Dividend announcements signaling role in financial reporting certification

Abstract

AbstractThis paper demonstrates a crucial signaling role for dividend announcements in the certification of corporate financial reporting. In light of the great financial reporting scandals of the 2000s, we adjust a price‐diffusion model to asymmetric information friction, such that first‐stage unexpected earnings announcements are conditionally absorbed by the market, depending on the corporate governance—level of the firm's transparency. In the second stage, the firm undertakes a complement dividend announcement‐signaling act, certifying the first‐stage earnings surprise announcement, in light of the firm's transparency. We conjecture theoretically and confirm empirically that the dividend announcement's cumulative abnormal return (CAR) is negatively and statistically significant, depending on the interaction between the unexpected earnings announcement's magnitude and the corporate transparency level. Hence, the study demonstrates a key role of dividend announcement, signaling the market about the initial financial reporting credibility. Specifically, low transparency level firms are incentivized to certify their preliminary financial reporting by dividend announcements, to alleviate the market hesitant absorption of their positive earnings surprise.