The Signaling Effects and Predictive Powers of Dividend Announcements: Evidence from Kingdom of Saudi Arabia

Abstract

This study examines the implications of changes in dividends in the market of Kingdom of Saudi Arabia (KSA). First, the research analyzes changes in dividends within the context of signaling hypothesis. Second, this study examines another aspect of signaling hypothesis by testing the abilities of dividends to predict future earnings and cash flows of Saudi firms. Financial economists have explored various aspects of changes in dividends and earnings for well developed markets such as markets of North America and Europe. The objective of this study is to see how the signaling hypothesis manifests itself in a small market, such as KSA, characterized by concentrated family-ownerships, non-taxability of dividends, and high degree of information asymmetry. Signaling hypothesis, initially formulated by Miller and Modigliani (1961), suggests that dividend changes convey material information and that share prices react positively to the announcements of dividend changes. Signaling hypothesis was further generalized to include other factors such as the information content of earnings announcements. Further development of the signaling hypothesis includes the association between dividend and earnings changes and future cash flows of the firms. In this context, we hypothesize that there is a positive relationship between dividend announcement and stock prices in the Saudi market. This study tests this hypothesis using all publicly traded firms listed on the Saudi Exchange Market (Tadawul). We use event study to test stock market responses to dividend announcements. To test the signaling hypothesis we used our cross section data to calculate accumulated average abnormal returns using 100 days as estimation period and 21 days as window period. We used parametric CAAR t test) and non-parametric (G sign) significance tests to verify that our results are significant and not due to pure chance. Our results show no significant reaction of prices to the dividend announcements, which means that signaling hypothesis cannot be generalized to all types of markets and that each market own characteristics have significant effect on the applicability of the signaling hypothesis. Further research is suggested to include earnings in the analysis.

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