An Examination of Investor Behavior during Periods of Large Dividend Changes

The “information content of dividends” hypothesis (which emanates from the early work of Lintner [17] and Miller and Modigliani [18]) states that managers use dividend announcements to signal their beliefs about the prospects of the firm. Thus, an announcement of an increase in the dividend rate reflects management's belief that the firm's cash flows in the foreseeable future will be sufficiently high to sustain payment at the increased rate. Similarly, an announcement of a dividend decrease occurs only when management is extremely pessimistic about the probability that future cash flows will be sufficient to continue dividends at their present rate. The theoretical implication of the “information content” hypothesisis that the announcement of a dividend (or change in dividend) conveys information about management's assessment of the firm's prospects, that this information is different from other information provided by management, and this information may cause an immediate investor reaction, including, but not limited to, price changes.