The Role of Earnings Information in Corporate Dividend Decisions

• Main Authors: WU, Chunchi, Hsu, J., Wang, X.
• Format: text
• Language: English
• Published: Institutional Knowledge at Singapore Management University 1998
• Subjects: Business
• Online Access: https://ink.library.smu.edu.sg/lkcsb_research/800
• Institution: Singapore Management University

This paper examines the role of earnings information in the determination of dividend policy. It decomposes accounting earnings into permanent and transitory components and postulates that dividend policy is driven by sustainable permanent earnings. Two measures of permanent earnings are proposed. The first is a permanent earnings variable extracted from accounting earnings by a random-level shift ARMA model. The 2nd measure is stock price times cost of capital. These 2 permanent earnings measures are employed in the Marsh-Merton (1987) model to explain corporate dividend behavior, and their performance is compared. A generalized friction method is adopted for empirical estimation to account for stepwise dividend movements over time. Results show that the permanent earnings measure extracted from accounting earnings data explains dividend dynamic behavior better than stock price.