Do Changes in Dividends Signal Something?

New Evidence from New Zealand

By:

Ed Vos, Roger Tong

Correspondence to:

Ed Vos
University of Waikato
Department of Finance
Private Bag 3105
Hamilton, New Zealand
Email: evos@waikato.ac.nz
Phone: 0064 7 838 4466 ext 8110
Fax: 0064 7 838 4145

Abstract:
All 137 publicly listed firms in New Zealand were used to analyse the
relationship between dividend changes and earning changes. The
question being asked is: Do dividend changes point to good past
performance, good current performance, or signal growth in future
performance. The findings show that there is no statistically significant
relationship between dividend changes and either past or future
performance but that dividend changes are related significantly to current
earnings. The calls into question the notion that dividends can be seen as
signals.

1.Introduction
One of the fascinating issues in corporate finance is the informationcontent effect of the dividend. From the homemade-dividend argument of
Miller and Modigliani (1961), dividend policy is irrelevant, given that future
earnings are held constant. On the other hand, it has been empirically
established that when dividends are increased or initiated, prices of the
associated common stocks tend to go up, and when dividends are cut (less
often) or omitted, prices fall. Many theorists explain the evidence that the
rises in the stock price following the dividend increases as the dividend
increases convey positive information, that is, managers use dividend to
signal their views of future earnings prospects. The idea that changes in
dividends have information content about the future earnings of the firm
remains the received wisdom in corporate finance.
Interestingly, the most recent two studies with regard to the information
content effect of the dividend have provided evidence to shake the classical
dividend signaling theory. The evidence of DeAngelo, DeAngelo and
Skinner (1996)s study suggests that the firms dividend increases are not
reliable informative signals about future earnings. Benartzi, Michaely and
Thaler (1997) argue that changes in dividends mostly tell us something
about what has happened, the predictive value of changes in dividends
seems minimal. The question is that the results from these studies tend to
be universal phenomena or subject to special cases. If the former is true, it
is time for us to rethink the common received dividend-signaling story.

The motivation for this study is therefore to provide empirical evidence on

the dividend signaling issue in an alternative case the context of the New
Zealand market. The goal of this study is to reveal the relationships
between changes in dividends and the past earnings, the concurrent
earnings and the future earnings prospects. By a series of careful tests, this
study reveals that changes in dividends only significantly reflect the
concurrent earnings changes, have neither information content about the
future earnings nor are lagged responses to the past earnings of the firm.
In a sense, the significance of this study is not only confirming the recent
previous studies in this area, but also providing some implications for
market participants in New Zealand to treat the dividends announcement
properly.
Before testing the dividend-signaling hypothesis, this paper reviews the
relevant literature to provide a background of this study. The report then
describes the research design and data requirements. A series of tests are
carried out to reveal the relationships between earnings changes and
dividend changes, earnings changes and the timing of dividend change,
and earnings stability and dividend changes. The final section discusses
and concludes the findings.
2. Literature review
The story that changes in dividends have information content is an old one.
Lintner(1956) first investigates dividend policy, and stresses that firms only
increase dividends when management believes that earnings have
permanently increased, meaning that a dividend increases implies a
2

rightward shift in distribution of earnings. Miller and Modigliani (1961)

explicitly suggest that dividends can convey information about future cash
flows when market are in incomplete.
Building on the notion of asymmetric information, Bhattacharya (1979) ,
Miller and Rock (1985), John and Williams (1985), and other theorists go
further. They point out that dividend changes are not actions that just
happen to have information content, rather, these are explicit signals about
future earnings, sent intentionally and at some cost by management to the
firm and its shareholders.
The role of changes in dividends as information signaling devices was
further stressed by Brickley (1983), who examines stock returns and
dividend and earnings patterns surrounding specially designated dividends
(SDDs) and compares them to those surrounding regular dividend
increases. Brickley suggests that both SDDs and regular dividend
increases appear to convey positive information about future dividends and
earnings beyond that relating to the current period.
However, using 310 firms during the period 1946 to 1967, Watts (1977)
regresses the next years earnings on this years dividends, and finds that
while the average coefficients (across firms) are positive, the t-statistics are
very low. Also, Penman (1983) finds that after controlling for managements
future earnings forecast, there is not much information conveyed by the
dividend changes themselves. Perhaps theorists are unconvinced by these
two studies, the signaling-based theoretical treatments of dividends remain
in corporate finance. For example in the latest revision of their leading
3

textbook, Ross, Westerfield and Jaffe (1996) conclude that The stock
market reacts positively to increase in dividends (or an initial dividend
payment) and negatively to decreases in dividends. This suggests that
there is information content in dividend payments.
It is worthy of attention that the classical dividend signaling theory is
shaken again by the most recent two studies in this area. DeAngelo,
DeAngelo, and Skinner (1996) study the signaling content of managers
dividend decisions for 145 NYSE firms whose annual earnings decline after
nine or more consecutive years of growth. Using a variety of model
specifications and definitions of favorable dividend signals, the authors find
virtually no support for the notion that dividend decision help identify firms
with superior future earnings and conclude that dividends tend not to be
reliable informative signals.
Benartzi, Michaely and Thaler, (1997) investigate NYSE and AMEX firms
earnings and dividends, and find limited support for the view that changes
in dividends have information content about future earnings changes.
While there is a strong past and concurrent link between earnings and
dividend changes, the predictive value of changes in dividends seems
minimal. The only strong predictive power this study finds is that dividend
cuts reliably signal an increase in future earnings. There is some evidence
that dividend-increasing firms are less likely to have subsequent earnings
decreases than firms that do not change their dividend despite similar
earnings growth. The authors conclude that changes in dividends mostly
tell us something about what has happened. If there is any information

content in dividends announcement, it is that the concurrent change in

earnings is permanent rather than transitory.

In New Zealand, the only study relating to dividend signaling theory is

Alexander & Blanchard (1992) working paper, which is a mail survey of
mangers attitudes towards dividend policy. By analyzing the responses to
the survey questions, the authors find that, in contrast to US financial
mangers who hold quite firmly to the idea that dividends provide a signal of
the firms future prospects, New Zealand financial mangers are at best
lukewarm to the notion.
In review of the literature, the issues with respect to the dividend signaling
become more fascinating and contradictory in corporate finance in recent
years. However, there is lack of a through empirical study in this area
based on New Zealand market. This study could make meaningful
contributions to the finance literature. Since the most recent conclusions in
this area are from Benartzi, Michaely and Thaler(1997) (BMT)s study , this
study is mainly following BMTs paper.
3 . Research Design and Data Requirements
3.1 Research Design
The main goal of this paper is to test the dividend-signaling hypothesis in
the context of New Zealand market. The traditional dividend-signaling
hypothesis is that changes in dividends convey information about the future
5

earnings of the firm. The information content implies the following two
predictions:
1. Firms that increase (decrease) dividends in year 0 will have positive
(negative) unexpected earnings in years 1, 2, etc.
2. Among firms that increase dividends, the larger the dividend increase,
the greater the unexpected earnings in the following years.
Thus, firstly, we will test the above two predictions by examining the
relationships between dividend changes in year 0 and earnings changes in
year 1, 2.
Secondly, since it is possible that dividend changes in year 0 are
responses to concurrent earnings or lagged responses to past earnings, we
will also examine the relationships between dividend changes in year 0 and
earnings changes in year 0, -1. The timing of the dividend change is further
considered to test this possibility, that is, we examine the relationships
between the earnings changes and interim dividend changes, and final
dividend changes respectively.
Thirdly, one alternative signaling hypothesis documented by previous
studies is that changes in dividends do tell us something: earnings are
unlikely to fall. That is, dividend increases signal that earnings have
increased permanently. To test this alternative hypothesis, we will compare
the earnings changes in year 1, 2 of the dividend increases groups with

that of respective no dividend changes groups which had similar earnings

growth in year 0.
To carry out the above researches, the model employed in this study to
calculate the unexpected earnings changes is random walk model.
Assuming earnings follow a random walk, the random-walk model takes
predicted earnings in year t as equal to the firms earnings in year t-1. All
earnings figures are standardized by the book value of shareholders equity
in Year 0. Thus, the formula to measure the unexpected earning changes
is:
UEi,t = (Ei,t - Ei,t-1 )/BVi,0
Where UEi,t is the unexpected earnings of firm-year i in year t, Ei,t is its
earnings in year t, and BVi,0 is the book value of equity for firm i in year 0.
The model of measuring the dividend changes is:
Divi,0 = (Divi,0 - Divi,-1 )/ Divi,-1
Where Divi,0 is the dividend in year 0 for firm

i,-1

is the dividend

in year 1.
3.2 Data
The research design determines our data requirements. Basically, we need
both dividend data and earnings data for a number of years. In addition,
we need book value of equity data to standardize the earnings. The target
sample of this study was all 137 publicly listed firms on NZSE. The sample
period used in this study is from 1991-1997. The data is obtained from two
sources:
7

1. 1992-1996 dividend and earnings data are collected from the Datex
service.
2. 1991 and 1997 earnings of sample firms are collected from their the
annual reports.
To remain in the sample, a firm must meet the following selection criteria:
1. It must pay dividends in at least two consecutive years. (we need two
years of dividend payments to calculate the changes in dividends)
2. It must have at least five years annual net profit before extraordinary
items information around the dividend payment year (years 2 through
+2). We use net profit before extraordinary items as earnings to
eliminate the transitory components of income.
This criteria drastically reduced number of firms that were to be included,
leaving only 51 out of 137 firms for the sample. Two additional years
earnings information from the firms annual reports provides us more
observations. Thus, the resulting sample contains 51 firms and 138 firmyear observations (Henceforth we refer to this as the main sample).
3.3 Limitations
The principal limitation of the data set is that it suffers from survivorship
bias, as the main information source of our study is the Datex, which only
includes the firms that are currently listed on the New Zealand Stock
Exchange. The relationships between dividend changes and earnings
8

changes for de-listed firms may be different from that for the survived firms.
The exclusion of de-listed firms may affect our analysis.
Another limitation of this study is that the sample size of 51 firms is
relatively small. Although the firm-year observations become 138 by
extending the observation period, while the observations are subdivided
into comparable groups, for some groups the number of observations are
not large.
4. Earnings Changes and Dividend Changes
To investigate the relationships between dividend changes and earnings
changes, the first step we calculate the dividend changes for each firm-year
in our sample. Here, annual dividend is the sum of interim and final
dividend in each year. We then divide the sample into five groups
according to the dividend change: Firm-year events experiencing a
dividend increases are divided into three groups according to the
magnitude of the dividend changes: low increases, medium increases and
high increases group. The low increases group are the firms which
increased their dividend less than 15%; the medium increases group are
the firms increased their dividend greater than or equal to 15% but less
than 50%; the high increases group are the firms increased their dividend
equal to or more than 50%. The other two groups are all the dividenddecreasing firms and all the dividend-no-change firms.

Using the defined random-walk model, we then calculate the unexpected

earnings changes for the past year (year-1), the current calendar year (year
0) and the two subsequent years (years 1 and 2) for each firm-year.
Table 1 reports the mean and t-value of the unexpected earnings of each
categorized group across firm-years. The t-statistics we calculate are
based on the difference in the mean unexpected earnings between the
group of stocks that did not change their dividends in year 0, and those
groups of stocks did change their dividends (dividend-increasing groups
and dividend-decreasing group).
TABLE 1 Earning Changes and Dividend Changes
Year -1

Year 0

Year 1

Year 2

Mean
Number of
Dividend Changes dividend
observations
change

Mean

t-value

Decreases

-0.18

26

2.29

-0.20

No changes

0.00

25

2.57

Increases:low

0.10

30

2.23

-0.30

1.60

1.93*

1.02

1.15

-0.32

-0.23

Increases:medium

0.28

29

4.51

0.56

3.31

2.73*

1.38

1.03

-0.58

-0.37

Increases:high

1.99

28

4.96

1.65

6.48

4.30*

1.73

0.91

-0.94

-0.44

Increases:all

0.76

87

3.81

1.05

3.74

3.20*

1.37

1.04

-0.60

-0.41

Mean t-value

Mean

t-value

Mean

t-value

-1.17

2.38

1.69*

1.97

0.76

-0.85

0.05

-0.15

-0.03

* Significantly different from the no-change group at the 0.10 level using a two-tailed Student's t-test for the
mean.

First, we look at the results for year 0. For the firms that chose not to
change dividends that year, earnings are flat; the mean change is 0.05%.
(Recall that we scale earnings by year 0 book value, so these numbers are
essentially return on book value of equity, in percent). For the firms cut
dividends experience a drop in earnings in year 0, down by -1.17%, but not
significantly different from no-change group. In comparison, firms that
10

increase dividends do quite well, average experience significant 3.74%

earnings increasing. Furthermore, the larger the increase in the dividend,
the better they do. For the firms with the highest dividend increases,
earnings in year 0 jump by 6.48%. It is clear from this first analysis that
relation between dividend increases and concurrent earnings is very
strong.
However, the picture for years 1 and 2 is quite different. None of the
groups of increasing dividends firms shows significantly faster earnings
growth than no-change group. Conversely, in year 2, each dividendincreasing group shows a decline of earnings, though not significantly
different from that of no-change group. It is interesting that, consistent with
BMT s findings, we also find the firms that cut dividends have anomalous
earnings in year 1: the mean earnings changes are significantly positive.
Since it is possible that dividend changes in year 0 are lagged responses to
the past year earnings, we also look at the earnings changes in year 1. In
fact, there are no significant differences of earnings changes between
dividend-decreasing group, dividend-increasing groups and no-dividendchange group. This suggests that there is no obvious linkage between the
past earnings and current year dividend decisions.
In summary, contrary to the predictions implied by dividend-signaling
hypothesis, our results so far show that the dividend increasing firms have
no obvious pattern of unexpected earnings in years 1 and 2, and there is
no hint of a positive relationship between the magnitude of a dividend
11

increase and future unexpected earnings. Consistent with BMTs findings,

there is a strong link between concurrent earnings and dividend increases.
If there is a signal, cutting dividend signal a strong growth in the following
year. Different from BMTs findings, we can not find there is a positive link
between the current dividend decisions and the past year earnings.
Another different point is that even for concurrent earnings changes, the
difference between dividend-decreasing firms and no-change firms in our
findings is not obvious.
5. Earnings Changes and the Timing of the Dividend Changes
So far what we have seen is that dividend changes are strongly correlated
with concurrent earnings changes. To further investigate this relationship
between dividend changes and concurrent earning changes, we examine
interim dividend decisions and final dividend decisions respectively. In New
Zealand, a firms final dividend decision usually follows its the concurrent
annual report. So if the conjecture that earnings lead dividend is true,
comparing with the interim dividend decisions, there should be a stronger
association between current earnings and the final dividend changes.
Using the same methodology with the last section, we categorize the
sample according to interim dividend changes and final dividend changes
respectively.

Where

the

interim(final)

dividend

changes

are

the

interim(final) dividends in year 0 minus the interim(final) dividends in year

1, then divided by the interim(final) dividends in year 1. Table 2 reports the
relationship between earnings changes and the timing of the dividend

12

Change. The results for interim dividend changes and final dividend appear
respectively in Panel A and Panel B.
TABLE 2 Earning Changes and the Timing of Dividend Change
Year -1
Mean
Number of
dividend
Dividend Changes
observations
change

Mean

t-value

Year 0

Year 1

Mean t-value

Year 2

Mean

t-value

Mean

t-value

1.99

1.41

-0.40

-1.16

Panel A: Earnings Changes for Interim Dividend Changes

Decreases

-0.55

22

2.93

0.41

0.13

0.20

No changes

0.00

30

2.30

Increases:low

0.11

17

2.08

-0.14

1.23

1.13

1.14

0.69

0.49

-0.87

Increases:medium

0.28

18

3.30

0.73

3.52

3.36*

1.72

1.10

-1.22

1.76*

Increases:high

2.76

11

4.60

1.32

5.26

3.02*

1.25

0.59

0.80

-0.55

Increases:all

0.77

46

3.12

0.81

3.05

3.13*

1.39

1.07

-0.12

1.74*

1.68

1.29

1.99

0.45

-0.13

0.19

2.23

Panel B: Earnings Changes for Final Dividend Changes

Decreases

-0.35

31

3.74

1.37

-0.18

-0.16

No changes

0.00

34

1.98

Increases:all

0.53

73

4.55

2.12*

4.22

4.37*

1.37

1.19

-1.02

1.59

Increases:low

0.10

27

3.86

1.16

2.34

2.28*

0.75

0.68

-0.80

-1.50

Increases:medium

0.30

25

3.07

0.84

3.59

3.89*

2.17

1.52

-1.24

-1.47

Increases:high

1.37

21

7.12

3.33*

7.29

5.50*

1.22

0.67

-1.08

-1.06

Increases:all

0.53

73

4.55

2.12*

4.22

4.37*

1.37

1.19

-1.02

1.59

0.02

-0.24

1.02

* Significantly different from the no-change group at the 0.10 level using a two-tailed Student's t-test for the
mean.

Looking at the figures of years 1 and 2 in both Panels, the results reinforce
the view that dividend changes contain little information about future
earnings.
For concurrent (year 0) earnings, we have two important findings: 1.
Comparing to the results for annual dividend decisions in Table 1, the
13

significant difference of earnings changes between low-dividend-increasing

group and no-dividend-change group disappeared. This suggests that the
links between concurrent earnings and interim dividend decisions are
relatively weak. 2. Comparing to interim dividend changes, the correlation
between final dividend changes and current earnings become stronger. For
example, the mean change in year 0 earnings for the low-dividend
increasing group in Panel A is 1.23%, in Panel B become 2.34%; for the
high-dividend increasing group in Panel A is 5.26%, in Panel B become
7.29%. These findings confirm that earnings lead dividend, not vice versa.
In addition, examining the number of observations, there are only 46 of 138
(33%) observations increasing interim dividends. There are 87 of 138
(63%) firms-year increasing annual dividends. It seems that, before
knowing exactly the annual profits of the firms, to dividend decisions most
mangers are very cautious.
6. Stability of Earnings and Dividend Changes
Since we have found little evidence to support the notion that changes in
dividends signal the future, the question becomes do changes in dividends
signal something about the present? One alternative signaling hypothesis
documented by previous studies (e.g. Lintner, 1956; Fama and Babiak,
1968) is that changes in dividends do tell us something: earnings are
unlikely to fall. That is, dividend increases signal that earnings have
increased permanently.

BMT also find some evidence to support this

argument.

14

To investigate if dividend increases signal that earnings have increased

permanently, following BMTs approach, we compare firms that have
changed their dividend to other firms that left their dividends unchanged but
experienced the same rate of earnings in year 0. According to the above
hypothesis, we expect, in years 1 and 2, the earnings of the firms that
increased their dividend will not fall and the earnings of the firms that left
their dividends unchanged could decline, and this difference should be
significant.
To forming comparable groups, we subdivide the no-dividend-change firms
according to the earnings change in year 0 into four groups: Firms
experiencing losses in year 0, firms experiencing gains but low growth,
medium growth and high growth in year 0.

The three growth groups are

categorized based on the mean of the respective dividend change groups.

For example, the medium growth group are those firms which experienced
a year 0 earning change that is around (about 1 percentage point from)
the mean earnings change of the respective medium-dividend-increase
group.
We also use random walk model to calculate every year earnings changes.
The results appear in Table 3.
The results show that, while firms that have increased dividends have
earnings growth in year 1, the comparison firms that had similar earnings
increases in year 0 and no change in dividends experience smaller
earnings growth. However, the difference is not significant for each group.
15

Conversely, in year 2 the firms that did not change dividend have better
growth than the comparison dividend-increasing firms. Again, the difference
is not significant for each group.
TABLE 3 Stability of Earnings and Dividend Changes
Year 0
Dividend Changes
Decreases

Mean
Number of
dividend
observations
change
-0.18
26

Year 1

Year 2

Mean

t-value

Mean

t-value

Mean

t-value

-1.17

-0.85

2.38

1.69*

1.97

0.76

No changes:losses

0.00

-4.34

-0.93

-2.67

No changes:gains L

0.00

14

0.94

0.32

0.76

No changes:gains M

0.00

3.20

0.89

0.72

No changes:gains H

0.00

No changes:all

0.00

25

0.05

-0.15

-0.03

Increases:low

0.10

30

1.60

1.02

0.62

-0.32

-0.87

Increases:medium

0.28

29

3.31

1.38

0.12

-0.58

-0.41

Increases:high

1.99

28

6.48

1.73

Increases:all

0.76

87

3.74

3.20*

1.37

-0.94
1.04

-0.60

-0.41

* Significantly different from the respective no-change group at the 0.10 level using a two-tailed t-test
for the mean.

Although consistent with our expectation, on average the earnings of

dividend increasing firms do not fall in years 1 and 2, but the result that the
earnings of the respective no-dividend-change firms also do not decline is
not what we expected. Furthermore, the difference of earnings changes
between these two types of firms is not significant in every case. This
suggests that dividend increases do not signal special things.

Thus we

can not accept the hypothesis that changes in dividends signal something
about the present.

16

7. Discussion and Conclusions

In this study, we have undertaken a series of tests to examine the classical
dividend-signaling hypothesis in the context of New Zealand market, and
attempt to discover whether changes in dividends signal something.
Consistent with the findings of Benartzi, Michaely and Thaler, (1997)
(BMT), we can not find any evidence to support the notion that changes in
dividends have information content about the future earnings changes.
There is a strong concurrent link between earnings changes and dividend
changes.
However, Contrary to the findings of BMT, we have following different
findings:
1. There is no obvious linkage between the past earnings and current year

dividend decisions. Similar to DeAngelo, DeAngelo and Skinner

(1996)s conjecture, this suggests that that dividend increases are not
lagged responses to the past earnings.
2.

We are unable to find that dividend increases have something to do

with the present. The dividend increases can not differentiate the
permanent growth firms from the temporary growth firms.

3. There is no significant difference of concurrent earnings changes

between dividend-decreasing firms and no-dividend-change firms.

Thus the conclusion we draw from our findings is that the dividend changes
only reflect concurrent earnings changes, they have little thing to do with
the past, the future, and the stability of the present. This conclusion is
consistent with Alexander & Blanchard (1992) s survey, they find New
17

Zealand financial mangers are at best lukewarm to the signal notion. Our
conclusion is also consistent with the logic in the reality. If firms choose to
pay out cash flow to the shareholders by dividends, firms earn higher
profits, then it is natural for the firms to pay higher dividend at that year;
Firms earn less profits, pay less or do not change dividend at that year.
According to this conjecture, we can explain the three different findings we
get. Firstly, if firms had good earnings in the past year, the last year
dividend payments already reflected the good profits of the firms. It is not
necessary for mangers to use the next year dividend to respond the former
year profits. Secondly, Since the dividend only reflects the cash flow of the
firms in current year, it can not help to explain the future. The future
earnings are growing, falling or constant have no relation with the previous
year dividend payments. In this sense, changes in dividends can not
differentiate the permanent growth firms from the temporary growth
firms. If there is something in the current year correlated with the future
earnings, it is the current earnings (e.g. Forlong & Vos, 1997) rather than
the current dividend, because the causality is that earnings lead dividend
not vice versa. Thirdly, For one or another reason, companies do not like to
cut a dividend, even if the firms had a downturn in a year, most mangers of
the firms may choose to keep dividend unchanged rather than cutting the
dividend. So in our findings, we are unable to find significant difference of
concurrent earnings change between dividend-unchanged firms and
dividend-decreasing firms.
The contributions of this paper are not only confirming the previous studies
but also have further devoted some new findings to the finance literature.
18

This paper is the first time using empirical tests to examine the dividend
signal notion based on New Zealand market. The results have important
implications for New Zealand investors. For investors whether the dividend
decisions by mangers convey positive information or not are essential.

Further research is needed to determine whether dividend initials and

omissions have information content about the future earnings in the context
of New Zealand market.

19

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Bhattacharya, S. (1979). Imperfect information, dividend policy, and the

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