Reactions to Dividend Changes Conditional on Earnings Quality

Abstract

We examine market participants' reactions to dividend changes conditional on earnings quality. We define earnings quality as the extent to which current earnings are associated with one-year, two-year, or three-year ahead operating cash flows. Controlling for the magnitude of the dividend change, the firm's information environment, the firm's investment opportunity set, the effects of dividend clienteles, and the firm's operating risk, we find that the market reacts less to dividend change announcements from firms with higher earnings quality. Similarly, controlling for the magnitude of the dividend change, the firm's information environment, and the release of other information around the dividend declaration date, we find that the magnitude of analyst forecast revisions is significantly less for firms with higher earnings quality. Overall, our results are consistent with market participants incorporating earnings quality when reacting to information in other financial disclosures.

JEL Classification: M41, M43, G35, G14, G29