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CMA Intermediate · Financial Management and Business Data Analytics · Dividend Decisions and Dividend Theories

An analyst studies 200 listed companies and finds that, in the year after dividend initiation, average abnormal share returns are positive, while in the year after dividend omission they are negative. Which dividend concept does this data pattern most directly support?

Positive abnormal returns after dividend initiation and negative ones after omission show that dividend changes carry information about future prospects. This directly supports the signalling or information content theory, whereas MM irrelevance would predict no price reaction to dividend announcements.

  1. AInformation content (signalling) of dividendsCorrect
  2. BModigliani-Miller dividend irrelevance with no information effect
  3. CWalter's model of optimum payout
  4. DResidual dividend policy

Explanation

Price reactions that follow dividend announcements indicate that markets treat dividend changes as news about future earnings, which is the signalling hypothesis. MM irrelevance would predict no abnormal reaction. Walter's model and residual policy relate to the r versus k and investment needs, not to announcement effects.

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