Does the Timing of Dividend Reductions Signal Value? Empirical Evidence

Abstract

This paper examines a firm’s dividend reduction timing relative to other dividend reductions in the same industry. It tests if the timing of dividend cuts is informative in firm valuation. The findings suggest that during periods of less accessible external financing, such as recessions, firms with greater investment opportunities are among the first firms to make necessary dividend reductions to take advantage of such opportunities. When external financing is more accessible, firms with superior investment opportunities are able to access capital markets in lieu of dividend-reducing internal financing, indicating higher firm values for earlier dividend reductions during periods of costly external financing and significantly lower firm values for early reductions when financing is more easily obtained. A series of empirical tests show that, in periods of less accessible external financing or during a recession, early dividend-reducing firms significantly outperform late reducers in announcement day and contraction cycle cumulative abnormal returns. The results also show that, outside of a recession, early dividend-reducing firms have significantly lower industry contraction cycle returns than late dividend reducers. Additionally, this study compares early dividend reductions that occur during periods of costly external financing (or during a recession) against early reductions that occur when external financing is more available (or outside of a recession) and finds the former to have significantly higher announcement day and contraction cycle cumulative abnormal returns.