Adjusted dividend-price ratios and stock return predictability: Evidence from China

Abstract

This paper examines the predictive ability of dividend-price ratios on stock returns in the Chinese A-share market. The results show that in both the in-sample and out-of-sample settings, stock returns are positively predicted by the raw dividend-price ratio and multiple adjusted dividend-price ratios over the 2002–2018 period, especially for the pre-2008 period. However, this predictive power disappeared after the China Securities Regulatory Commission (CSRC) released the unique Semi-Mandatory Dividend Rule (the Rule) in 2008, and this sudden decrease in predictive ability has shown no signs of reversing. Tests using the event-study methodology show a reduction in the positive relation between dividend-price ratios and stock returns in the short term, indicating that the Rule has an adverse impact on the signaling effect of dividend announcements. We further demonstrate that the interference of the Rule with the information conveyed by the dividends explains the disappearance of the predictive power of dividend-price ratios. For firms with insufficient cash flow, dividends provide a negative signal of the firms' value after the enactment of the Rule instead of a positive signal of strong future cash flows. Consequently, the Rule has a negative impact on the efficiency of the cash-flow channel for predicting returns and buries the predictive power of dividend-price ratios.