Cross-sectional differences in the profits, returns and risk of firms initiating dividends

Purpose - The purpose of this paper is to examine cross-sectional differences in the profits, returns and risk of high- and low-market-to-book ratios (M/B) stocks before and after the initiation of regular cash dividend payments. Design/methodology/approach - This study uses parametric and non-parametric statistics and ordinary least squares regression to test for differences in the profits, returns and risk of high- and low-M/B stocks before and after dividend initiation. Findings - Low-M/B stocks display the most positive price reaction to dividend initiation announcements. High-M/B firms have larger profits, cash levels and capital expenditure before and at the time of dividend initiation, but more closely resemble the low-M/B firms in terms of these characteristics within three years following dividend initiation. Excess returns earned by low-M/B firms are related to decreases in systematic risk, while the returns of high-M/B firms are related to their higher profitability. Research limitations/implications - Averaging results from 1965-2000 does not account for possible changes in the information content of dividend initiations over time (as evidenced by steadily declining dividend yields over this period). Practical implications - The findings are consistent with the idea that firms begin paying dividends as they are maturing into a slower growth period, and do not support the idea that dividend initiation signals faster future earnings growth. Originality/value - The analysis adds to the body of knowledge by explicitly conditioning the expectations from various dividend theories based upon individual firms' growth phase as reflected in their M/B ratios, and suggests that signaling, agency and risk explanations for dividends must be considered jointly with a firm's growth prospects when studying dividend events.