Do corporate
dividend changes predict future profitability and cash flows of
firms? According to John Lintner's information content of dividends
(ICD) hypothesis, this question should be answered affirmatively.
Statistical
Analysis
Different
statistical analysis have been carried out since Lintner's first
presentation of the ICD hypothesis in 1956. The main findings of
these analysis can be summarized as follows:
- There is
no statistically significant relationship between both above cited
variables. (Watts – Journal of Business 1973, 191 et seq.)
- The ICD
hypothesis is not reliable because management tends to increase
dividends on the basis of overoptimistic forecasts about future
earnings. (De Angelo, Skinner – Journal of Financial Economics
1996, 341 et seq.)
- The ICD
hypothesis is only reliable as far as the year before and after a
dividend increase is concerned. (Benartzi, Michaely, Thaler –
Journal of Finance 1997, 1007 et seq.)
- The
validity of the ICD hypothesis depends on firm characteristics such
as corporate governance structure (How is the ownership structure
shaped? Who are the shareholders and which kind of dividend policy do
they expect?) and growth stage (The ICD hypothesis namely applies to
low-growth firms because such firms have simply less other investment
opportunities.). (Choi, Joo, Park – Accounting and Finance 2011,
869 et seq.)
- Negative
dividend changes are somewhat predictive of future earnings decreases
whereas positive dividend changes provide less information about
future earnings. (Choi, Joo, Park – Accounting and Finance 2011,
869 et seq.)
Comments
Reading
about the above described ICD hypothesis discussion, I am wondering
about 3 main issues:
- First and
foremost, can we lead this discussion without taking into account the
legal form of the firm, the practical implementation of such legal
form, and the way dividends are decided upon by respective organs?
For example, many jurisdictions provide for the shareholders’
meeting to decide upon a distribution of dividends. However, the
processes of such shareholders' decision making as well as the
required quorum might deviate substantially among various
jurisdictions. In addition, I would expect a decision and (its
motivation) to distribute dividends differentiate considerably in a
small company where shareholders and top management are identical as
opposed to a multinational corporation where stocks are listed and
widespread among individuals.
- What about the applicable tax regime
for dividends? For example, a higher dividend policy might be linked
to a favorable tax regime rather than the company's past and/or
future profitability.
- Finally,
is this discussion not an example of a confusion between correlation
and causality? Is a firm's future profitability higher because of
higher dividends in the past? Isn't it more likely that past
dividends got higher because of higher profits? Didn't those higher
profits simply mean that the company was doing well in the past and,
therefore, continued to do well in the future?