Do Firms Manage Earnings to Meet Dividend Thresholds?

Abstract

Dividend paying firms tend to manage earnings upward when their earnings would otherwise fall short of expected dividend levels. This behavior is evident only in firms with positive debt and is more aggressive prior to the Sarbanes-Oxley Act, subsequent to the 2003 dividend tax cut, in high payout firms, in firms whose CEOs receive higher dollar dividends and have higher pay-performance sensitivities, and in firms that raise less outside equity. Moreover, this earnings management behavior appears to significantly impact the likelihood of a dividend cut. Our findings imply that managers treat expected dividend levels as an important earnings threshold.

Keywords: dividend policy, dividend smoothing, earnings management, accruals

JEL Classification: G35, M41, M43, G34, G38, H25