Dividend Cuts Research Articles

Creditor Intervention, Investment, and Growth Opportunities

We show that creditors do not just ensure that inefficient investment is not undertaken, but also do not preclude efficient investment. Examining what happens following a debt covenant violation, a situation through which creditors acquire some control rights over the firm, we find that investment declines when the firm has few growth opportunities but it may increase otherwise. The results are robust to the use of different proxies for growth opportunities. The firm’s performance improves but it suffers dividend cuts and increased CEO turnover. The results suggest that creditors consider the benefits of growth opportunities as a source of future cash flows to meet outstanding debt obligations.

Bank dividend policy and the global financial crisis: Empirical evidence from Europe

The global financial crisis has caused controversial discussions about the capital base of the banking industry in Europe. Dividend cuts and omissions have been suggested as one possibility to improve the financial strength of banks by retaining earnings. However, there are fears that investors could interpret a reduction of dividends as a sign for future problems. The dividend signalling and dividend smoothing hypotheses quite clearly are the theoretical basis for these worries. The basic idea of this study is that without empirical evidence supporting the hypothesis dividends did matter in the past, banks should not fear dividend cuts or even dividend omissions. The empirical evidence from the European banking industry reported here does not indicate that dividend signalling and dividend smoothing are relevant economic phenomena.

Agency Problems and Stock Repurchases: Evidence from Japan

This paper examines stock repurchases from an agency perspective by identifying agency costs across three dimensions — interest conflicts and information asymmetry, managerial discretion, and the use of alternative mechanisms to mitigate agency conflicts. We use ownership structure as a proxy for interest conflicts and information asymmetry, employ cash balance and free cash flow as two measures of managerial discretion, and consider cash dividends and interest-bearing liabilities as alternative vehicles for distributing cash. We find that a monitoring structure motivates managers to mitigate agency costs through stock repurchases. Particularly, monitored firms with higher levels of cash balance prefer cash dividends to stock repurchases, whereas monitored firms with more cash dividends repurchase more shares because of their stronger incentive to mitigate agency costs. However, when firms have a very high level of dividends, they substitute stock repurchases for dividends to avoid a dividend cut in the future.

Does the timing of dividend reductions signal value? Empirical evidence

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.

Does the Timing of Dividend Reductions Signal Value? Empirical Evidence

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.

Communicating Private Information to the Equity Market before a Dividend Cut: An Empirical Analysis

This paper presents the first empirical analysis of the choice of firms regarding whether or not to release private information (“prepare the market”) in advance of a possible dividend cut, and the consequences of such market preparation. We use a hand-collected data set of dividend cutting firms that allows us to distinguish between prepared and non-prepared dividend cutters and test the implications of two alternative theories: the “signaling through market preparation” theory and the “stock return volatility reduction” theory. We document several important differences between prepared and non-prepared dividend cutters. Overall, our empirical results are consistent with the signaling theory.

The impact of technical defaults on dividend policy

This paper examines how loan covenant violations impact firm dividend policy. Using contract-level loan data for nonfinancial firms in the US, this study provides evidence that the occurrence of a covenant violation significantly increases the likelihood of a dividend reduction in the subsequent quarter. Moreover, we show that the degree of creditor–shareholder conflict and firm financial constraints are important determinants of dividend cuts upon technical default. Additionally, this paper finds the tendency of dividend cuts upon technical default weakened after the repeal of the Glass–Steagall Act. These findings suggest that loan covenants serve a critical role in mitigating creditor–shareholder conflicts.

Weighing the Evidence on Earnings Management to Meet Dividend Thresholds

Daniel, Denis, and Naveen (2008) report evidence that firms manage earnings upward when premanaged earnings are expected to fall short of dividend payments. However, we find that this evidence is not robust when controlling for firms’ tendency to manage earnings upward to avoid reporting earnings declines. We further report that the decision to cut dividends depends on whether reported earnings fall short of past dividends, but not on earnings management that eliminates a shortfall in pre-managed earnings relative to dividend payments. Overall, our evidence suggests that firms that face dividend constraints are more likely to cut dividends rather than to manage earnings to avoid dividend cuts.

“Preparing” the Equity Market for Adverse Corporate Events: A Theoretical Analysis of Firms Cutting Dividends

AbstractThis paper presents the first theoretical analysis of the choice of firms between “preparing” and not preparing the equity market in advance of a possible dividend cut. In our model, insiders have private information about their firm’s intermediate cash flow as well as about the net present value of its growth opportunity. We show that, in equilibrium, firms in temporary financial difficulties but with good long-term growth prospects are more likely to prepare the market in advance of dividend cuts, while those with permanently declining earnings are less likely to prepare the market. Our model generates several new testable predictions.

Did Option Prices Signal the 2008 and 2009 Dividend Cuts and Omissions?

The large number of dividend cuts and omissions in 2008 and 2009 provides the opportunity to study the predictability of dividend cuts in a controlled environment. We employ the information contained in forward-looking option prices in an attempt to predict dividend cuts. We provide evidence that implied dividends, calculated from put and call prices on a firm’s stock, are significantly related to a firm’s propensity to cut or omit its dividend. Option traders made clear their anticipation of these events through price adjustments reflected in implied dividends that allow us to successfully identify firms more likely to reduce or omit dividend payments.

Capital Structure Shifts And Recession: An Empirical Investigation

<span style="font-family: Times New Roman; font-size: small;"> </span><p style="margin: 0in 0.5in 0pt; text-align: justify; mso-pagination: none;" class="MsoNormal"><span style="color: black; font-size: 10pt; mso-themecolor: text1;"><span style="font-family: Times New Roman;">This study investigates whether the 2007-2009 recession impacted the capital structures of U.S. corporations.<span style="mso-spacerun: yes;"> </span>Investigating all non-financial firms in the S&P 500 Index, the study finds that by boosting their book equity via dividend cuts and some debt reductions, firms kept book leverage unchanged.</span></span></p><span style="font-family: Times New Roman; font-size: small;"> </span>

Dividend Decapitalization And Financial Performance Signals

This study examines the stock price response to dividend announcements which include a return of capital to owners. The continuation of an amount previously distributed exclusively from earnings is effectively a dividend reduction. Dividend cuts have been shown to provide an unfavorable signal to investors. Empirical results indicate that the market does not infer unfavorable subsequent financial performance signals from decapitalization dividends.

Managerial views about dividend policy in Pakistan

PurposeVery little is known about the influences on dividend decisions in Pakistan, despite the importance of the market in the region and the nation's non‐standard tax system. This study therefore aims to provide detailed evidence regarding this issue by examining the views of those charged with the decisions in practice.Design/methodology/approachThe study reports the findings from interviews with 23 Pakistani company officials about influences on their firms' dividend policies. A semi‐structured interview document was used to guide the discussions. The interviewees chosen ensure that a wide spread of professional and industrial backgrounds were covered in the study.FindingsThe results suggest that, despite differences in environmental idiosyncrasies, the dividend decision‐making process in Pakistani companies is similar in many important respects to that in the USA and other developed markets. However, unlike in earlier studies, the interviewees suggested that past dividends do not influence current dividend levels in Pakistan and respondents were not reluctant to announce news of a dividend cut; instead, firms focus only on current earnings and company liquidity when deciding on a disbursement level.Originality/valueThe study suggests that views about dividends in Pakistan differ from those reported in other markets in a number of important respects. Some, but not all of this evidence relates to the Pakistan taxation system, where until very recently share dividends (as with all capital gains) were tax exempt.

Losses, Dividend Reductions, and Market Reaction Associated with Past Earnings and Dividends Patterns

This paper examines investors’ reactions to dividend reductions or omissions conditional on past earnings and dividend patterns for a sample of eighty-two U.S. firms that incurred an annual loss. We document that the market reaction for firms with long patterns of past earnings and dividend payouts is significantly more negative than for firms with less-established past earnings and dividends records. Our results can be explained by the following line of reasoning. First, consistent with DeAngelo, DeAngelo, and Skinner (1992) , a loss following a long stream of earnings and dividend payments represents an unreliable indicator of future earnings. Thus, established firms have higher loss reliability than less-established firms. Second, because current earnings and dividend policy are a substitute source of means of forecasting future earnings, lower loss reliability increases the information content of dividend reductions. Therefore, given the presence of a loss, the longer the stream of prior earnings and dividend payments, (1) the lower the loss reliability and (2) the more reliably dividend cuts are perceived as an indication that earnings difficulties will persist in the future.

Dividend policy issues in the financial crisis: the example of the German automotive industry

The global financial crisis has created some problems for car manufacturers and their suppliers. Dividend cuts and omissions have been suggested as one possibility to improve the financial strength of firms in the automotive industry. However, some observers have expressed fears that investors could interpret a reduction of dividends as a sign for future problems. This argument is quite clearly based on the dividend signalling and dividend smoothing hypotheses. Therefore, we use VAR/VECM techniques to analyse the dividend policy of the German automotive industry. The empirical evidence reported in this study does indicate that there is no support for the dividend signalling hypothesis. However, dividend smoothing seems to be a relevant economic phenomenon. As a consequence, firms in this sector of the German economy considering dividend cuts or omissions should at least communicate clearly why they plan to do so.

To Cut or Not to Cut a Dividend

Motivated by the argument that managers will cut their dividend only when there are visible signs of poor performance, I revisit the issue of why firms cut their regular cash dividend. I use a propensity score matching methodology to differentiate firms according to their likelihood of cutting a dividend where the likelihood is a function of observable firm characteristics. I have three main findings: First, I find that the market reaction to dividend cut announcements is proportional to the element of surprise. Specifically, for a given magnitude of the dividend cut, I find that the three-day cumulative abnormal return around the dividend cut announcement is more negative for firms with less visible signs of poor performance compared to those that have experienced a more prolonged period of poor performance. Second, while on average firms cut their dividend as a last resort response to poor performance as suggested by prior studies, a significant number of firms cut their dividend pro-actively even without such visible signs of poor performance. The preservation of a low leverage ratio appears to be of first-order importance to these pro-active firms. Third, I find that by and large, firms use their poor performance to justify a dividend cut. Moreover, the absence of concurrent poor performance seems to preclude the option of cutting the dividend. Instead, firms may resort to cut back on capital expenditures.

Creditor Control Rights, Investment and Growth Opportunities

We show that creditors do not just ensure that inefficient investment is not undertaken, but also do not preclude efficient investment. Examining what happens following a debt covenant violation, a situation through which creditors acquire some control rights over the firm, we find that investment declines when the firm has few growth opportunities but it may increase otherwise. The results are robust to the use of different proxies for growth opportunities. The firm’s performance improves but it suffers dividend cuts and increased CEO turnover. The results suggest that creditors consider the benefits of growth opportunities as a source of future cash flows to meet outstanding debt obligations.

Dividend policy and the global financial crisis: empirical evidence from the Italian insurance industry

The financial crisis has led to controversial discussions about the capital base of the insurance industry. Dividend cuts and capital increases have been suggested to counter diminishing equity. However, some observers seem to fear that investors could interpret a reduction of dividends as a sign for future problems. The empirical evidence from the Italian insurance sector reported here does indeed indicate that dividend smoothing is a relevant economic phenomenon. Therefore, Italian insurance companies should rethink dividend policy rather carefully due to the possible negative consequences of dividend cuts.

Dividend policy, signalling and free cash flow: an integrated approach

PurposeScholars have examined the importance of a firm's dividend policy through two competing paradigms: the signalling hypothesis and the free cash‐flow hypothesis. It has been argued that our understanding of dividend policy is hindered by the lack of a model that integrates the two hypotheses. The purpose of this paper is to address this by developing a theoretical dividend model that combines the signalling and free cash‐flow motives. The objective of the analysis is to shed light on the complex relationship between dividend policy, managerial incentives and firm value.Design/methodology/approachIn order to consider the complex nature of dividend policy, a dividend signalling game is developed, in which managers possess more information than investors about the quality of the firm (asymmetric information), and may invest in value‐reducing projects (moral hazard). Hence, the model combines signalling and free cash‐flow motives for dividends. Furthermore, managerial communication and reputation effects are incorporated into the model.FindingsOf particular interest is the case where a firm may need to cut dividends in order to invest in a new value‐creating project, but where the firm will be punished by the market, since investors are behaviourally conditioned to believe that dividend cuts are bad news. This may result in firms refusing to cut dividends, hence passing up good projects. This paper demonstrates that managerial communication to investors about the reasons for the dividend cut, supported by managerial reputation effects, may mitigate this problem. Real world examples are provided to illustrate the complexity of dividend policy.Originality/valueThis work has been inspired by, and develops that of Fuller and Thakor, and Fuller and Blau, which considers the signalling and free cash‐flow motives for dividends. Whereas those authors consider the case where firms only have new negative net present value (NPV) projects available (so that dividend increases provide unambiguously positive signals to the market in both the signalling and free cash‐flow cases), in this paper's model, the signals may be ambiguous, since firms may need to cut dividends to take positive NPV projects. Hence, the model assists in understanding the complexity of dividend policy.

On the Impact of the Financial Crisis on the Dividend Policy of the European Insurance Industry

The financial crisis has led to controversial discussions about the capital base of the European insurance industry. Dividend cuts have been suggested to preserve capital. However, some observers seem to fear that investors could interpret a reduction of dividends as a sign of future problems. The empirical evidence reported here does not indicate that dividend smoothing or dividend signalling are relevant economic phenomena examining the dividend policy of the European insurance industry. Therefore, insurance companies should not be too concerned about the negative consequences of dividend cuts.