An Examination of the Free Cash Flow and Information/Signaling Hypotheses Using Unexpected Dividend Changes Inferred from Option and Stock Prices: The Case of Regular Dividend Increases

Abstract

This paper measures unexpected dividend changes in testing the free cash flow and information/signaling hypotheses using the Bar–Yosef/Sarig method. The empirical findings reveal the following: (i) The association between announcement period abnormal returns and the cash level is significantly positive for low q firms; (ii) The positive association between announcement period, abnormal returns, and the cash level is stronger in low q than in high q firms for most regressions; (iii) Low q firms reduce their capital and research and development (R&D) expenditures during the four fiscal years following dividend increase announcements. Our results are consistent with the free cash flow hypothesis.