Dividend Initiations, Analyst Forecasts, and the Cost of Capital

Abstract

In this paper, I explore the information content of dividends by looking at dividend initiation announcements. While earlier literature has used analyst forecasts to explore the information content of dividends, they have all focused on dividend changes. I show that analysts revise their one-year-ahead (long-run growth) forecasts upwards (downward) one month after the initiation announcement. However, after the fiscal year end in which a firm announced the dividend initiation, both one-year-ahead earnings and long-run earnings growth forecasts are significantly lower than before the firm became a dividend payer. These results suggest dividends are not a signal of good future prospects. Rather, the results indicate that dividend initiations signal that a firm has fewer long-run growth opportunities. They also suggest dividends are a way of reducing the agency problem. I show that the cost of capital decreases significantly one year after the initiation announcement. Thus, it seems that paying dividends helps reduce the agency problem following a decrease in growth opportunities. Finally, my results also suggest that firms do not start paying dividends in order to reduce their cost of capital.