Earnings Thresholds Related to Dividend Cover

Abstract

An important line of international accounting research is the comparative quality of earnings across various jurisdictions. Several studies use earnings thresholds as a measure of earnings quality (e.g., Bhattacharya et al. 2003; Lang et al. 2003; Barth et al. 2005; Lang et al. 2005; Peasnell et al. 2005). An implicit assumption in these studies is that firms in all countries are managing earnings towards the same objective (Land and Lang 2002). We argue that international research ought to consider the possibility of an earnings threshold relating to dividend cover. Given that firms are reluctant to reduce dividends (DeAngelo and DeAngelo 1990; DeAngelo et al. 1992), the dividend-cover earnings threshold is economically important. We examine earnings distributions for the dividend-cover earnings threshold for a sample of 2,264 observations from New Zealand firms over the period 1986 to 2002. We find an asymmetry in the distribution of earnings associated with the dividend-cover earnings threshold. We also find that this asymmetry disappears after a change in legislation that removed the nexus between earnings and dividends. Similar to prior research, we find that an asymmetry exists for the zero earnings threshold, but it is not as pronounced as that found in U.S. data. An implication of our results is that research using international data ought to consider country-specific institutional settings when considering earnings thresholds.