The Dynamics of Corporate Dividend Reductions
FINANCIAL MANAGEMENT, Winter 1995
Posted: 23 Jul 1998
The claim that dividend 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.
JEL Classification: G34
Suggested Citation: Suggested Citation