Frequency and Motives for Stock Dividends in a Unique Environment

• DOI: http://doi.org/10.1111/irfi.12020
• Author: Khamis H. Al‐Yahyaee
• Date: 01 June 2014
• Published date: 01 June 2014

Frequency and Motives for Stock

Dividends in a Unique

Environment

KHAMIS H. AL-YAHYAEE

Department of Economics and Finance, College of Economics and Political Science,

Sultan Qaboos University, Muscat, Sultanate of Oman

ABSTRACT

We investigate the possible differences in the information content of stock

dividends between firms that distribute stock dividends frequently (frequent

distributors) and firms that distribute stock dividends infrequently (infre-

quent distributors) using a unique data set from Oman where the market

microstructure frictions are either absent or limited. We find that infrequent

stock dividend distributors have higher postdistribution operating perfor-

mance relative to frequent distributors. We also find that the illiquidity

measure is significantly related to the announcement effect only for frequent

stock dividend distributors, whereas short-term performance is significantly

related to the announcement effect only for infrequent distributors. Our

findings indicate that infrequent stock dividends are used mainly to convey

favorable private information about the firms’ future prospects, and frequent

stock dividends are used to reduce stock price to an optimal trading range in

order to improve trading liquidity.

JEL classification: G14, G35.

I. INTRODUCTION

Stock dividends are a puzzling corporate behavior. In theory, stock distributions

either by stock dividends or by stock splits are cosmetic operations aimed at

dividing the corporate pie into more pieces with no change in the total firm

value (Adaoglu and Lasfer 2011). However, numerous empirical studies report a

significant positive market reaction to stock dividends. The underlying reasons

for this positive market reaction remain unsettled.1One plausible explanation is

that there is an ‘optimal’ trading range, and that stock dividends realign stock

prices to this range (Copeland 1979; Adaoglu and Lasfer 2011; Nguyen and

Wang, 2013). Realigning stock price could attract more attention to a stock

(Grinblatt et al. 1984), which may lead to an increase in the liquidity of the

stock (Muscarella and Vetsuypens 1996). In fact, Baker and Powell (1992) find

1 For a recent literature review on this topic, see Bechmann and Raaballe (2007), Adaoglu and

Lasfer (2011), Al-Yahyaee (2014), and Nguyen and Wang (2013).

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International Review of Finance, 14:2, 2014: pp. 295–318

DOI: 10.1111/irfi.12020

© 2013 International Review of Finance Ltd. 2013

that moving the stock price into a better trading range and improving the

stock’s liquidity are the primary motives for managers to split their firms’ stocks.

The empirical evidence from previous studies on improved liquidity follow-

ing stock distributions is mixed. In this vein, Bechmann and Raaballe (2007)

study the stock distribution effect using a sample of stocks on the Copenhagen

Stock Exchange. They report weak evidence for the liquidity effect. Likewise,

Adaoglu and Lasfer (2011) examine the motives for Turkish companies to pay

stock dividends. Similar to Bechmann and Raaballe (2007), they document

weak evidence that stock dividends improve liquidity. Conversely, Lin et al.

(2009) find that the incidence of no trading decreases and liquidity improves

after stock distributions using daily data for the period 1975–2004. Similarly,

Metha et al. (2011) conduct a survey of Indian managers and find that the

improvement of liquidity is the primary motive for stock distributions. Nguyen

and Wang (2013) find greater participation of small investors following stock

dividends for a sample of Chinese firms that distribute stock dividends from

1996 to 2010.

A competing explanation for stock distributions is the signaling hypothesis.

This theory suggests that firms split their stocks and distribute stock dividends

to signal information about their future profitability. According to the signaling

hypothesis, stock distributions are associated with positive announcement

excess returns because managers use stock distributions to convey favorable

private information about their firms’ future prospects. In this vein, Foster and

Vickrey (1978) show that stock dividend announcements signal positive infor-

mation to investors, and larger stock dividends convey more favorable infor-

mation. Similarly, Grinblatt et al. (1984) document that managers convey

favorable private information concerning future earnings to investors through

stock dividends. Kunz and Rosa-Majhensek (2008) demonstrate that Swiss com-

panies are using stock distributions to send positive signals to the stock market,

which is consistent with the signaling hypothesis. Adaoglu and Lasfer (2011)

document some evidence that the market reaction is higher for firms that

underperformed in the previous 6 months before the announcement. Their

results imply that firms announce stock dividends to signal future recovery.

Al-Yahyaee (2014) examines shareholder wealth effects of stock distributions

using a sample of Omani firms. He finds a positive stock market reaction to

stock dividend distributions. His results indicate that stock distributions are

used primarily to signal future operating performance and to a lesser extent to

reduce stock prices to an optimal trading range.2Nguyen and Wang (2013) find

positive abnormal returns around the announcement dates of stock dividends

and a positive association between these returns and managers’ private infor-

mation. These findings are largely consistent with the signaling theory. On the

other hand, many previous empirical studies (e.g., Lakonishok and Lev 1987;

2 This study notably differs from that of Al-Yahyaee (2014) in that it investigates the possible

differences in the information content of stock dividends between firms that distribute stock

dividends frequently and firms that distribute stock dividends infrequently. This important

issue has not been examined in Al-Yahyaee (2014).

International Review of Finance

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