An examination of the long-run market reaction to the announcement of dividend omissions and reductions

This study investigates the long-run stock performance following dividend omissions and reductions, and looks for answers for three questions: 1) Does the market underreact to announcement of dividend omissions and reductions? 2) if the market does, how long does it take for the market to correct this underreaction, and 3) are there any factors that influence the long-run underperformance? We document significantly negative long-run abnormal stock returns for up to five years after announcement by using either holding period matching approach or Fama-French calendar time portfolio regression. The results are robust across time periods and methodologies. However, we find the horizon of long-run post-announcement abnormal returns might be overstated in prior literature. When looking at each year individually, we find the abnormal performance is confined in the first postannouncement year. The long-run postannouncement abnormal returns beyond the first year reflect the compounding effects for buy-and-hold methodology and averaging effects for Fama-French calendar time regression. Our findings provide empirical support for the argument presented by Fama (1998) that the horizon of long-run anomaly is severely overstated. We find several factors that influence short-term market reaction to announcement of dividend omissions and reductions. However, most of these factors have no impact on the long-run abnormal stock performance. The magnitude of underreaction is not associated with percentage of dividend changes, reason for dividend changes, dividend yield or firm risk changes around announcement. Our paper also makes an important contribution in methodology: We caution future researchers of long-run abnormal stock performance to be aware of the fact that both buy-and-hold matching methodology and Fama-French calendar time portfolio regression tend to overstate the magnitude and horizon of long-run abnormal performance. This paper contributes to the on-going debates about the validity of Efficient Market Hypothesis.