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Special Dividends: What Do They Tell Investors about Future Performance?

2003; Elsevier BV; Volume: 12; Issue: 2 Linguagem: Inglês

1873-5673

Claire E. Crutchley, Carl D. Hudson, Marlin R. H. Jensen, Beverly B. Marshall,

Financial Reporting and Valuation Research

Abstract Previous research documents positive short-term stock returns at the announcement of a special dividend and evidence of increased earnings at the time of the dividend. This paper examines the long-run performance of firms paying special dividends to determine whether the stock returns and earnings performance continue to improve over the long run. We find that special dividend announcing firms have unexpectedly high earnings the year of the special dividend announcement; however these unexpected earnings decline significantly in the years following the special dividend. Special dividend paying firms also earn significant positive excess returns the year before the special dividend announcement. On average, investors cannot expect the stock and operating performance that precede a special dividend to continue following the announcement. (C) 2003 Academy of Financial Services. All rights reserved. JEL classification: G35 Keywords: Dividends; Performance 1. Introduction Special dividends are typically viewed in the marketplace as a temporary increase in a firm's payout because investors are not anticipating the dividend to occur again. However, Brickley (1983) finds a significant positive stock price reaction to the announcement of special dividends and documents that the firm's earnings improve following the special dividend announcement. His results indicate that special dividend announcements signal positive information about future earnings for the firm. Why would a firm choose a special dividend as a means of distributing excess cash? Consider the three alternatives available to managers for distributing excess cash to shareholders. A firm could chose to initiate or increase dividends, repurchase shares, or pay a special dividend. The alternative selected will depend on expected future cash flows and the firm's prior share price performance. Jagannathan, Stephens, and Weisbach (2000) find that dividends are initiated or increased following increases in cash flows. If the current cash flow level does not appear sustainable, a firm is unlikely to initiate or increase dividend levels because of the negative consequences that would occur if it were subsequently forced to decrease or suspend the dividend. Stephens and Weisbach (1999) and Jagannathan et al. (2000) find that firms are more likely to repurchase stock following a period of poor stock performance. Therefore, a firm would be reluctant to use share repurchase as a means of distributing excess cash following a significant run-up in the share price. As such, we expect firms to choose special dividends as a means of distributing cash in a setting characterized by temporary increases in cash flows and prior positive share price performance. The decision to issue a special dividend reduces the potential for managers to squander excess cash either on executive perks or negative net present value projects (Jensen, 1986). Therefore, the use of a special dividend is unlikely to convey the same positive news as other distribution forms. Under the signaling theory (Miller and Rock, 1985), the choice to pay a special dividend rather than initiating regular dividends or announcing a permanent dividend increase may indicate that the current earnings performance level is unsustainable. Furthermore, the decision to distribute excess cash to shareholders via a special dividend rather than through share repurchase would suggest that managers believe the current share price is not undervalued. We analyze long-run earnings and stock returns of firms announcing special dividends by calculating excess returns and unexpected earnings using matched firm techniques (Barber and Lyon, 1996; Barber and Lyon, 1997). We find no evidence that special dividends signal future earnings increases. Rather our evidence is consistent with increases in earnings and stock returns before the time of the announcement. A significant decline in unexpected operating performance follows the announcement for those firms already paying regular dividends. …