Is 'no-dividend news' good news? CBE research provides answers

A study co-authored by Dr Jo Drienko from The Australian National University (ANU) College of Business and Economics (CBE) explores ‘dividend hibernation’: a fixed payout policy that contributes to an increase in unexpected future earnings.

Dividends, a portion of a company’s profit periodically paid to shareholders, are known to send out a powerful message about the financial prospects of an organisation. Experts commonly refer to this form of market communication as ‘signalling’.

Over half a century ago, economist and Noble Prize winner Merton Miller made a groundbreaking argument: dividends are not directly responsible for moving stock prices; rather, it is their ability to signal information about future earnings that does.

This revelation laid the foundations of a theory that, 65 years later, is helping Jo explain his research.

“Dividend signalling posits that dividend increases are an indication of positive prospects for the firm. When corporate managers expect greater profitability within their companies, they are more likely to provide such a signal, committing to higher dividend payments,” says Jo.

But what happens if a company decides to leave its dividend payout unchanged for extended periods of time? What do they signal in that case?

When companies decide to keep dividends fixed for two consecutive quarters or more, they enter what Jo refers to as dividend hibernation, a business practice with important implications for market participants.

Employing a research framework that looks at the extent to which United States firms hibernate their dividends, Jo has found that these companies are, on average, more profitable and have higher investment efficiency when compared to matched non-hibernating ones.

Firms that hibernate their dividends for the past seven quarters and continue to do so in the current quarter experience a 1.0 per cent, 1.6 per cent, 2.2 per cent and 2.4 per cent increase in future unexpected earnings in the second, third, fourth and fifth years, respectively.

Simultaneously, dividend hibernation increases information asymmetry – a situation where company managers are in possession of more information than its shareholders.

“Firms that change their dividends disseminate more information to the market. However, when a company keeps its dividends fixed, the information gap between insiders and outsiders widens, increasing the opaqueness of the firm,” says Jo.

While hibernation causes this detriment, it also allows firms to save on costly signalling and invest the proceeds, inducing lower underinvestment.

Dividend hibernation mitigates the underinvestment problem as managers do not use scarce funds to overpay dividends and underinvest in their businesses.

“This helps explain why no dividend change announcements are often met by positively significant stock price reactions.”

With his paper, published in the Journal of Corporate Finance, Jo is making a novel contribution to the payout policy and signalling-theory literature. His findings are helping market participants understand that no dividend news can be, indeed, good news.

Click here to read more about Jo’s research.

The College is always keen to explore research collaborations with the public and private sector and to reconnect with alumni. Please get in touch if you would like to know more about partnering with us.