The Dynamics of Corporate Dividend Reductions

FINANCIAL MANAGEMENT, Winter 1995

Posted: 23 Jul 1998

See all articles by Gerald R. Jensen

Gerald R. Jensen

Northern Illinois University

James M. Johnson

Northern Illinois University

Abstract

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

Jensen, Gerald and Johnson, James M., The Dynamics of Corporate Dividend Reductions. FINANCIAL MANAGEMENT, Winter 1995, Available at SSRN: https://ssrn.com/abstract=7336

Gerald Jensen (Contact Author)

Northern Illinois University ( email )

Barsema Hall
Finance Department
DeKalb, IL 60115
United States
815-753-6399 (Phone)

James M. Johnson

Northern Illinois University ( email )

Wirtz Hall
DeKalb, IL 60115
United States
815-753-1116 (Phone)

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