Dividend Changes and Future Profitability

Abstract

In this study we investigate the relation between dividend changes and future profitability. We find that dividend changes are positively associated with future profitability after controlling for (i) past profitability, (ii) the effect of invested equity capital on past, current and future profitability, and (iii) market expectations of future profitability prior to the dividend change. The relation between dividend increases and future profitability remains highly significant even after controlling for profitability in the dividend change year. Moreover, the magnitude of the relation between dividend changes and unexpected future profitability increases in the distance between the dividend change year and the future year. Finally, similar to previous studies, we document that dividend changes are positively associated with subsequent capital expenditures. These results suggest that dividend increase announcements convey that (i) current profitability will be higher than expected, (ii) the shock to current profitability is relatively permanent, and (iii) the company expects to invest in positive NPV projects that will generate accounting profits in future years.