Summary
We investigate the joint effects of dividend propensity (i.e. whether a firm pays cash dividends) and voluntary disclosure on the relationship between current stock returns and future earnings. We examine whether dividend propensity and voluntary disclosure act as substitutes or complements in the financial communication process. We also examine whether the effects of dividend propensity and voluntary disclosure vary between high- and low-growth firms. Consistent with prior studies, we find that share price anticipation of earnings improves with increasing levels of annual report narrative disclosure, and that firms that pay dividends exhibit higher levels of share price anticipation of earnings than non-dividend-paying firms. The paper adds to the literature on share price anticipation of earnings in two crucial respects. First we show that the associations of voluntary disclosure and dividend propensity with share price anticipation of earnings are statistically significant for high-growth firms and insignificant for low-growth firms. Second we show that the significant effects we find for dividend propensity and voluntary disclosure in high-growth firms are not perfectly additive.
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Extract
The Effects of Voluntary Disclosure and Dividend Propensity On Prices Leading Earnings
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1. IntroductionConsiderable attention has been given to examining the association between corporate disclosure and share price anticipation of earnings (e.g. Schleicher and Walker, 1999; Lundholm and Myers, 2002; Gelb and Zarowin, 2002; Hussainey et al., 2003 and Schleicher et al., 2007). These papers find that the stock market's ability to anticipate future earnings changes is significantly improved when firms voluntarily provide higher levels of disclosure. However, these studies do not take into account the possibility that dividend policy may provide an alternative device for conveying value-relevant information to the stock market that might act as a substitute or complement for narrative disclosure in the financial communication process.Hanlon et al. (2007) examine the impact of dividend propensity (i.e. whether a firm pays cash dividends) on the stock market's ability to anticipate future earnings. They modify and use the returns-earnings regression model introduced by Collins et al. (1994) to compare the association between current-year stock returns and future earnings for firms that pay dividends in the current year as compared with non-dividend-paying firms. They find that US dividend-paying firms exhibit significantly higher levels of share price anticipation of earnings than non-dividend-paying firms. In addition, Hanlon et al. (2007) control for disclosure quality, as measured by AIMR-FAF scores, and they find that the significance of the dividend policy for anticipating future earnings is reduced. This suggests that dividends and disclosure might be substitute forms of financial communication. However, it is possible that the relative information content of dividends and voluntary disclosure could be different in the US than in the UK as the proportion of UK dividend-paying firms is greater than US dividend-paying firms in the period of 1996-2002 (73% in the UK compared with 23% in the US; see Denis and Osobov, 2008 for more details). 1The present paper examines the joint effects of dividend propensity and voluntary disclosure on share price anticipation of earnings.In undertaking this task, we argue that it is vital to take into account the growth characteristics of firms. There are strong theoretical and empirical grounds for expecting this to be the case. Several researchers (see, for example, Brown et al., 1999; Francis and Schipper, 1999 and Lev, 1989) have identified a number of problems with the financial reporting process, instances of accounting 'failure'. Particular attention has been paid to the inability of the financial reporting system to capture the value-relevance of intangible investments on a timely basis (see, for example, Amir and Lev, 1996; Lev, 2001 and Lev and Sougiannis, 1996). High growth and intangible asset intensity are factors that tend to reduce the predictive value of current earnings for future earnings. Investors of high-growth firms are aware that current earnings pro...See the full content of this document
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