Signaling Managerial Optimism Through Stock Dividends and Stock Splits: A Reexamination of the Retained Earnings Hypothesis
53 Pages Posted: 27 Mar 2001
Date Written: March 2001
Abstract
The retained earnings hypothesis predicts that stock distributions accounted for by reducing retained earnings are a more credible signal of managerial optimism than stock distributions that do not reduce retained earnings. This study examines the costs of false signaling that are a necessary precondition for the hypothesis and finds them to be generally very small. The absence of the requisite costs of false signaling calls the validity of the hypothesis into question for most firms. However, prior studies have reported broad-based market evidence consistent with the retained earnings hypothesis. To resolve this apparent inconsistency, this study replicates and extends tests of the retained earnings hypothesis contained in three prior studies. It shows that the findings in support of the retained earnings hypothesis can be attributed to specification and measurement choices that bias the results in favor of the hypothesis. The support for the retained earnings hypothesis is weaker when the sources of the bias are removed. However, some support for the hypothesis remains for a limited set of distributing firms.
Keywords: Retained earnings hypothesis, Signaling, Stock splits, Stock dividends
JEL Classification: G14, G32, G35, M41
Suggested Citation: Suggested Citation