝑅𝑚𝑡 are the returns of stock i and the market portfolio at the time t. 𝜀𝑖𝑡 is the disturbance in the model with mean value of zero. In this study, the CRSP Equal Weighted Index is used as the market portfolio. After deciding a normal performance model, the estimation window should be set. The estimation window of from -120 days to -16 days will be used to compute the normal daily returns. With the market model and actual return data from CRSP, the abnormal return of each date can be calculated. They have to be combined to find a cumulative abnormal return over the
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event window. The cumulative abnormal return of security i from 𝑡1 to 𝑡2 (where 𝑡1≤ 𝑡2) is defined as
CAR𝑖(𝑡1, 𝑡2) = ∑ 𝐴𝑅𝑖𝑡 𝑡2
𝑡=𝑡1
Given the cumulative abnormal returns of each company, their statistical significance must be tested. This paper will conduct one sample T-test with average of the cumulative abnormal returns (𝐶𝐴𝑅̅̅̅̅̅̅(𝑡1, 𝑡2)) in order to test whether they are significantly different from zero and have positive value on a statistical basis.
𝑡𝐶𝐴𝑅 = 𝐶𝐴𝑅 ̅̅̅̅̅̅(𝑡1, 𝑡2)
𝑠𝐶𝐴𝑅̅̅̅̅̅̅(𝑡1,𝑡2) √𝑛
where n = number of events
ii. Data
This paper obtains announcements of cash dividend omissions which were made during the period from January 2009 to December 2013 from the Center for Research in Security Prices (CRSP) for companies traded on the New York Stock Exchange (NYSE), American Stock Exchange (AMEX), and National Association of Securities Dealers Automated Quotation System (NASDAQ). Companies from the list are accepted to the final sample for the research if they qualify for two criteria. These criteria are as follows and they are referred to the article from Liu et al. (2008): (1) the announcing firm has satisfactory data on the CRSP and Compustat dataset; (2) the announcing firm omits cash dividend for the first time. The resulting sample contains total 358 cash dividend omissions during the period from January 2009 to December 2013. More information about the total sample is shown at table 1. Additionally, four kinds of financial data are collected from Compustat dataset. In order to have a look on the firm’s financial state at the moment of the omission announcement, corporate information during the last quarter before the announcement is considered for classification.
11 Table 1
Distribution of Dividend Omissions by Year from 2009 to 2013
Firms are included in the omission sample if they are listed on the NYSE, AMEX and NASDAQ and made an recognizable omission announcement during the period.
Year Number of Omissions Percentage of sample
2009 89 24.86 2010 50 13.96 2011 59 16.48 2012 80 22.35 2013 80 22.35 Total 358 100.00 IV. Results
This paper compares cumulative abnormal returns of the firms with dividend omission announcements in different sub-samples and finds that specific samples obtain positive price reaction after the dividend omission announcement. The cumulative abnormal returns are examined from the market model where model parameters are calculated by the estimation window from 120 days to 16 days before the announcement date. The 31-day window around the event (from 15 days before to 15 days after the announcement) is used to calculate cumulative abnormal returns. Companies’ return data are from CRSP dataset and financial information is from Compustat dataset.
Every subsample is categorized as its distinctive characteristics. Firstly, as table 2 presents, firms which are included in top ten percentages from each of four standards – investment intensity, return on assets, debt-to-equity ratio and relative market value – are extracted and become sub-samples. As a total sample consists of 358 companies, each sub-sample has 35 events. Table 2 presents the statistical results of those four sub-samples. Among all sub-samples, positive incidences of cumulative abnormal returns from day -15 to +15 relative to omission announcements are observed from two of them. For the firms with high investment intensity, the average of cumulative abnormal
12 Figure 1
Cumulative Abnormal Returns of Firms with High R&D and ROA
Plot of cumulative abnormal returns from the event date -15 to +15 for the dividend omission announcement. The abnormal returns are computed by normal returns from the market model. Firms with high investment
intensity or return on assets obtain significantly positive cumulative abnormal returns.
Figure 2
Cumulative Abnormal Returns of Firms with High D/E and MV
Plot of cumulative abnormal returns from the event date -15 to +15 for the dividend omission announcement. The abnormal returns are computed by normal returns from the market model. Firms with high debt-to-equity
ratio or relative market value do not obtain significantly positive cumulative abnormal returns. -0.2 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2 -15 -12 -9 -6 -3 0 3 6 9 12 15 CAR Event Time High R&D High ROA -0.2 0 0.2 0.4 0.6 0.8 1 1.2 1.4 1.6 1.8 2 -15 -12 -9 -6 -3 0 3 6 9 12 15 CAR Event Time High D/E High MV
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Descriptive Statistics Data Series for Sub-samples (1) Average (CAR) Std. Dev. (CAR) Minimum (CAR) Maximum
(CAR) T-value P-value
High investment intensity n=35 1.5439 6.8344 -12.5745 18.6313 1.3384* 0.0948*
High return on assets n=35 0.4839 1.1556 -0.2040 3.9786 2.4772*** 0.0092***
High debt-to-equity ratio n=35 0.5374 7.5555 -16.1442 18.0337 0.4208 0.3383
High relative market value n=35 -0.0194 0.1196 -0.2760 0.3590 -0.9597 0.1720
*,**,*** : Significant at the 10%, 5% and 1% level respectively
Table 3
Descriptive Statistics Data Series for Sub-samples (2) Average (CAR) Std. Dev. (CAR) Minimum (CAR) Maximum
(CAR) T-value P-value
High investment intensity and
return on assets n=65 0.9021 3.5010 -2.6150 19.5624 1.7476** 0.0437**
High investment intensity, return on asset and debt-to-equity ratio
n=23 0.8675 3.9274 -2.6432 18.6313 1.0594 0.1505
High investment intensity, return on assets and relative market value
n=34 -0.0088 0.2431 -1.0417 0.5162 -0.2115 0.4169
High investment intensity, return on assets,
debt-to-equity ratio and relative market value
n=19 -0.0439 0.2745 -1.0417 0.3378 -0.6968 0.2474
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return is positive (1.5439) and significantly different from zero at the 10% level. This result is consistent with the previous literature of Liang et al. (2008) that more investment-focused suffer less than others. Additionally, the second sub-sample with firms which have comparatively high return on assets also obtains positive cumulative abnormal return with the average of 0.4839) at the significance level of 1%. This result presents same conclusion with the paper of Bulan et al. (2007) but with stronger significance level. Furthermore, it can be found that positive relation between return on asset and abnormal stock price around the announcements is stronger than relation between investment intensity and stock return.
On the other hand, companies with high debt-to-equity ratio or relative market value compared to peers obtain cumulative abnormal returns which are not significantly different from zero. Although firms with high debt-to-equity ratio obtain positive average of cumulative abnormal return (0.5374), the value is not statistically significant. It means that debt signaling works for positive price reaction but not strong enough. Lastly, enterprises with large market value even face negative cumulative abnormal return with the average of -0.0194) as dividend signaling theory proposes. This shows that high market value of the firm does not help it to attain positive stock price response after the dividend omission announcement. This result is not consistent with the paper by Christie (1994) which proposes that higher market value is related to positive post-announcement stock price. As a result, if firms announce dividend omissions but have moderately intensive in investment or financially profitable, investors respond less sensitively to the negative signal of announcements and this even results positive share price reaction in the short term. Nonetheless, comparatively high debt-to-equity ratio and market value do not contribute to achieve positive post-announcement abnormal return.
In order to investigate further effects of firms’ characteristics on post-announcement abnormal returns, more event studies are conducted with different compositions of sub-samples. From the table 2, it is found that heavy magnitude of investment and return on assets are the characteristics
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which help companies to achieve positive stock returns after the omission announcements and become good omitters. In this respect, new sub-samples are created. The first sub-sample contains firms of which both levels of investment and return on assets are larger than the median value in each criterion. Companies in second sub-sample simultaneously have higher level of investment intensity, return on assets and debt-to-equity ratio than the median value in each group. The third sub-sample consists of enterprises of which all levels of expenditure on research and development, return on assets and comparative market value are larger than the median value in each criterion. Lastly, firms in the fourth sub-sample concurrently have higher level of all four criteria – investment intensity, return on assets, debt-to-equity ratio and relative market value – than the each median value. Table 3 shows the statistical results of those four sub-samples. Among four of them, only the first sub-sample obtains positive cumulative abnormal returns (0.9021) which are significantly different from zero at the 5% level. It means that firms with both high investment intensity and return on assets can obtain positive price reaction in the short run even though they announce dividend omission. This result is consistent with the previous findings of this study. However, as last three sub-samples’ results suggest, this positive relation disappears when the firm also has considerably high debt-to-equity ratio or relative market value. It means that positive influence is nullified by other financial features.
If the firms with high expenditure on investments or financial profitability obtain positive price reaction after the dividend omission announcements, what are the expected results for companies with lower value on each criterion? In order to answer to this question, this paper conducts the T-test again with those two different sub-samples. According to table 4, both two groups with low investment intensity and return on assets undergo average of negative post-announcement stock price responses which are not statistically significant. These results support that there are significant difference of abnormal return between groups with high and low investment intensity or financial profitability. Therefore, it can be said that investment intensity and financial profitability ar e important characteristics of the firms which determine the direction of price movement after the
16 Table 4
Descriptive Statistics Data Series for Sub-samples (3) Average (CAR) Std. Dev. (CAR) Minimum (CAR) Maximum
(CAR) T-value P-value
Low investment intensity n=35 -0.3116 5.1914 -10.8845 14.2844 -0.3001 0.3833
Low return on assets n=35 -0.3579 1.6282 -8.0100 1.4732 -1.3005 0.1011
*,**,*** : Significant at the 10%, 5% and 1% level respectively
Figure 3 Figure 4
Cumulative Abnormal Returns of Firms with Low R&D Cumulative Abnormal Returns of Firms with Low ROA Plot of cumulative abnormal returns from the event date -15 to +15 for the dividend
omission announcement. The abnormal returns are computed by normal returns from the market model. Firms with low invest intensity do not obtain significantly
positive cumulative abnormal returns.
Plot of cumulative abnormal returns from the event date -15 to +15 for the dividend omission announcement. The abnormal returns are computed by normal returns from the market model. Firms with low return on assets do not obtain significantly
positive cumulative abnormal returns.
-1 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 0.8 1 1.2 -15 -12 -9 -6 -3 0 3 6 9 12 15 CAR Event Time -1 -0.8 -0.6 -0.4 -0.2 0 0.2 0.4 0.6 0.8 1 1.2 -15 -12 -9 -6 -3 0 3 6 9 12 15 CAR Event Time
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dividend omission announcements. If the companies have relatively high value of those two criteria, they will have significantly positive stock price reaction compared to other firms.
Overall, the results propose that stock price can move positively under certain circumstance although the firm announces the dividend omission. If the company has spent large amount of its cash on research and development or obtained high return on assets compared to other firms, investors do not necessarily consider the dividend omission as a negative signal for future prospect. Therefore, this awareness of investors brings positive price response in short run. This is contrast to dividend signaling theory. Nevertheless, most of other firms do not obtain positive post-announcement stock price reaction as the theory proposes. For example, companies with low investment intensity or financial profitability achieve negative post-announcement abnormal return. This result supports the validity of the statement that heavier expenditure on investments and return on assets are the characteristics of good dividend omitters.
V. Conclusion
Using a sample of 358 cash dividend omission announcements during the period from 2009 through 2013, this paper examines the post-announcement stock price performance of announcing firms in the short term. The short-run abnormal performances are measured by applying the market model. Over the 31-day event window, this article discovers statistically significant positive abnormal returns for the dividend-omitting firms with high level of investment and return on assets. Nonetheless, company’s level of debt-to-equity ratio or market value does not have significant influence on its share price reaction after the announcement. Furthermore, if any of those two features are comparatively high for the firms which have large amount of investment and return on assets, significantly positive abnormal returns are nullified. These results suggest that investors do not consider dividend omission announcements as negative signal and even expect positive price reaction of the firm with high investment intensity or return on asset even though it announces cash dividend omission.
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