The reflection of a firm's earnings and dividends announcements in its stock price

Abstract

Corporate earnings and dividends announcements are crucial to the stock market. They gain more importance under markets with asymmetric information, as they are seen by outside investors as signals for the financial health of the firm, sent by the management. There is a wide support in literature for Lintner’s (1956) view that corporate managers tend to be conservative in their dividend policy. However, it was later modified, and even believed to lose some of its significance, due to the adoption of stock repurchases in recent decades. Earnings announcements and dividends announcements are related, but they have different effects on the stock price. A better understanding for Miller and Modigliani’s (1961) dividend irrelevance theorem is that expectations of future earnings seem to be the main reason behind the effect of dividends announcements on the stock price. That is, the dividends announcements are merely a signal that is interpreted to higher earnings in the future. Many theories and hypothesis on this subject are controversial and have been for decades. They may be unrealistic or they lack human and behaviour aspects. One of them is efficient market hypothesis (EMH) that states that all information are symmetric among all parties and reflected in the stock price. Although dividends typically have tax disadvantages, corporates still pay them and investors still demand them, hence appears the dividend puzzle. Taxes seem to have only a secondary effect on the dividend policy.