Complementarity of Prior Accounting Information: The Case of Stock Dividend Announcements

• Published in: The Accounting review 1993-01, Vol.68 (1), p.28-47
• Main Authors: Banker, Rajiv D., Das, Somnath, Datar, Srikant M.
• Format: Article
• Language: English
• Subjects: Accounting; Capital expenditures; Cash; Coefficients; Dividends; Information; Information content; Investors; Market value; Rates of return; Retained earnings; Statistical analysis; Stock dividends; Stock returns; Stock splits; Studies
• ISSN: 0001-4826; 1558-7967

We present empirical evidence that prior accounting information, such as capital expenditure, retained earnings, funds from operations, and dividend history, is useful in explaining cross-sectional variations in the market response to stock dividend announcements. An important accounting issue concerns the information content of disclosures and their usefulness to the investor. We demonstrate the complementary role of previously disclosed firm-specific accounting information in the market's assessment of subsequently disclosed information. Thus, two firms declaring the same amount of stock dividend may experience predictably different market reactions to the announcement when it is conditioned by prior information about the firms. Comparable research by Kane et al. (1984) has shown that changes in earnings and dividends either corroborate or contradict prior information. A broader approach by Gonedes (1978) and Antle et al. (1991) shows that the sequence and history of information arrival are relevant in interpreting the information content of accounting signals. Ou and Penman (1989) demonstrate the role of prior accounting information in predicting earnings changes in subsequent periods, and John and Lang (1991) have shown, both theoretically and empirically, that the market uses information about prior insider trading to interpret the information content of dividend changes. Stock dividends are appropriate for an investigation of the complementary role of prior accounting information because their issuance is largely a paper transaction, and because they have been interpreted as a signal of better future prospects. Although significant positive abnormal returns usually accompany stock dividend announcements, alternative (and more credible) instruments could signal future prospects (such as an increase in cash dividends). The uncertainty about how investors interpret stock dividend distributions suggests a role for previously disclosed accounting information as a conditioning factor. A survey of managers of firms declaring stock dividends (Eisemann and Moses 1978) indicates that such distributions are intended either to conserve cash in difficult times or to express confidence in the firm, two diametrically opposed motivations. So one firm may declare stock rather than cash dividends in order to invest in more profitable ventures, and another may do so because it faces operating losses and a severe cash crunch. Absent other information, it is likely that