Complementarity or Substitution: Time-Variant Implications of Dividends and Stock Repurchases – An Explorative Study

51 Pages Posted: 7 Dec 2020 Last revised: 5 Mar 2021

See all articles by Carsten Homburg

Carsten Homburg

University of Cologne

Roman Schick

University of Cologne

Date Written: November 27, 2020

Abstract

Prior studies associate dividends with permanent earnings signals and stock repurchases with transitory earnings signals. In contrast, we provide empirical evidence that in recent decades, dividends and stock repurchases have converged to each other in terms of their signaling for future earnings. According to our explorative empirical analysis using a modified version of the Dechow et al. (2008) earnings persistence model, the relation between dividend and stock repurchase signals has changed from complementary to substitutive. However, cumulative abnormal returns following payout announcements indicate that the stock market is not fully aware of this convergence as cumulative abnormal returns in response to stock repurchases do not increase in conjunction with their changing signals. We also explore potential reasons for the documented convergence, and find that the declining signaling of dividends for future earnings may be driven by increased institutional ownership, reducing agency-problems between management and shareholders. Furthermore, the signaling of stock repurchases converges to that of dividends because the former are paid more persistently and are less related to transitory non-operating income. Our findings help investors and managers in allocating their assets more efficiently by improving their understanding of payout policy implications.

Keywords: Dividends, Stock Repurchases, Earnings Persistence, Information Efficiency

JEL Classification: G14, G35

Suggested Citation

Homburg, Carsten and Schick, Roman, Complementarity or Substitution: Time-Variant Implications of Dividends and Stock Repurchases – An Explorative Study (November 27, 2020). Available at SSRN: https://ssrn.com/abstract=3739725 or http://dx.doi.org/10.2139/ssrn.3739725

Carsten Homburg

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

Roman Schick (Contact Author)

University of Cologne ( email )

Albertus-Magnus-Platz
Cologne, 50923
Germany

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