A Study On Dividend Signaling Theories Finance Essay

A Study On Dividend star sign Theories Finance EssayIntroductionDividend annunciation is a world-shattering force that is closely scrutinized by a firms important stakeholders such as investors and pecuniary analysts. Typically, dividend proclamation contains randomness that emblems firms net profit condition. Consequently, financial grocery stores may react to these selective information releases by directly affecting the announcing firms neckcloth damage. Finance literature suggests that dividend declaration affects a firms express(a) price. Stock price may react corroboratively or contradictly to dividend resolves. For example, Dewenter and Warther (1998) and Fukuda (2000) both provide tell of a verifying ( veto) merchandise reaction to dividend emergences (decreases). Dividend sign of the zodiac is a tool which investors can role to investigate the impact of dividend announcements on derivation prices.Literature review is cogitate on dividend signboardi ng and more specifically on the effect of dividend announcement to the bloodline price. Relatively to the literature review, it hasnt been directed any seek circumspection intimately dividend sign of the zodiac but it has been contemplated some data-based studies in an order to examine the stock price effect to dividend announcement in real markets. Moreover, the studies will be compargond and reading, 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 formulate the managers superior inside information about the firms future sugar conditions. approaching earnings and trigger price can change any time, in that locationfore, manage rs utilise dividends as an instrument to signal their superior information about the changes in earnings conditions. (C. subgenus Chen and C. Wu, 1999). Signaling theory in like manner predicts that higher dividends signal better earnings performance and in that respectfore, lead to a higher market cling to of the firm (Kathleen P. Fuller, 2002).There are numeral studies about antithetic scenarios for dividend signaling. Bhattacharya (1979) and Miller and Rock (1985) argue that when there are information asymmetries in the midst of 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 undeniable information about firms positiveness to the shareholders. (As it is ready in M. Donga, C. Robinson and C. Veld, 2005 p. 127)Miller and Modigliani (1961) claim, in their dividend signaling hypothesis, that firms summation dividends to convey positive i nformation about earnings prospects. According to this hypothesis, dividend changes can be interpreted as forecasts of future profitability (as it is embed 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 build in C. Chen and C. Wu, 1999, p.30)Consistent with theoretical predictions, studies support that when dividends are affixd stock prices consort to increase and when dividends are decreased stock prices tend to decrease. Based on these studies there is a positive correlation amongst dividend and stock price. On the another(prenominal) hand, some researchers argue that there is not any monumental relationship between dividend changes and stock price. Michaely, and Thaler (2002) counter-argue that dividends signal the past and not t he future. (as it is found U. S. Dhillon et al, p.2)2. Stock price reaction to dividend announcementsAccording to financial literature about dividend signaling hypothesis, dividend increasing companies earn positive stock return and dividend diminish companies earn negative stock return. To perceive better this event, it is important to analyze some empirical studies about the market reaction to dividend announcements and to compare their results. Researchers utilise 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) incur constructed a sample of 145 large firms by searching Compu stats principal(a) and research tapes for NYSE-listed firms (public utilities, limited partnerships, American depositary receipts (ADRs), and Canadian companies) with a regrets in annual earnings that follows at least ten earnings reports indicating strictly increasing earnings, i.e., after nine or more incidental annual earnings increases. According to this sample, they ache analyzed the stock markets announcement, daylight and over longer panorama (1-3 classs), reaction to firms dividend increases. Sample firms exhaust experienced an economically small, but statistically significant average equity value increase roughly unrivaled-half of 1% when there was an announcement of dividend increase. These findings bode a positive crosstie among stock market views and dividend increases because the information that bon ton provides, justify a higher quality value. (H. DeAngelo et al. ,1996)U. S. Dhillon et al (2003) cede create a sample of 1700 firms (updated on a quarterl y basis) with dividend forecasts in the note value Line Investment Survey. Their analysis contains, among other items, forecasts of the dividend for the current calendar year (and, in some cases, the next year) along with the publication date. Consistent to dividend signaling hypothesis, they take hold focused on the results of stock price reaction, at a two-day cumulative excess return, to dividend announcements using two diametric methods. In their study, they conduct presented the stock price reaction for positive, negative and no dividend changes. Capturing on the segment 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 notice 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 ne gative price reaction. In this study is also be examined the announcements of no dividend changes. The sample, in this case, is divided into three sub-samples (1) positive 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 oppose expectations. (U. S. Dhillon et al, 2003)K.P. Fuller (2003) has used a sample of firms with un evaluate d ividend increases announced and has examined how the merchandise behavior of various investors affect a firms need to employ dividend changes to signal private information to the market. He has hypothesized that insider grease ones palmsing (selling) prior to a dividend increase is associated with significant and positive (negative) price reactions. The results have supported that the great the measuring rod 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 issue 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 resultant earnings. At the 12-month horizon, firms were expected to increase their dividends (about 3.5%) but risk adjusted returns were found importantly 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 slight significant, at less than 5% level due to the larger distribution of (risk-adjusted) returns.At the 36-month period, the firms that did not present the appropriate 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 performanc e evaluated over 12-24 months appears that stock returns are ordered with improved profitability only after an extended period of 36 months. That happens because the information presents a good portrait 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 expect ed 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 provoke observation 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 exceptional dividend announcement relate with the stock price. He supported that when firms announce unanticipated peculiar(a) dividends the stock prices increase by about 2%. According to his study, investors treat limited dividends as hedged managerial signals about future profitability, in a way that unanticipated particulars are associated with weaker stock market reactions than are veritable(a) dividend increases of comparable size. He also claims that regular divide nd 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 add up 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 closely 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 divide nd 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 intelligence service to investors, any such signaling content is typically small.To assume, the signaling models that have been chosen 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 issue 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 apparent it is that the firm needs to signal its intrinsic value. To conclude, analysts must continue to study the dividend signaling effect and more specifically to examine other significant factors associated with dividend announcement.