Examination of the Long-run Market Reaction to the Announcement of Dividend Omissions and ...

116 Pages·2003·0.57 MB·English

by  Liu, Yi

An Examination of the Long-run Market Reaction to the Announcement of
Dividend Omissions and Reductions

A Thesis
Submitted to the Faculty
of
Drexel University
by
Yi Liu
in partial fulfillment of the
requirements for the degree
of
Doctor of Philosophy
June 2003
ii
Dedications

To my wife
(cid:133) with love
iii

Acknowledgements

Many thanks go to my chair Dr. Samuel Szewczyk for leading me into this area.
Without his insights and support, I would never be here. I am extremely grateful to Dr.
Zaher Zantout. Thank him for working with me until 6 a.m.. Thank him for checking
every detail of the tables. His continuous critiques shaped the paper.
I would like to thank my committee members Dr. Michael Gombola, Dr. Edward
Nelling and Dr. Linhui Tang for their suggestions. Dr. Jacqueline Garner shows me how
a SAS Jedi Warrior is willing to help and does help others. A debt of gratitude is owed to
Dr. Arnie Cowan, who developed Eventus, and tailored it to me. My colleague, Dr.
Elizabeth Webb, who is to be a social responsible professor, makes jokes to make the
four-year journey shorter.
I would like to thank my wife. Without her, I will still be in the dark side. I hope
tremendous time I spent on the dissertation does not separate, but combine us.
I want to thank my mother and sister, although they are not physically with me.
Their support does not reduce through thousands of miles away. The power of their
encouragement is proportional to the square of the distance, according to the universal
law of love.
There are times of overwhelming excitements, and times of overwhelming
frustration. This dissertation has become the essential part of my life in two years. It is
the life and the entertainment for me. I am very happy that by the end, I don(cid:146)t hate the
paper as I expected. I changed my mind of throwing it into trash can, but instead would
publish it somewhere.
Future follows random walk (Fama, 1998), who can tell?
iv
Table of Contents
List of Tables...............................................................................................................VII
List of Figures............................................................................................................VIII
Abstract........................................................................................................................IX
Chapter 1: Literature Review...........................................................................................1
1.1 Introduction...............................................................................................................1
1.2 Literature on dividend policy.....................................................................................4
1.2.1 Irrelevance of dividend policy.............................................................................4
1.2.2 Information related explanation...........................................................................5
1.2.3 Agency cost based explanation............................................................................6
1.2.4 Behavioral finance and dividend policy...............................................................7
1.2.5 Other explanations..............................................................................................8
1.2.6 The trends of dividend payout through time.......................................................9
1.3 Theoretical models concerning overreaction and underreaction................................10
1.4 Review of empirical evidence on overreaction and underreaction.............................14
1.4.1 Empirical evidence of autocorrelation of stock returns......................................15
1.4.2 Empirical evidence of underreaction and overreaction......................................16
1.4.3 Summary on empirical evidence........................................................................20
Chapter 2: Methodology...............................................................................................21
2.1 Methodologies review..............................................................................................21
2.1.1 Defining the normal return: time series vs. cross-sectional approach.................21
2.1.2 Calculating the abnormal return across time: CAR vs. BHAR...........................24
2.1.3 Calculating abnormal return across sample firms: VW vs. EW..........................26
v
2.1.4 Drawing inferences...........................................................................................27
2.1.5 Time-series regression.......................................................................................30
2.2 Our methodology.....................................................................................................32
2.2.1 Buy-and-hold abnormal returns.........................................................................32
2.2.2 Calendar time portfolio approach......................................................................35
Chapter 3: Data..............................................................................................................37
3.1 Sample construction.................................................................................................37
3.2 Matched firm selection............................................................................................39
3.2.1 Matched by size................................................................................................39
3.2.2 Matched by size and industry............................................................................39
3.2.3 Matched by size and prior performance.............................................................40
3.2.4 Matched by industry and prior performance......................................................42
3.2.5 Matched by size, industry and prior performance..............................................42
3.2.6 Matched by size and book-to-market ratio.........................................................42
3.2.7 Matched by size and leverage............................................................................43
Chapter 4: Market reaction following announcements..................................................45
4.1 Announcement abnormal returns..............................................................................45
4.2 Post-announcement results using buy-and-hold matching methodologies...............46
4.2.1 Post-announcement results during the whole sample period..............................46
4.2.2 Are abnormal results caused by mis-matching ?................................................48
4.3 The duration and magnitude of long-run abnormal returns.......................................49
4.4 Post-announcement results using Fama-French calendar time portfolio approach.....51
4.5 Conclusions.............................................................................................................53
vi
Chapter 5 : The determinants of long-run abnormal returns............................................55
5.1 Introduction.............................................................................................................55
5.2 Are abnormal returns subject to chance? Robustness test across sub-periods...........57
5.2.1 Sub-periods by every three years......................................................................57
5.2.2 Sub-periods by economic conditions................................................................58
5.2.3 Fading dividends and fading market reaction.....................................................60
5.2.4 Major political and economic events and market reaction..................................62
5.3 Univariate analysis...................................................................................................63
5.3.1 Post-announcement changes in risk...................................................................63
5.3.2 Are long-run abnormal returns only concentrated on small size firms?..............64
5.3.3 Are long-run abnormal returns related to the reasons cited?...............................67
5.3.4 Long-run abnormal returns and dividend yield..................................................68
5.3.5 Announcement abnormal returns and long-run abnormal return........................70
5.4 Multivariate analysis................................................................................................71
5.4.1 Multiple regression on the determinants of short-run market reaction................71
5.4.2 Multiple regression on the determinant of long-run market reaction..................73
5.5 Conclusions.............................................................................................................76
List of References..........................................................................................................78
Appendix A: Tables.......................................................................................................83
Appendix B: Figures....................................................................................................102
Vita.............................................................................................................................106
vii
List of Tables

1. Literature Review...................................................................................................83
2. Chronological Distribution and Industry Representation.........................................85
3. Mean Values of Matching Criteria for Event Firms and Matched Firms..................86
4. Announcement Abnormal Returns and Post-Announcement Risk Changes.............87
5. Post-Announcement Long-run Abnormal Returns...................................................88
6. Duration of Post-Announcement Long-run Abnormal Returns...............................89
7. Post-Announcement Monthly Abnormal Returns....................................................90
8. Abnormal Returns by Sub-periods.........................................................................91
9. Abnormal Returns by the Condition of the Stock Market.......................................93
10. Abnormal Returns, by Sub-Samples Defined By Period of Announcement..........94
11. Abnormal Returns, by Sub-Samples Defined by Changes in Risk........................95
12. Abnormal Returns, by Sub-Samples Defined by Firm Size..................................96
13. Abnormal Returns, by Sub-Samples Defined by Reasons.....................................97
14. Abnormal Returns, by Sub-Samples Defined by Dividend Yield..........................98
15. Abnormal Returns by Announcement Abnormal Returns.....................................99
16. Regression Analysis of the Announcement Abnormal Returns..........................100
17. Regression Analysis of the Post-Announcement Abnormal Returns...................101
viii
List of Figures

1. How the Horizon of Holding-Period Long-Run Abnormal Returns is
Overstated....................................................................................................102
2. How the Horizon of Long-Run Abnormal Returns is Overstated When
Using Fama-French Calendar Portfolio Approach.........................................103
3A. Two-Day Average Announcement Abnormal Returns by Sub-Periods.........104
3B. The Average Two-Day Announcement Abnormal Returns and Average
Percentage of Firms Paying Dividends By Sub-Periods.................................105
ix
Abstract
An Examination of the Long-run Market Reaction to the Announcement
of Dividend Omissions and Reductions
Yi Liu
Samuel H. Szewczyk, Supervisor, Ph.D.

This study investigates the long-run stock performance following dividend
omissions and reductions, and looks for answers for three questions: 1) Does the market
underreact to announcement of dividend omissions and reductions? 2) if the market does,
how long does it take for the market to correct this underreaction, and 3) are there any
factors that influence the long-run underperformance?
We document significantly negative long-run abnormal stock returns for up to
five years after announcement by using either holding period matching approach or
Fama-French calendar time portfolio regression. The results are robust across time
periods and methodologies. However, we find the horizon of long-run post-
announcement abnormal returns might be overstated in prior literature. When looking at
each year individually, we find the abnormal performance is confined in the first
postannouncement year. The long-run postannouncement abnormal returns beyond the
first year reflect the compounding effects for buy-and-hold methodology and averaging
effects for Fama-French calendar time regression. Our findings provide empirical support
for the argument presented by Fama (1998) that the horizon of long-run anomaly is
severely overstated. We find several factors that influence short-term market reaction to
announcement of dividend omissions and reductions. However, most of these factors
have no impact on the long-run abnormal stock performance. The magnitude of
x
underreaction is not associated with percentage of dividend changes, reason for dividend
changes, dividend yield or firm risk changes around announcement.
Our paper also makes an important contribution in methodology: We caution
future researchers of long-run abnormal stock performance to be aware of the fact that
both buy-and-hold matching methodology and Fama-French calendar time portfolio
regression tend to overstate the magnitude and horizon of long-run abnormal
performance.
This paper contributes to the on-going debates about the validity of Efficient
Market Hypothesis.