Introduction
Dividends are a payable index for a shareholder’s investment in a firm’s stock. The effect of dividends on the share price has been recognized in the business platform. Studies by Gordon emphasized the correlation between a firm’s share price and its dividends. Gordon explained the ripple effect of share price index upon announcements of the firm’s dividend policy (15).
Past literatures presented the same argument to relate the hypothesis between dividends and the stock’s price. The study is based on abnormal returns that affect the share price. When dividends increased in the stock market, there was an increase in the abnormal return (Chen 5). However, when the dividends decrease the abnormal return decreased significantly.
The disparity in abnormal returns was due to the market structure and dividend payments. Different dividend models can be utilized to analyze the effect of dividend payments on the share price. These models include the Signal Dividend Hypothesis, which proposes dividend payments determine the signal of abnormal returns and the firm’s profit margin (Divecha and Dale 12). The free cash flow dividends hypothesis proposed the friction between the firm’s management and the shareholders is reduced upon payments. The dividend maturity model asserts the effect of dividends on the life span of the organization.
Dividends Models
Four dividends modes will be analyzed in this paper. These models include; Dividend signal, free flow cash model, the maturity model and the catering hypothesis.
Dividend signal model or hypothesis explains the use of organization to inform the public on their forecasted cash returns. By interpretation, investors would be influenced by the information. An investor will invest based on the assumption with cash flow of the organization will increase. The dividend signal hypothesis distinguishes highly valued companies from poorly managed firms. The price of payments differentiates the firms.
A free cash flow model involves limited cash investments due to dividend payments. This form of payments exists in an organization with separate management systems. The owner of the highest stock is different from the management of the company. Top managers increase their investments to stabilize investment difficulties. Maturity dividend model proves the state of an organization as it enters an advance stage. The organization is rated with its dividend payments and the value of its share price (Fracassi 4).
The announcement of dividend payments by the company would set the abnormal return to negative. Factors like a tax cut, the cost of transactions, and the firm’s investments determines the stock price. Catering hypothesis assign a fixed time for dividend payments. The firm’s stock index would determine the payments of Dividends (Pettit 3).
Announcements of dividend payments can be divided using the following benchmarks:
- Available data produced by the company.
- Dividends type
- The method of payments
- Frequency of the dividends
- Share type
- Time of announcement
- Ex- dividend date
- Variation of announcement
This paper examined the changes in a firm’s dividend. The announcements of dividend payments affected the share price within a 3 days frame. The firm’s dividend announcement reduced the share price by 1.33% when the company reduced its dividend payments. The deviation from the normal was 7.35%. Note that the firm’s profitability reduced prior to the firm’s announcement. When the firm announced an increase in dividend payments, its share price increased by 0.91% and the deviation from normal was 3.1%.
The table above shows the assumptions of dividend models.
The regression analysis of dividend payments by different firms is shown below:
Regression response of dividend increase announcement
Regression of price sensitivity to dividends decrease announcement
The regression table shows the cumulative abnormal returns for the increase and decrease of dividend announcement. The analysis reveals the significance of the announcement and its relation to the share price. The analysis is determined at the 10 % significance, 5% and 1%. Finally, the announcement of dividend payments influences the share price because of future increase in the net income of the company. The decrease and increase in the payment of dividends caused a shift in the share price.
Works Cited
Chen, Dar-Hin 2007, The Announcement Effect of Cash Dividend Changes on Share Prices: An Empirical Analysis of China. Web.
Divecha, Arjun and Dale Morse, Market Responses to Dividend Increases and Changes in Payout Ratios, Journal of Financial and Quantitative Analysis. (1987): 163-173. Print.
Fracassi, Cesare 2009, Stock Price Sensitivity to Dividend Changes. Web.
Gordon, Myron, Dividends, Earnings and Stock Prices, Review of Economics and Statistics. (1959): 41, 99-105. Print.
Pettit, Richardson, Dividend Announcements, Security Performance, and Capital Market Efficiency, Journal of Finance. (1972) 27, 993-1007. Print.