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Firm Size and Dividend Announcement Effect
Abstract
This paper examines the impact of firm size on market reaction to unexpected dividend changes. The empirical results indicate, after controlling for the magnitude of dividend changes, a negative relationship exists between firm size and the extent of abnormal returns around the dividend announcement date. The results are consistent with Miller and Rock's [14] position that the dividend announcement effect varies across firms with different degrees of information asymmetry.
... . Some authors found a negative relationship between firm size and abnormal returns around the dividend announcement date [Eddy and Seifert (1988), Haw and Kim (1991) and Mitra and Owers (1995), among others]. Ghosh and Woolridge (1988) concluded that the most significant factors are the percentage change of dividends, the firm's size and the share performance before the announcement date. ...
... Several authors have documented a relationship between market share price reaction to dividend change announcements and firm-specific factors, such as Asquith and Mullins (1983), Ghosh and Woolridge (1988), Eddy and Seifert (1988), Haw and Kim (1991), Mitra and Owers (1995) and Healy, Hathorn and Kirch (1997). Asquith and Mullins (1983) found that market reaction to dividend announcements depends on the magnitude of the dividend payment. ...
... Ghosh and Woolridge (1988) concluded that, for firms that omit or cut dividends, the most significant firm specific factors that influence this relationship are the percentage change in dividend, the firms' size, the share performance before the announcement date and the negative information released before the dividend change. Eddy and Seifert (1988) and Haw and Kim (1991) found a negative relation between firm size and abnormal returns for firms that increase dividends and Mitra and Owers (1995) found a similar relation for firms that initiate dividends. These results are consistent with Miller and Rock's (1985) position that the dividend announcement effect varies across firms with different degrees of information asymmetry. ...
According the dividend signalling hypothesis, it is expected a positive relationship between dividend change announcements and the subsequent share price reactions. However, empirical results are not consensual. This study investigates whether firm-specific factors contribute to explain a negative market reaction to dividend change announcements, contributing to the scarce analysis of firm-specific factors explaining the inverse share price reaction to dividend change announcements. The study applies the panel data approach to three European markets. The results show that the market reaction to dividend change announcements is negatively associated with the firm size. We find that the negative market reaction to dividend increase announcements is associated with firms that have, on average, lower dividend changes and higher growth opportunities. Moreover, the results suggest that a high percentage of dividend negative changes, decreases the likelihood that the market reacts positively to a dividend decrease announcement. Globally, we find some evidence for the dividend signalling hypothesis.
... . Some authors found a negative relationship between firm size and abnormal returns around the dividend announcement date [Eddy and Seifert (1988), Haw and Kim (1991) and Mitra and Owers (1995), among others]. Ghosh and Woolridge (1988) concluded that the most significant factors are the percentage change of dividends, the firm's size and the share performance before the announcement date. ...
... In contrast with prior studies [Haw and Kim (1991), Ghosh and Woolridge (1988) and Mitra and Owers (1995)], we did not find a significant relationship between firm size and the cumulative abnormal returns for both the Portuguese and the French markets. ...
... To do so, we will relate the firm specific factors to the market share price reaction around the dividend change announcements date to evaluate whether the firm-specific factors can influence the market reaction in the dividend announcement period. Several authors have documented a relationship between market share price reaction to dividend change announcements and firm-specific factors, such as Asquith and Mullins (1983), Ghosh and Woolridge (1988), Eddy and Seifert (1988), Haw and Kim (1991), Mitra and Owers (1995) and Healy, Hathorn and Kirch (1997). Asquith and Mullins (1983) found that market reaction to dividend announcements depends on the magnitude of the dividend payment. ...
The dividend policy is one of the most debated topics in the finance literature. According to the dividend signalling hypothesis, which has motivated a significant amount of theoretical and empirical research, dividend change announcements trigger share returns because they convey information about management's assessment on firms' future prospects. Consequently, a dividend increase (decrease) should be followed by an improvement (reduction) in a firm's value. However, some studies have not supported the hypothesis of a positive relationship between dividend change announcements, and the subsequent share price reaction, such as the ones of Lang and Litzenberger (1989), Benartzi, Michaely and Thaler (1997), Chen, Firth and Gao (2002), Abeyratna and Power (2002) and Vieira (2005). Furthermore, some authors found evidence of a significant percentage of cases where share prices reactions are opposite to the dividend changes direction, like the works of Asquith and Mullins (1983), Benesh, Keown and Pinkerton (1984), Born, Mozer and Officer (1988), Dhillon and Johnson (1994) Healy, Hathorn and Kirch (1997), and, more recently, Vieira (2005). Consequently, we try to identify firm-specific factors that contribute in explaining the adverse market reaction to dividend change announcements. Globally, our evidence suggests that only for the UK sample we have firm-specific factors influencing the market reaction to dividend change announcements. We conclude that the UK firms with a negative market reaction to dividend increase announcements have, on average, higher size, lower earnings growth rate and lower debt to equity ratios.
... Interestingly, Haw and Kim (1991) linked the effect of the dividend change to the size of the company. Their study showed that a change in the dividend level had a more substantial impact on the listings of smaller companies, resulting from a greater asymmetry of information. ...
This paper aims to examine the impact of an unexpected change in the level of dividend caused by the coronavirus (COVID-19) pandemic on share prices on the Polish stock exchange. Our article analyses the period from 1 February 2020 to 5 June 2020, which was when companies listed on the primary market of the Warsaw Stock Exchange (WSE) published information about Boards of Directors’ dividend recommendations for 2019. The original group of companies included 140 firms. 56 companies (40%) fulfilled all the study criteria, and these were subsequently divided into 2 groups. The groups were defined by the recommendations on profit distribution. The first group consisting of 38 companies (68% of the surveyed) consisted of firms which unexpectedly announced plans to retain all profits in the company or a dividend payment but with a lower value than in the previous year (cancellation or reduction of the dividend amount). The second group of 18 companies (32% of the surveyed) comprised those which unexpectedly announced willingness to pay a dividend per share at a higher level (increase in dividend amount). The research confirmed that the announcement of a change in the level of the dividend or the cancellation of the payment of profit is essential price-creating information on the Polish securities market and has a significant impact on the share prices. In a situation of uncertainty caused by external factors, such as the coronavirus pandemic, the sensitivity of individual companies to lockdown and uncertainty as to the return to normality have a significant negative impact on the market. They cause a fall in the share prices higher than expected, especially when they are accompanied by a shortage of information from the companies and a recommendation to suspend or reduce dividend payment.
... The extent that informational asymmetry is greater for small firms than for large firms (Haw and Kim, 1991), the information content of dividend announcements will be greater for small firms. Therefore, we expect this coefficient to have a negative signal. ...
The aim of this research was to analyse, statistically significant, quantitative variables that determine the share price of oil and gas sector companies listed on the Nigerian Stock exchange, during the economic slowdown period of 2009–2013, after the world financial crisis of 2008, and investigate whether the signalling hypothesis holds or not. In terms of analytical tools, multiple regression analysis is used. During dividend increase announcements, the regression coefficient determinant (R2) indicates that over 90 per cent of variations in stock prices is explained by variations in dividend announcements. This study supports the dividend signalling hypothesis (DSH) but discredits the efficient market hypothesis. During a dividend decrease, the R2 for both equations indicates that over 64 per cent of variations in stock prices is explained by variations in dividend announcements. This result also supports the DSH. The implication of this is that racketeers can capitalise on this and make unjustified returns. By so doing, both sector investors and the stock market will be short changed. As this research considers only the oil and gas sector, further studies need to be conducted that consider possibly all listed firms in the Nigerian stock market, within the same interval to further investigate if the signalling hypothesis will hold or not. But most appropriately, applicable, as a comparative study of the same sector before and after the world financial crisis of 2008 the paper seeks to find out if this phenomenon is also applicable to OPEC member states. This research is in progress.
... Investors are informed differently and have differently valuable information (real information) so they react differently to new information which leads to significant turnover increase. According to Haw and Kim (1991), the change of dividend payoff rate has a greater impact on the perception of investor who owns stocks of smaller companies. The assumption is that information asymmetry is greater in smaller companies. ...
... With regard to control variables, the FS coefficient is negative and statistically significant, suggesting that the dividend payout ratio is negatively associated with firm size, which is in agreement with the results of Malkawi (2008). This negative relation might be associated with the fact that the informational asymmetry is greater for small firms than for large firms (Haw and Kim, 1991) and that smaller firms opt to use dividend announcements to convey information to the market. The results suggest that the payout is not driven by tax reasons (Miller and Scholes, 1982;Archbold and Vieira 2010). ...
This paper provides an analysis of the market reaction to dividend change announcements for publicly-traded, family-controlled firms. Family firms have a significantly lower proportion of independent directors than non-family firms, which is consistent with the idea that family members dominate the board of directors and that family shareholders are common in publicly-traded firms. The author analyzed 390 dividend change announcements in Portugal over the period from 1991 to 2010 using a panel data approach. The results show no evidence of a significant market reaction to dividend change announcements, providing no evidence in support of the dividend-signaling hypothesis in the context of family firms. This conclusion agrees with previous studies in which there was no distinction between family and non-family firms. Empirical results show that family firms engage in lower payouts than their non-family counterparts, giving some supports to the expropriation hypothesis. This finding may indicate that families expropriate the wealth of shareholders through lower dividends. This result is also consistent with the clientele theory of dividends.
... High values of BM ratio may indicate distress and low values may indicate high growth opportunities. To the extent that informational asymmetry is greater for small firms than for large firms [Haw and Kim (1991)], the information content of dividend announcements will be greater for small firms. Although large firms have higher media coverage and greater institutional ownership, the smaller firms have less information available in the market, so, when they announce dividend changes, it will generate greater market surprises that induce a larger reaction by the market. ...
Purpose: This paper examines the effect of investor sentiment on the market reaction to dividend change announcements.
Design/methodology/approach: We use the European Economic Sentiment Indicator data, from Directorate General for Economic and Financial Affairs (DG ECFIN), as a proxy for investor sentiment and focus on the market reaction to dividend change announcements, using panel data methodology.
Findings: Using data from three European markets, our results indicate that the investor sentiment has some influence on the market reaction to dividend change announcements, for two of the three analysed markets. Globally, we find no evidence of investor sentiment influencing the market reaction to dividend change announcements for the Portuguese market. However, we find evidence that the positive share price reaction to dividend increases enlarges with sentiment, in the case of the UK markets, whereas the negative share price reaction to dividend decreases reduces with sentiment, in the French market.
Research limitations/implications: We have no access to dividend forecasts, so, our findings are based on naïve dividend changes and not unexpected change dividends.
Originality/value: This paper offers some insights on the effect of investor sentiment on the market reaction to firms’ news, a strand of finance that is scarcely developed and contributes to the analysis of European markets that are in need of research. As the best of our knowledge, this is the first study to analyse the effect of investor sentiment on the market reaction to dividend news, in the context of European markets.
... Prior event studies indicate that larger firms have smaller abnormal returns (Haw & Kim, 1991;Im et al., 2001). Smaller firms and less profitable firms are likely to experience greater CAR from IT-based KM efforts for two reasons identified by Dehning et al. (2003). ...
The importance of knowledge management (KM) processes for organizational performance is now well recognized. Seeking to better understand the short-term impact of KM on firm value, this article focuses on public announcements of information technology (IT)-based KM efforts, and uses cumulative abnormal return (CAR) associated with an announcement as the dependent variable. This article employs a contingency approach, arguing that the KM announcement would have a positive short-term impact on firm value in some conditions but not in others. Thus, it pursues the following research question: What are the effects of contextual factors on the CAR associated with the announcement of an IT-based KM effort? Specific hypotheses are proposed based on information-processing theory, organizational learning theory, the knowledge-based theory of the firm, and the theory of knowledge creation. These hypotheses link CARs to alignment between industry innovativeness and the KM process, alignment between firm efficiency and the KM process, firm-specific instability, and firm diversification. The empirical study utilizes secondary data on 89 KM announcements from 1995 to 2002. The results largely support the hypotheses. Overall, this article provides empirical support for the theory-based arguments, and helps develop a contingency framework of the effectiveness of KM efforts.
... Atiase (1985) has observed that the amount of non-accounting information production and dissemination is an increasing function of the capitalised value of the firm. Several studies since then, including Eddy and Seifert (1988), Bhushan (1989) and Haw and Kim (1991) have concluded that firm size, represented by the amount of market capitalisation, may be proxying to its information environment. Similarly to Mitra and Owers (1995)[3], we use market capitalisation as a proxy for firm size. ...
Purpose
The purpose of this paper is to investigate the impact of dividend initiations on shareholders’ wealth using a sample of 38 Greek listed firms.
Design/methodology/approach
The event study methodology of Brown and Warner was employed to examine the share price reaction to initial dividend announcements across different information environments.
Findings
Results show that dividend initiations bring about significant positive abnormal returns in the announcement period. The price response to dividend initiations is inversely associated with the information environment. Finally, the volatility of stock returns is higher in the low information environment group of firms than in the high information environment group of firms.
Research limitations/implications
The observations are not many, although the whole population is included, since there are no data available prior to 2000.
Practical implications
These findings are useful to researchers, practitioners and investors who have an interest in firms listed on the Athens Stock Exchange (ASE) for their proper strategic decision making.
Originality/value
For the first time the stock price behaviour of firms listed on the ASE around dividend initiation announcement dates is examined.
The impact of dividend announcements on share price and trading volume: empirical evidence from the Gulf Cooperation Council (GCC) countries
Bu çalışmada Borsa İstanbul’a kayıtlı imalat sanayi ve finansal sektör şirketlerinde pay sahiplerine yapılan nakit temettü dağıtımlarının pay senedi üzerinde kısa dönemli fiyat etkisi yaratıp yaratmadığı 2006-2018 verileri ile olay etüdü yöntemi kullanılarak araştırılmıştır. Bu amaçla söz konusu dönemde gerçekleştirilen 1.307 adet temettü duyurusu için 3 günlük olay penceresinde normalüstü getiriler analiz edilmiştir. Bir önceki yıla göre temettü artış duyurularında pozitif, azalış duyurularında negatif normalüstü getiriler görülmüştür. Benzer şekilde yüksek temettü verimine sahip duyurularda pozitif, düşük temettü verimine sahip duyurlarda negatif normalüstü getiriler elde edilmiştir. Ayrıca yapılan panel regresyon analizi sonucunda, olay penceresindeki normalüstü getiri ile temettü verimi/temettü değişimi değişkenleri arasında pozitif yönlü doğrusal ilişki tespit edilmiştir. Bu ilişki imalat sanayi sektöründe büyük ve küçük ölçekli tüm şirketler için finansal sektörde ise büyük ölçekli şirketler için geçerlidir. Ayrıca büyük şirketlerde küçük şirketlere göre, imalat sanayi şirketlerinde finansal şirketlere göre bulgular daha güçlüdür. Elde edilen bu bulgular hem imalat sanayi hem de finansal sektörde Borsa İstanbul şirketleri için temettü duyurularının pozitif fiyat etkisini doğrulamaktadır.
Abstract
Purpose-The purpose of this paper is to investigate the stock market response to dividend announcements in high growth emerging markets of Gulf countries.
Design/methodology/approach-The sample includes 1,092 dividend announcements from 299 listed firms over the period 2010-2015.
Findings-In the environment where there is an absence of capital gain and income tax, the authors find some evidence for the stock price reaction that partly supports the signaling hypothesis. The findings show that the Gulf Cooperation Council (GCC) market is inefficient because of the leakage information before the announcement in bad news, and the delay of share price adjustment in good news. In addition, the authors report significant trading volume (TV) reaction in all the three announcements clusters, where dividends increase, decrease, and are constant, lending support to the hypothesis that the dividend change announcements have an impact on the TV response due to different investors' preferences. Originality/value-This is the first empirical paper on market reaction in share price and TV around dividend announcement using data for the majority of GCC countries.
Purpose
This paper investigates the stock market response to dividend announcements in high growth emerging markets of Gulf countries.
Design/methodology/approach
Our sample includes 1092 dividend announcements from 299 listed firms over the period 2010 - 2015.
Findings
In the environment where there is an absence of capital gain and income tax, we find some evidence for the stock price reaction that partly supports the signaling hypothesis. Our findings show that the GCC market is inefficient because of the leakage information before the announcement in bad news, and the delay of share price adjustment in good news. In addition, we report significant trading volume reaction in all the three announcements clusters, where dividends increase, decrease, and are constant, lending support to the hypothesis that the dividend change announcements have an impact on the trading volume response due to different investors’ preferences.
Originality/value
This is the first empirical paper on market reaction in share price and trading volume around dividend announcement using data for the majority of GCC countries.
This chapter investigates the relationship between financial measures and dividend payout policy choices of firms. We examine why firms choose to pay dividends continuously, intermittently, or not pay them. Specifically, the findings provide evidence that firms with relatively larger debts tend to pay dividends less frequently than firms with smaller debts.
The results also suggest that good financial performers are more likely to pay dividends more regularly. Additionally, the results of this study indicate that highly leveraged firms tend to make less frequent payouts than lowly leveraged firms.
Overall, this research adds to our understanding of firms’ dividend payout policy choices. First, evidence on the relationship between the various types of financial measures and firms’ choice of dividend payout frequencies should be useful to investors. Second, the findings of this study provide financial statement users with useful information about the firm’s dividend payout patterns. Third, in general, it also adds to the accounting and finance literature on dividends.
(Abstract) In this paper, we investigate how information risk can influence market reaction to dividend changes, and how information risk can influence the management's dividend strategy. Taking into account all possible situations when firms disclose different information to the market through dividend changes, we find confirmative results to support dividend signaling theory: (1) for high information risk firms, market reacts more (both positively and negatively) to dividend changes information; and (2) for high information risk firms, management choose to use larger scale of dividend changes to signal information. In sum, information risk can explain cross-sectional variations of dividend signaling roles across firms.
We investigate if market participants' reactions to dividend changes are related to “earnings quality,” defined as the extent to which a firm's past earnings are associated with its future cash flows. Consistent with predictions from analytical work (Holthausen and Verrecchia [1988]; Kim and Verrecchia [1991]), we find that, controlling for the firm's dividend change, information environment, investment opportunity set, operating risk, and dividend clienteles, the market reacts less to dividend increase announcements from firms with greater earnings quality. Controlling for the firm's dividend change, information environment, and the release of other information around the dividend declaration date, we also document that analyst forecast revisions are significantly lower for firms with higher earnings quality following dividend increases. In both the market reaction and analyst forecast revision tests, our results for dividend decreases are generally not statistically significant.
According to the dividend signalling hypothesis, dividend change announcements trigger share returns because they convey information about management's assessment on firms' future prospects. We analyse the classical assumptions of the dividend signalling hypothesis, using data from three European countries. The evidence gives no support to a positive relation between dividend change announcements and the market reaction for French firms, and only weak support for the Portuguese and UK firms. After accounting for non-linearity in the mean reversion process, the global results do not give support to the assumption that dividend change announcements are positively related with future earnings changes. We also formulate two hypotheses in order to explore the window dressing phenomenon and the maturity hypothesis, finding some evidence in favour of both, especially in the UK market.
This paper examines investors’ reactions to dividend reductions or omissions conditional on past earnings and dividend patterns for a sample of 82 U.S. firms that incurred an annual loss during the period 1986-2003. We document that the market reaction for firms with long patterns of past earnings and dividend payouts is significantly more negative than for firms with less-established past earnings and dividends records. Our results can be explained by the following line of reasoning. First, consistent with DeAngelo, DeAngelo, and Skinner (1992), a loss following a long stream of earnings and dividend payments represents an unreliable indicator of future earnings. Thus, established firms have higher loss reliability than less-established firms. Second, because current earnings and dividend policy are a substitute source of means of forecasting future earnings, lower loss reliability increases the information content of dividend reductions. Therefore, given the presence of a loss, the longer the stream of prior earnings and dividend payments, (1) the lower the loss reliability and (2) the more reliably dividend cuts are perceived as an indication that earnings difficulties will persist in the future.
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.
Purpose
The purpose of this paper is to examine the factors affecting the relationships between CEO stock option compensation and earnings management. Design/methodology/approach – Regression of CEO stock option compensation and other factors on measures of discretionary accruals. Findings – A positive relationship between CEO stock option compensation and discretionary accruals was found, implying that earnings management is more likely where stock options are a larger part of CEO compensation. Earnings management is found to be moderated in large firms with stock option compensation and the relationship between stock options and earnings management has intensified in recent years. It was also found that stock options exacerbate earnings management in firms with growth opportunities. Research limitations/implications – Beyond the scope of this paper, these findings raise the following questions: What does the evidence of a size effect mean? Does it reflect information asymmetry, governance, external monitoring, or political risk? Why has the stock option effect on earnings management become more pronounced in recent years? Is it possible to mitigate the negative effects of option compensation on earnings management through the presence of stronger governance structures? Is it possible to mitigate the negative effects of option compensation on earnings management through the presence stronger governance structures? There are implications for compensation policies for corporate executives. Originality/value – This paper extends prior research on the relationship between CEO stock option compensation and earnings management. It provides new insight into the factors affecting this relationship.
This paper proposes that corporate private information is transmitted to the market in two complementary phases. The accounting information is released first, followed by a dividend change announcement. Hence, investors assess the dividend signal only after consideration of accounting information. The analysis suggests that the dividend signal has three components: the expected favourableness of a dividend signal (good, bad, or ambiguous), the direction of dividend change (+ or -) and the role of the dividend signal (confirmatory, clarificatory or unclear) in clearing corporate uncertainty. The mechanism of classifying the signal according to the three components is presented and tested. Consistent with the dividend literature, dividend change announcements are found to influence share prices. Also, the role of dividend signals has a distinguishable effect on the firm's share price. Nevertheless, the expected favourableness of a dividend signal emerges as the dominant factor among the three signalling components.
This paper uses cointegration and causality tests to study the temporal behavior of dividends and earnings at the individual firm level. We find that, for a sample of 143 non-utility firms, approximately one-fifth of the firms exhibits a temporal relationship between dividends and earnings that is consistent with the information signaling hypothesis of dividends. In the case of 72 utilities, about a third exhibit dividend policies that are consistent with the signaling notion of dividends. Further examination of firm characteristic differences between signaling and non-signaling firms shows that, in the case of non-utility firms, signaling firms tend to be smaller, have a lower growth rate of total assets, and have a higher leverage ratio. In the case of utilities, we find no major differences in firm characteristics between signaling and non-signaling firms. Copyright Blackwell Publishers Ltd, 2002.
This study examines, month-by-month, the empirical relation between abnormal returns and market value of NYSE and AMEX common stocks. Evidence is provided that daily abnormal return distributions in January have large means relative to the remaining eleven months, and that the relation between abnormal returns and size is always negative and more pronounced in January than in any other month — even in years when, on average, large firms earn larger risk-adjusted returns than small firms. In particular, nearly fifty percent of the average magnitude of the ‘size effect’ over the period 1963–1979 is due to January abnormal returns. Further, more than fifty percent of the January premium is attributable to large abnormal returns during the first week of trading in the year, particularly on the first trading day.
This is the second part of a study about common stock returns around split events (Part I) and dividend change events (Part II) as revealed in the 1947–1967 experience of the New York Stock Exchange (NYSE). Part I is the subject of a companion article in this issue of the Journal. The evidence about splitting stocks was found in many ways consistent with the efficient capital markets hypothesis, slightly method-dependent and time-dependent to an appreciable degree. By contrast, the results from Part II presented below point to persistent inefficiencies in the market. In almost any way one looks at the stocks' residuals in the months following the selected dividend changes, decreases in particular, they turn out abnormally large. The interpretation is advanced that, on the average, the NYSE under-reacts when dividend changes are announced. The possibility is also recognized that unexplored basic problems with the residual approach could account for the abnormal results.
This paper examines common stock returns and dividend and earnings patterns surrounding specially designated dividends labeled by management as ‘extra’, ‘special’ or ‘year-end’ and compares them to those surrounding regular (unlabeled) dividend increases. The results support the notion that management uses the labeling of dividend increases to convey information to the market about the future potential of the firm. Unlabeled increases appear to contain the most positive information. Contrary to the sometimes suggested view, specially designated dividends appear to convey positive information about future dividends and earnings beyond that relating to the current period.
Nonsynchronous trading of securities introduces into the market model a potentially serious econometric problem of errors in variables. In this paper properties of the observed market model and associated ordinary least squares estimators are developed in detail. In addition, computationally convenient, consistent estimators for parameters of the market model are calculated and then applied to daily returns of securities listed in the NYSE and ASE.
Existence conditions for signaling equilibria in which the signal is not exogenously costly are derived for the continuum
of classes case. Applications to labor market models based on productivity quotas and time-profiles of wages, and an exploratory
model of the “information content” of corporate dividends are discussed. The last application focuses on intertemporal consistency
requirements and the role of insider trading observations.
This paper assumes that outside investors have imperfect information about firms' profitability and that cash dividends are taxed at a higher rate than capital gains. It is shown that under these conditions, such dividends function as a signal of expected cash flows. By structuring the model so that finite-lived investors turn over continuing projects to succeeding generations of investors, we derive a comparative static result that relates the equilibrium level of dividend payout to the length of investors' planning horizons.
This analysis suggests a relationship between the rapidity of price adjustments to information and the accuracy or reliability of the information, as it is perceived by investors. To understand this relationship, we construct a competitive two-person trading game in which investors use an equilibrium strategy to determine their level of investment in information processing. Then, we relate this equilibrium level to the rapidity of price adjustments. The relationship is subtle, however, and in different circumstances the rapidity of price adjustments may increase or decrease as the level of accuracy or reliability of the information changes. In a final section, we argue that aspects of our analysis may be useful for providing a positive theory for the rapidity of price adjustments in a securities market.
This study examines the empirical relationship between the return and the total market value of NYSE common stocks. It is found that smaller firms have had higher risk adjusted returns, on average, than larger firms. This ‘size effect’ has been in existence for at least forty years and is evidence that the capital asset pricing model is misspecified. The size effect is not linear in the market value; the main effect occurs for very small firms while there is little difference in return between average sized and large firms. It is not known whether size per se is responsible for the effect or whether size is just a proxy for one or more true unknown factors correlated with size.
This study documents empirical anomalies which suggest that either the simple one-period capital asset pricing model (CAPM) is misspecified or that capital markets are inefficient. In particular, portfolios based on firm size or earnings/price (E/P) ratios experience average returns systematically different from those predicted by the CAPM. Furthermore, the ‘abnormal’ returns persist for at least two years. This persistence reduces the likelihood that these results are being generated by a market inefficiency. Rather, the evidence seems to indicate that the equilibrium pricing model is misspecified. However, the data also reveals that an E/P effect does not emerge after returns are controlled for the firm size effect; the firm size effect largely subsumes the E/P effect. Thus, while the E/P anomaly and value anomaly exist when each variable is considered separately, the two anomalies seem to be related to the same set of missing factors, and these factors appear to be more closely associated with firm size than E/P ratios.
A signalling equilibrium with taxable dividends is identified. In this equilibrium, corporate insiders with more valuable private information optimally distribute larger dividends and receive higher prices for their stock whenever the demand for cash by both their firm and its current stockholders exceeds its internal supply of cash. In equilibrium, many firms distribute dividends and simultaneously issue new stock, while other firms pay no dividends. Because dividends reveal all private information not conveyed by corporate audits, current stockholders capture in equilibrium all economic rents net of dissipative signalling costs. Both the announcement effect and the relationship between dividends and cum-dividend market values are derived explicitly.
We extend the standard finance model of the firm's dividend/investment/financing decisions by allowing the firm's managers to know more than outside investors about the true state of the firm's current earnings. The extension endogenizes the dividend (and financing) announcement effects amply documented in recent research. But once trading of shares is admitted to the model along with asymmetric information, the familiar Fisherian criterion for optimal investment becomes time inconsistent: the market's belief that the firm is following the Fisher rule creates incentives to violate the rule.
We show that an informationally consistent signalling equilibrium exists under asymmetric information and the trading of shares that restores the time consistency of investment policy, but leads in general to lower levels of investment than the optimum achievable under full information and/or no trading. Contractual provisions that change the information asymmetry or the possibility of profiting from it could eliminate both the time inconsistency and the inefficiency in investment policies, but these contractual provisions too are likely to involve dead-weight costs. Establishing which route or combination of routes serves in practice to maintain consistency remains for future research.
Empirical research indicates that small firms earn higher average rates of return than large firms, even after accounting for beta risk. Roll conjectured that the small firm effect might be attributed to improper estimation of security betas. The evidence shows that while the direction of the bias in beta estimation is consistent with Roll's conjecture, the magnitude of the bias appears to be too small to explain the firm size effect.
Recent empirical studies have found that small listed firms yield higher average returns than large firms even when their riskiness is equal. The riskiness of small firms, however, has been improperly measured. Apparently, the error is due to auto‐correlation in portfolio returns caused by infrequent trading. Other anomalous predictors of risk‐adjusted returns, such as price/earnings ratios and dividend yields, may also derive some of their apparent power from this spurious source.
Lecturer, Graduate School of Business Administration, Tel Aviv University, Israel, and Visiting Assistant Professor, North Carolina State University at Raleigh, and the Jerusalem School of Business Administration, The Hebrew University, and the Bank of Israel, Jerusalem, Israel, respectively. The authors thank Professor Yoram Peles of the Jerusalem School of Business Administration and an anonymous referee for helpful comments. Any remaining errors are, of course, ours. We also thank Dr. Dan Palmon of New York University for providing some data and Ms. Harriet McLaughlin of North Carolina State University for very extensive programming computations.
“The Rapidity of Price Adjustments to Information,”
- R E Verrechia