The Cash Flow Permanence and Information Content of Dividend Increases vs. Repurchases

Abstract

We hypothesize that the payout method chosen to distribute a cash flow shock is primarily determined by the permanence of the shock. Dividend increases will be observed following cash flow shocks with a relatively large permanent component while repurchases will be used to distribute shocks that are primarily transient. Further, this implies that the market will use the announcement of the payout method to update its beliefs about the permanence of past and contemporary cash flow shocks. Using a large sample of dividend increases and repurchases, we find support for these hypotheses. The post-shock cash flows of dividend increasing firms do not fully revert back to pre-shock levels. Those of repurchasing firms completely revert to pre-shock levels, even settling below them. The stock price reactions to the announcements of both repurchases and dividend increases show strong evidence that the information in a payout announcement is not only the size of the payout, but also the method used to distribute the cash. The announcement of a payout method that does not match the market's expectations causes the market to update its previous assessment of the permanence of the cash flow shock.