A Study On Dividend Signaling Theories Finance Essay

A Study On Dividend planetary house Theories Finance EssayIntroductionDividend announcement is a signifi ceaset event that is closely scrutinized by a firms important stakeholders such as investors and financial analysts. Typically, dividend announcement contains entropy that signals firms cyberspace condition. Consequently, financial markets may reply to these data releases by directly affecting the announcing firms storage expenditure. Finance lit suggests that dividend announcement affects a firms rootage bell. Stock cost may react affirmatoryly or cast outly to dividend announcements. For example, Dewenter and Warther (1998) and Fukuda (2000) both provide establish of a dogmatic(p) (negative) market reaction to dividend increases (decreases). Dividend signalize is a tool which investors can use to investigate the impact of dividend announcements on job prices.Literature limited review is focused on dividend signaling and more specifically on the effect of divid end announcement to the stock price. Relatively to the literature review, it hasnt been directed any research tutelage roughly dividend signaling but it has been dissectd some empirical studies in an order to examine the stock price effect to dividend announcement in substantive markets. Moreover, the studies will be compargond and analyzed, based on signaling theory, in an effort to explain further dividend signaling effect.The paper is organized as follows Section 1 describes generally about dividend signaling based on empirical and theoretical evidence. Section 2 describes the analysis of some empirical studies and section 3 concludes the results of these studies.Signaling theoryThe signaling theory claims that dividends should reflect the managers superior inside information about the firms time to come earnings conditions. Future earnings and trigger price can change any time, therefore, managers use dividends as an instrument to signal their superior information about the changes in earnings conditions. (C. Chen and C. Wu, 1999). Signaling theory also predicts that higher dividends signal better earnings performance and therefore, lead to a higher market value of the firm (Kathleen P. replete(predicate), 2002).There are numeral studies about different scenarios for dividend signaling. Bhattacharya (1979) and Miller and Rock (1985) argue that when there are information asymmetries amidst firms and outside shareholders, it is possible to induce a signaling role for dividends. Furthermore, managers are well informed about dividends payments but they dont reveal always the necessary information about firms profitability to the shareholders. (As it is ground in M. Donga, C. Robinson and C. Veld, 2005 p. 127)Miller and Modigliani (1961) claim, in their dividend signaling hypothesis, that firms increase dividends to convey positive information about earnings prospects. According to this hypothesis, dividend changes can be interpreted as forecasts of fut ure profitability (as it is found in K. Harada, P. Nguyen, 2005, p. 504)Campbell and Shiller (1987) state that the stock price reflects all information about future dividends and therefore, stock price forecasts future dividends and any changes in the process of dividends affects the behavior of the future dividend.( as it is found in C. Chen and C. Wu, 1999, p.30)Consistent with theoretical predictions, studies support that when dividends are increased stock prices tend to increase and when dividends are decreased stock prices tend to decrease. Based on these studies there is a positive correlation between dividend and stock price. On the former(a) hand, some researchers argue that there is non any significant birth between dividend changes and stock price. Michaely, and Thaler (2002) counter-argue that dividends signal the past and not the future. (as it is found U. S. Dhillon et al, p.2)2. Stock price reaction to dividend announcementsAccording to financial literature about div idend signaling hypothesis, dividend increasing companies earn positive stock return and dividend decreasing companies earn negative stock return. To understand better this event, it is important to analyze some empirical studies about the market reaction to dividend announcements and to compare their results. Researchers use variable models of signaling dividends in an order to examine the influence of dividend announcement in the stock price. These studies attempt to reconcile the theory with the evidence by considering the fundamentals of numerous companies and detailing the context in which the dividend changes takes place. Generally, it has been examined what happens when the dividend increases and when the dividend decreases.REGULAR DIVIDENTSH. DeAngelo et al. ( 1996) grow constructed a archetype of 145 large firms by searching Compustats primary and research tapes for NYSE-listed firms (public utilities, limited partnerships, American depositary receipts (ADRs), and Canadia n companies) with a decline in annual earnings that follows at least ten earnings reports indicating strictly increasing earnings, i.e., after nine or more consecutive annual earnings increases. According to this sample, they defy analyzed the stock markets announcement, day and over longer horizon (1-3 years), reaction to firms dividend increases. Sample firms shake experienced an economically small, but statistically significant sightly equity value increase roughly one-half of 1% when there was an announcement of dividend increase. These findings indicate a positive association among stock market views and dividend increases because the information that company provides, justify a higher quality value. (H. DeAngelo et al. ,1996)U. S. Dhillon et al (2003) have developed a sample of 1700 firms (updated on a quarterly basis) with dividend forecasts in the appraise Line Investment Survey. Their analysis contains, among other items, forecasts of the dividend for the current cale ndar year (and, in some cases, the next year) along with the publication date. Consistent to dividend signaling hypothesis, they have focused on the results of stock price reaction, at a two-day cumulative excess return, to dividend announcements using two different methods. In their field, they have presented the stock price reaction for positive, negative and no dividend changes. Capturing on the fraction of the sample that reflects the analysts expectation of a dividend increase, it has been noted a strong market reaction to dividend increases. In other words it has observed that for positive dividend announcements there was a positive stock price reaction. In the case that the dividend decreases, there is a significant negative price reaction meaning that for negative dividends announcements there was a negative price reaction. In this study is also be examined the announcements of no dividend changes. The sample, in this case, is divided into common chord sub-samples (1) posi tive dividend surprises, when analysts expectations of a dividend decrease did not materialize, (2) negative dividend surprises, when analysts expectations of a dividend increase did not occur, and (3) no dividend surprise, when analysts forecast of no dividend change was met. The results have demonstrated a significant relation between dividend changes and market reaction. Furthermore, whether dividends increase or remain unchanged, a significant positive reaction is observed when announced dividends exceed analysts forecasts. In contrast, a significant negative price reaction is observed when announced dividends are below analysts forecasts, and the price reaction is insignificant when announced dividends match expectations. (U. S. Dhillon et al, 2003)K.P. Fuller (2003) has used a sample of firms with unexpected dividend increases announced and has examined how the trading behavior of various investors affect a firms need to employ dividend changes to signal private information to the market. He has hypothesized that insider buying (selling) prior to a dividend increase is associated with significant and positive (negative) price reactions. The results have back up that the greater the amount of informed trading, the lower the price reaction to a dividend signal. Further, the larger the buy demand relative to the sell demand prior to the signal, the smaller the price reaction to an unexpected dividend increase. (K.P. Fuller, 2003)K. Harada and P. Nguyen (2005) have examined the relationship between dividend adjustments and long-term stock returns for a large sample of Japanese firms, over three different holding periods. A very significant yield in the research is the conditions under which the adjustments take place using the model of dividend changes. Based on signaling hypothesis, there is a significant association between dividend changes and subsequent earnings. At the 12-month horizon, firms were expected to increase their dividends (about 3.5%) but risk adjusted returns were found significantly negative (about -2.7%). At the 24-month horizon, stock returns were found also negative for the firms that expected to increase dividends (about -2.5%). In this research, it has to be mentioned that the results are much less significant, at less than 5% level due to the larger dispersion of (risk-adjusted) returns.At the 36-month period, the firms that did not present the curb conditions for a dividend increase have displayed a negative stock performance of dividend-increasing (about -6.35%). But when the firm was expected to increase the dividend (under appropriate conditions) , there was resulted a significantly positive association between dividend increases and risk-adjusted returns (about +14.5%). Overall, the stock performance evaluated over 12-24 months appears that stock returns are consistent with improved profitability altogether after an extended period of 36 months. That happens because the information presents a good por trait of the company, after 1 or 2 years, and the market participants react positive to this favorable information.On the other hand, in the research was examined the dividend decreases and the relationship with the stock price. The researchers supported that there is a significant positive association between the dividend decreases and stock price. More specifically, at the 12-month horizon, it is noted that dividend reductions are associated with a positive market reaction. (about +2.3%). Over the time, it was observed a significant positive increase association (about 4.5%, from 2.3% at 12-month horizon to 6.8% at 36-month horizon). These results concern firms that decrease their dividends. Regarding the firms that are expected to decrease their dividends, at the 12-month horizon expected dividend reductions that have been implemented result a significantly positive abnormal return (about +3.12%) that continues to increase at the 24-month horizon (+5.98%). An interesting observat ion that is provided among the two types is that only the first type of expected dividend reductions is associated with a positive stock performance, whereas the second type does not generate a significant change in the firms value. (K. Harada, P. Nguyen, 2005)SPECIAL DIVIDENTSBrickley (1982, 1983) has examined how the special dividend announcement related with the stock price. He supported that when firms announce unanticipated special dividends the stock prices increase by about 2%. According to his study, investors treat special dividends as hedged managerial signals about future profitability, in a way that unanticipated specials are associated with weaker stock market reactions than are invariable dividend increases of comparable size. He also claims that regular dividend increases have a significantly more favorable market impact than do unanticipated specials. (Brickley, 1983)H. DeAngelo et al. (2000) have studied the stock markets reaction to special dividends. Their study indicates that the sign of special dividend changes do not systematically convey significant information. They observed a positive average stock market reaction (about 1%) when firms increase special dividends. The results have shown that the stock market typically reacts positive to the special dividend increases. Furthermore, they found that the stock market typically reacts favorably to the fact that a special dividend is declared (holding regular dividends constant), but that the market reaction is not systematically related to the sign or magnitude of the change from one positive special dividend payment to another. (H. DeAngelo et al., 2000)ConclusionAccording to the dividend-signaling hypothesis (Miller and Modigliani, 1961), firms increase their dividends to signal a growth in subsequent earnings. Moreover, dividend increase announcement may have a significant effect in the stock market price. Therefore, a number of studies have been examined in an attempt to understand the relation between dividend announcement and stock price.Many researchers have analyzed dividend signaling effect, based on different models, and they have found almost the same results. H. DeAngelo et al. (1996), U. S. Dhillon et al (2003) and K. Harada and P. Nguyen (2005) have found a significant positive association between dividend increases announcement and stock price, contrary to K.P. Fuller (2003) that has found a significant negative association between dividend increases announcement and stock price response.Other researchers have examined how special dividend announcement affects stock price. Brickley (1983) and H. DeAngelo et al. (2000) have resulted that stock market typically reacts favorably to the declaration of a special dividend, holding the regular dividend constant. Furthermore they have found that the stock market response averages approximately 1%, both when firms increase specials and when they reduce them to a still-positive level. Overall, their data indicate that although special dividends generally convey good news to investors, any such signaling content is typically small.To assume, the signaling models that have been elect predict a positive relationship between dividend (regular and special) changes and stock price reaction to the announcement. The results are related with the financial literature, which provides extensive evidence that stock prices react to dividend changes. Even though a great number of researchers have resulted a positive association between the two factors, there is a researcher that has supported a negative association between the factors and that has led some analysts to question the signaling role of dividends. Analysts claim that dividend signaling is a very important bulge and that it is related with other factors too. For example, the greater the number of informed traders active in a firms stock, the less likely it is that the firm needs to signal its intrinsic value. To conclude, analysts moldiness co ntinue to study the dividend signaling effect and more specifically to examine other significant factors associated with dividend announcement.