Reversal of Fortune : Dividend Policy and the Disappearance of Sustained Earnings Growth

Managers of more than two-thirds of 145 NYSE firms responded to stalled earnings growth by increasing dividends, with most increases at least as large as the dividend increase in the peak earnings year. These dividend increases are difficult to reconcile with signalling models since (i) most firms' prior sustained earnings growth evaporated, and (ii) there is essentially no relation between favorable dividend signals and future earnings. The stock market recognized the reduced growth earnings, with average abnormal returns of - 17.65 percent in the year of the initial earnings decline and -41.40 percent cumulated over that and the next three years. We find some evidence that sample firms' dividend policies reflect behavioral biases that lead managers to send overly optimistic signals