Dividend Reductions Research Articles

Forced Versus Voluntary Dividend Reduction: An Agency Cost Explanation

AbstractWe examine whether the agency cost arising from shareholder‐bondholder conflict is an important determinant of the timing of dividend reduction decisions. Firms forced to reduce dividends owing to bond covenant violations experience lower earnings, more frequent losses, and greater earnings declines around the dividend reduction year than do firms that voluntarily reduce dividends. Relative to voluntary‐reduction firms, forced‐reduction firms have higher debt‐to‐equity ratios and managerial holdings. These findings coupled with the increased dividend payout ratios and lower announcement period returns suggest that financially distressed firms that anticipate poor performance have greater incentives to delay reducing dividends to avoid a wealth transfer to bondholders.

The Impact of Losses and Cash Flows on Dividends: Empirical Evidence for Japan

The article's purpose is to examine the impact of cash flows, earnings, and losses in setting dividend policy in Japan. More specifically, i) earnings, cash flows and annual losses are posited to be associated with dividend changes in firms with established earnings and dividend records; and ii) dividend reductions, current operating earnings and cash flows have information content in predicting future earnings. The results here support these hypotheses. Moreover, annual losses are shown to be a necessary but not a sufficient condition for dividend reductions in firms with established earnings and dividend records. About 80% of the 191 Japanese firms that reported losses during the period 1990-94 reduced or omitted dividends. In contrast, only 16% of the 338 firms that did not report losses during the same period reduced dividends.

Asymmetric information, dividend reductions, and contagion effects in bank stock returns

In an environment of asymmetric information, banks face information externalities due to their role as intermediaries of information. In particular, bank insiders will possess private information from monitoring loan customers. Accordingly, outsiders may interpret changes in a bank's financial policy as signals about the quality of its loan portfolio and to the extent that the assets (loans) of different banks are viewed as similar, they will interpret such signals as pertaining to non-announcing banks as well leading to contagion effects. We test for the presence of contagion effects in stock returns associated with announcements of dividend cuts by money-center banks. We find that dividend cuts induce negative abnormal returns in the stocks of non-announcing money-center banks and to a lesser extent in the stocks of large regional banks. The observed contagion effects appear consistent with informed rather than contagious panic behavior because these effects are systematically related to risks that are common to all affected banks.

Asymmetric Information, Dividend Reductions, and Contagion Effects in Bank Stock Returns

In an environment of asymmetric information, banks face information externalities due to their role as intermediaries of information. In particular, bank insiders will possess private information from monitoring loan customers. Accordingly, outsiders may interpret changes in a bank's financial policy as signals about the quality of its loan portfolio and to the extent that the assets (loans) of different banks are viewed as similar, they will interpret such signals as pertaining to non-announcing banks as well leading to contagion effects. We test for the presence of contagion effects in stock returns associated with announcements of dividend cuts by money-center banks. We find that dividend cuts induce negative abnormal returns in the stocks of non-announcing money-center banks and to a lesser extent in the stocks of large regional banks. The observed contagion effects appear consistent with informed rather than contagious panic behavior because these effects are systematically related to risks that are common to all affected banks.

The Effects of SFAS No. 90 on Nuclear Electric Utilities

We study the effect of SFAS No. 90 on electric utilities that were required to record substantial write-offs due to nuclear power plants that had been impaired by regulatory disallowances or abandonments. We identified 57 firms that recorded write-offs required under SFAS No. 90 totaling $17.7 billion. During the period surrounding the release of SFAS No. 90, many of the affected firms reduced their dividends and their common stock earned somewhat lower returns than similar firms that were not affected by the pronouncement. However, we do not attribute these differences directly to SFAS No. 90. We identify other factors that are more plausible explanations for the lower returns and dividend reductions: adverse regulatory rulings that disallowed the recovery of nuclear construction costs and lower quality earnings because of large noncash “allowance for funds used during construction” (AFUDC) accruals. We believe that follow-up studies comparing actual effects of controversial FASB pronouncements with those predicted during the board's deliberations are useful to both the board and those who lobby the board.

Contagion Effects of Dividend Reduction or Omission Announcements in the Electric Utility Industry

AbstractThis study examines the contagion effects of dividend reduction or omission announcements in the electric utility industry. Using a series of ten electric utility dividend announcements covering the period 1979–1991, I analyze differences in contagion reactions across utilities. I find the strength of the contagion reaction is significantly related to utility size, average dividend yield, debt ratio, market‐to‐book ratio, cash flow, and Altman's Z‐score. There is also evidence of a flight to quality, including a preference for utilities operating in more favorable regulatory environments.

An analysis of contagion and competitive effects at commercial banks

We examine whether an adverse event at one bank generates externalities for the banking industry, and assess whether the population of commercial banks is homogeneous. We find dividend reductions are negative events for both announcing money center and regional banks, but only reductions at money center banks have negative, contagion-type externalities. Dividend reductions at regional banks have positive competitive effects on geographic rivals. Regulatory enforcement actions induce negative valuation effects that are idiosyncratic to targeted banks, but actions against regional banks generate positive competitive effects on geographic rivals. Our evidence suggests that regional banking markets are not contestable.

Analysis of price reactions to interim dividend reductions — a note

Price reactions to interim dividend reductions are empirically analysed. Initial interim dividend reductions lead to a more strongly negative price reaction than for interim dividend reductions following an earlier final dividend reduction. When the subsequent interim dividend reduction is reduced proportionately more than the preceding final dividend reduction, the price reaction is stronger than when the proportionate reduction is less. The magnitude of price reactions to interim dividend reductions is found to be statistically significantly related to the size of the dividend reduction, the gearing ratio, the industrial classification, the incidence of a prior dividend cut and the actual change in interim earnings.

Dividend Reductions and Interim Effect: UK Evidence

Short-term price reactions to dividend reductions of UK firms that did not reduce their dividends in the previous three-year period are studied. Price reactions to interim and final dividend reductions are found to be significantly negative and stronger for interim dividend reductions. Though market reacted negatively around final dividend reduction announcements it bounced back to its prior level within one month of announcements. The magnitude of price reactions to dividend reductions is found to be statistically related to the size of the dividend reduction, the post-announcement effect from day 2 to day 20, the gearing ratio and dummy variable interim versus final dividend reduction. Interim dividend reductions were found to have incremental information about future annual earnings changes. No incremental information content was found for the final dividend reductions; however, they have information content when included as the only independent variable.

The determinants of organizational form changes: evidence and implications from real estate

We study changes in the real estate industry among organizational forms with varying degrees of restrictiveness and document the associated changes in profitability, free cash flow, debt, dividends, and investment policies. All troubled firms in our sample move to a more flexible organizational structure, with subsequent reductions in dividends, improvements in performance, and increases in asset sales and investments. Healthy firms that move to a tighter structure have larger free cash flows before the change; they increase dividends, reduce free cash flows and improve profitability after the change. We document evidence of tax considerations in organizational changes.

The stock-market reaction to dividend cuts and omissions by commercial banks

We postulate that the announcement effect of dividend reductions should be more severe for banks than for nondashfinancial firms because bank customers may avoid financially weak institutions and discontinue the relationship when negative information is released. To test our hypothesis we investigate a total of 81 dividend reductions by 56 commercial banks listed on the NYSE, AMEX and NASDAQ for the period 1974–1991. We find significant abnormal returns of −8.02% for the two-day event window and − 11.46% for a two-week period. These negative valuation effects are stronger than those reported in studies for dividend reductions of nondashfinancial firms and for other negative bank announcements. We also explore the relationship between abnormal returns and specific bank characteristics cross-sectionally and find a stronger reaction for larger banks.

The Dynamics of Corporate Dividend Reductions

The claim that divided payments serve as signals to market participants is widely accepted. However, recent evidence has increased the uncertainty regarding the information conveyed when a firm drops its dividend. In particular, DeAngelo, DeAngelo, and Skinner (1992) and Healy and Palepu (1988) find that a dividend reduction tends to be followed by a significant increase in firm earnings. Our analysis extends prior research by examining twenty-one firm characteristics three years before and three years after a dividend drop. Consistent with past results, we find that firm earnings drop prior to a dividend reduction and increase afterwards. However, following a dividend drop, firms tend to reduce asset expenditures, external financing activities, employees, and spending on R&D. In addition, firms tend to sell more assets and their sales level remains depressed in the post-dividend-drop period. These post-dividend-drop occurrences may negatively impact a firm's future competitive position and, furthermore, may explain the negative stock price reaction that accompanies the dividend-drop announcement. Overall, our results suggest that a dividend-drop marks the end of a firm's financial decline and the beginning of firm restructuring.

Accounting choice in troubled companies

This paper studies accounting choice in 76 NYSE firms with persistent losses and dividend reductions (40% forced by binding covenants). We find that managers' accounting choices primarily reflect their firms' financial difficulties, rather than attempts to inflate income. Firms with and without binding covenants exhibit minor accrual differences in the ten years before the dividend reduction. In the dividend reduction and following three years, the full sample exhibits large negative accruals that likely reflect the fact that 87% of sample firms engage in contractual renegotiations -with lenders, unions, government, and/or management-that provide incentives to reduce earnings.

Dividends and Losses

ABSTRACTAn annual loss is essentially a necessary condition for dividend reductions in firms with established earnings and dividend records: 50.9% of 167 NYSE firms with losses during 1980–1985 reduced dividends, versus 1.0% of 440 firms without losses. As hypothesized by Miller and Modigliani, dividend reductions depend on whether earnings include unusual items that are likely to temporarily depress income. Dividend reductions are more likely given greater current losses, less negative unusual items, and more persistent earnings difficulties. Dividend policy has information content in that knowledge that a firm has reduced dividends improves the ability of current earnings to predict future earnings.

Union negotiations and corporate policy: A study of labor concessions in the domestic steel industry during the 1980s

This paper studies managerial compensation, financial reporting, and dividend policies of the seven major domestic steel producers during requests for union concessions. Substantial layoffs, reported losses, and sacrifices by nonunion stakeholders buttressed managers' case for union concessions. From 1980 to 1988, sample firms reduced their work force by about 300,000 (almost two-thirds) and annual wage payments from $16.1 to $8.6 billion. Reported income is lower during union negotiations, controlling for cash flows, as is managerial pay, with average CEO salary plus bonus declining 18%. Dividend reductions and white-collar pay cuts are substantial, pervasive, and clustered during union negotiations.

Union negotiations and corporate policy A study of labor concessions in the domestic steel industry during the 1980s

Abstract This paper studies managerial compensation, financial reporting, and dividend policies of the seven major domestic steel producers during requests for union concessions. Substantial layoffs, reported losses, and sacrifices by nonunion stakeholders buttressed managers' case for union concessions. From 1980 to 1988, sample firms reduced their work force by about 300,000 (almost two-thirds) and annual wage payments from $16.1 to $8.6 billion. Reported income is lower during union negotiations, controlling for cash flows, as is managerial pay, with average CEO salary plus bonus declining 18%. Dividend reductions and white-collar pay cuts are substantial, pervasive, and clustered during union negotiations.

Dividend Policy and Financial Distress: An Empirical Investigation of Troubled NYSE Firms

ABSTRACTThis paper studies the dividend policy adjustments of 80 NYSE firms to protracted financial distress as evidenced by multiple losses during 1980–1985. Almost all sample firms reduced dividends, and more than half apparently faced binding debt covenants in years they did so. Absent binding debt covenants, dividends are cut more often than omitted, suggesting that managerial reluctance is to the omission and not simply the reduction of dividends. Moreover, managers of firms with long dividend histories appear particularly reluctant to omit dividends. Finally, some dividend reductions seem strategically motivated, e.g., designed to enhance the firm's bargaining position with organized labor.

AN ANALYSIS OF SHAREHOLDER REACTION TO DIVIDEND CUTS AND OMISSIONS

AbstractIn this paper the proposition is tested that stock market reaction to a dividend change is a function of its information content. A multiple regression model is formulated to identify the factors that contribute significantly to the capital loss suffered by shareholders when firms decide to cut/omit dividends. Results indicate that, in conformity with the information content hypothesis, the announcement period capital loss induced by a dividend deduction significantly depends on the percentage change in dividends, the size and risk of the firm, and the price performance of the firm's stock in the immediately preceding period. The results further reveal that (1) simultaneous announcements of poor earnings cause larger capital losses; (2) prior announcements of loss/lower earnings, strikes, etc. attenuate the negative impact of dividend cuts; (3) managerial reassurances that the dividend reduction is growth‐motivated produces a weakly favorable effect, and (4) institution of stock dividends concurrently with the dividend cut significantly reduces the negative valuation effect. It is concluded from the evidence that stock market reaction to managerial signals is a function of the perceived costs associated with these signals.

The informational content of the timing of dividend announcements

Abstract This paper contains a test of a new aspect of the informational content of dividend; namely, is there information in the timing of the announcements? The empirical evidence indicates that the market expects ‘bad news’ to be delivered late and that these expectations are confirmed. Mean excess returns of stock prices around late announcements are, depending on the assumed returns generating process, either significantly negative or insignificant while significantly positive around the entire population of announcements. Moreover, the proportion and magnitude of dividend reductions associated with late announcements are significantly larger than in the complete universe of announcements.

RETURNS ON HIGH‐QUALITY AND LOW‐QUALITY PREFERRED STOCKS IN PERIODS OF COMMON‐STOCK DIVIDEND REDUCTIONS

AbstractThis study compares the pre‐event return behavior of low‐quality and high‐quality nonconvertible preferred stocks in periods of common‐stock dividend reductions. Using the single‐index model to compute abnormal returns, the cumulative average residuals of low‐quality preferred stocks are significantly negative while those of the high‐quality group show a small, positive drift over the 12‐month period preceding the announcement month.