Dividend

THE JOURNAL OF FINANCE • VOL. LVI, NO. 6 • DEC. 2001

Dividend Changes and Future Profitability

DORON NISSIM and AMIR ZIV*

ABSTRACT

We investigate the relation between dividend changes and future profitability, measured in terms of either future earnings or future abnormal earnings. Supporting “the information content of dividends hypothesis,” we find that dividend changes provide information about the level of profitability in subsequent years, incremental to market and accounting data. We also document that dividend changes are positively related to earnings changes in each of the two years after the dividend change.

It is well documented that dividend changes are positively associated with stock returns in the days surrounding the dividend change announcement ~see, e.g., Aharony and Swary ~1980!, Asquith and Mullins ~1983!, Kalay and Loewenstein ~1985!, and Petit ~1972!!. According to “the information content of dividends hypothesis” ~Miller and Modigliani ~1961!!, dividend changes trigger stock returns because they convey new information about the firm’s future profitability. However, recent studies have not supported this hypothesized relation between dividend changes and future earnings ~e.g., DeAngelo, DeAngelo, and Skinner ~1996!, Benartzi, Michaely, and Thaler ~BMT, 1997!!. We reexamine the relation between dividend changes and alternative measures of future profitability, and provide strong evidence that dividend changes are positively related to future earnings changes, future earnings, and future abnormal earnings. To investigate whether dividend changes convey new information about future profitability, one has to estimate expected profitability. Most prior studies assume that earnings follow a random walk with drift, and measure unexpected profitability as the realized change in earnings minus the estimated drift. They then examine the association between dividend changes and unexpected earnings. We first use a similar approach and find,...