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Do dividends signal future earnings in the Nordic stock markets?

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Abstract

We study the informational content of dividends on three Nordic civil law markets, where other simultaneous but blurring motives for dividends may be weaker. Using aggregate data on real earnings per share and payout ratios, long time series from 1969 to 2010, and methodologies which address problems of endogeneity, non-stationarity and autocorrelation (including a vector error correction model approach), we find evidence on dividend signaling in Nordic markets. However, we also find heterogeneity in the relationship between dividends and earnings on markets similar in many respects, suggesting that even small variations in the institutional surroundings may be important for the results.

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Notes

  1. Dividend catering refers to the managerial behaviour of opportunistically modifying corporate payout policies when investor sentiment favours the payment of dividends. Investor sentiment for dividends is in turn often measured from the dividend premium (see Denis and Osobov 2008; Ferris et al. 2009), i.e. the difference between the market-to-book ratios between dividend payers and non-payers.

  2. The idea that dividends could signal information about future earnings is not at odds with the dividend irrelevance proposition of Miller and Modigliani (1961), since there are no informational asymmetries in that model, and dividends can alternatively to being paid out, be left within the firm (however, keeping the investment policy of the firm fixed).

  3. However, DeAngelo and DeAngelo (1990) have argued that there are several reasons for the reluctance to reduce dividends, besides that suggested by Lintner (1956). A reluctance to cut dividends might thus be a necessary but not sufficient condition for dividends to carry an informational content.

  4. See also e.g. Nissim and Ziv (2001), who with the reference to a number of studies conclude that it is well documented that dividend changes are positively associated with stock returns in the days surrounding the announcement.

  5. Ferris et al. (2009) also suggest that the weak catering is because of idiosyncratic behavior of the private benefits of control or a lack of interest in exploring transitory market misevaluations of their equity.

  6. The data used to derive real EPS and the DPR are monthly values of the MSCI price indexes for the three Nordic countries, P/E-ratios, dividend yields and the country specific consumer price indexes (CPIs). The monthly value for the price index is divided by the corresponding P/E-ratio to obtain earnings per share, which is then divided by the CPI to obtain real EPS. DPR is obtained by multiplying dividend yield with the P/E-ratio.

  7. Serial correlation in the residuals encounters a problem in the Dickey–Fuller (Dickey and Fuller 1979) test, which drives into biased estimations. However, an appropriate lag selection removes the problem in the DF test (Brinca 2006). Due to this problem, we have adopted the Augmented Dickey-Fuller (Dickey and Fuller 1981) test.

  8. It has been argued that specifying the null hypothesis as a unit root or non-stationary may be a weakness of tests such as the ADF test (Pfaff 2008). For that reason, the Kwiatkowski-Phillips-Schmidt-Shin test (Kwiatkowski et al. 1992) is also adopted in the study.

  9. The Saikkonen and Lutkepohl cointegration test is based on a reduced rank regression and differs from the Johansen procedure since it starts with an estimation of the deterministic term (Saikkonen and Lütkepohl 2000a, b, c; Lutkepohl 2004). The Johansen Trace procedure is then applied after the deterministic term is subtracted from the model. Saikkonen and Lutkepohl have suggested a generalized least squares (GLS) procedure to estimate the specific parameters of deterministic term.

  10. Engle and Granger (1987) noticed that when modeling with VARs where the variables are cointegrated, their estimates in first differences or levels will be biased and therefore suggests the VECM (Penm et al. 1997).

  11. Impulse responses traces the reactions of the dependent variable to a unit shock of all the other variables in a dynamic system, that is, by hitting the error term with a shock, one traces the effects on the dependent variable over time (Brooks 2008).

  12. Before the tests were applied, we wanted to determine the optimal lag order for the cointegration tests. The AIC, HQ, SC and FPE information criteria suggest an optimal lag order of 5, 4, 3 and 5, respectively.

  13. See also Lin (2013) who find that in civil law countries, dividends are more sensitive to earnings as compared to common law countries.

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Acknowledgments

We thank Mats Nyman, Investment Strategist at Handelsbanken Capital Markets for data support. We thank Mark Shackleton and other participants at 48th BAFA meeting, 17–19 April, 2012, UK. We are also thankful to the discussants and participants at the 49th BAFA meeting, 9–11, April, 2013, Newcastle, UK, the 20th Global Finance Conference, 20–22 May, 2013, Monterey Bay, California, USA, and the World Finance Conference, 1–3 July, 2013, Limassol, Cyprus, for valuable comments. We are grateful to the Editor and an anonymous referee for valuable comments.

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Authors and Affiliations

  1. Hanken School of Economics, P.O. Box 497, 00101, Helsinki, Finland

    Eva Liljeblom

  2. School of Business, Stockholm University, 106 91, Stockholm, Sweden

    Sabur Mollah

  3. EF Education First Ltd, Haldenstrasse 4, 6006, Luzern, Switzerland

    Patrik Rotter

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  1. Eva Liljeblom
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Correspondence to Sabur Mollah.

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Liljeblom, E., Mollah, S. & Rotter, P. Do dividends signal future earnings in the Nordic stock markets?. Rev Quant Finan Acc 44, 493–511 (2015). https://doi.org/10.1007/s11156-013-0415-3

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