THE RELATIONSHIP BETWEEN DIVIDENDS AND EARNINGS

Abstract

The relationship between dividends and earnings has long been a controversy to analysts and investors. Some studies on the subject provide evidence in support of a positive and significant causal relation from dividends to earnings. Theses studies support the view that higher dividend payouts signal an increase in future earnings. In this paper, we provide a critique of these studies and hypothesize that no significant relationship between earnings and dividend holds in the long run. We provide logical and empirical evidence in support of our hypothesis. We argue that empirical studies that conclude a causal relationship exists between earnings and dividends are based on short periods of time and are therefore misleading to potential investors. Our empirical analysis is based on quarterly data for the S&P 500 index over the 1988-2002 period and includes the Dickey-Fuller test, a simple regression test, and the Granger causality test.