Stock Price Reaction to Dividend Announcements

Abstract

According to Modigliani and Miller announcement of dividends have no effect on stock prices in a perfect world with no taxes and bankruptcy cost. However, in the practical world, the declaration of dividends is often causes changes in stock prices. Previous studies show conflicting proof on the connection between dividend announcements and the stock performance. This study attempts to examine the reaction of the share price to dividend announcements and information efficiency of companies listed on the Dhaka Stock Exchange. The event study methodology is used with a 41-day event period, 10 days before the dividend declaration date and 30 days after the declaration date, with day 0 as the announcement date. 21 commercial banks and 21 pharmaceutical and chemical companies are selected as samples which are listed on the Dhaka Stock Exchange. The analysis is conducted for a period of five years (from 2013 to 2017). For calculating abnormal returns expected returns were subtracted from daily returns. The average cumulative returns are calculated by adding up abnormal daily returns of pre and post announcement period. A chart of the cumulative average abnormal returns for the positive and negative dividend declaration are plotted to demonstrate the trend of the abnormal returns over the event period. Both positive and negative cumulative average abnormal returns are observed in pre and post announcement period. The chart for the cumulative average abnormal returns fluctuated over the entire event period. This study discovered an inverse relationship between dividend announcement and stock prices as stock prices decrease at several points over the event period even though dividend has increase. News of dividend decrease also causes a raise in stock price at several points over the event period. Thus, the first hypothesis, that dividend increase announcement causes a raise in share prices is inaccurate. Similarly, the second hypothesis, that dividend decrease announcement causes a reduction of share prices, is inaccurate. The study also supports the third hypothesis that is inefficiency of Bangladesh stock market. This led to a conclusion that, dividend announcements do not provide any significant impact on stock price performance. If real and symmetrical information appears on the market and the companies stop the leakages of dividend information before the date of the declaration, the declaration of the dividends may influence stock prices.