Do Changes in Dividends Signal the Future or the Past

TL;DR: In this article, the authors investigate the idea that changes in dividends have information content about the future earnings of the firm and find only limited support for it and conclude that the size of the dividend increase does not predict future earnings.

Abstract: Many dividend theories imply that changes in dividends have information content about the future earnings of the firm. We investigate this implication and find only limited support for it. Firms that increase dividends in year 0 have experienced significant earnings increases in years -1 and 0, but show no subsequent unexpected earnings growth. Also, the size of the dividend increase does not predict future earnings. Firms that cut dividends in year 0 have experienced a reduction in earnings in year 0 and in year -1, but these firms go on to show significant increases in earnings in year 1. However, consistent with Lintner's model on dividend policy, firms that increase dividends are less likely than nonchanging firms to experience a drop in future earnings. Thus, their increase in concurrent earnings can be said to be somewhat "permanent." In spite of the lack of future earnings growth, firms that increase dividends have significant (though modest) positive excess returns for the following three years. THE IDEA THAT CHANGES in dividends have information content is an old one. Lintner's (1956) famous investigation of dividend policy stresses that firms only increase dividends when management believes that earnings have permanently increased, meaning that a dividend increase implies a rightward shift in (management's perceived) distribution of earnings. A bit later, Miller and Modigliani (1961) explicitly suggest that dividends can convey information about future cash flows when markets are incomplete. Indeed, as demonstrated by Miller and Rock (1985), through the sources and uses of funds identity, the dividend decision could reveal information about current earnings