Dividend Yields, Stock Returns and Reputation

Abstract

Accepted:Problem/ Relevance -The relationship between dividend yields and stock returns is an unresolved issue in finance. Previous papers show mixed results on the relationship. To clarify the relationship, we consider dividend reputation. We investigate whether dividend reputation plays a role in explaining the relationship between dividend yields and stock returns.Research Objective/ Questions -We hypothesize that firms with dividend reputation tend to have less risk compared to firms without dividend reputation, and the expected return of firms with dividend reputation will be lower given the dividend yield, which is called the "reputation effect." A mix of firms with and without dividend reputation in a sample could distort the relationship between stock returns and dividend yields. We group stocks according to reputation and analyze the relationship between dividend yields and stock returns.Methodology -We construct our sample from all firms listed on the NYSE, AMEX, and NASDAQ stock exchanges. In our analysis, reputation effects are included to analyze the relationship between dividend yields and stock returns. We divide our sample firms into three groups according to the track record of dividend payments to control for reputation effects: (1) reputation-established firms, (2) reputation-building initiation, and (3) no reputation firms. To test the hypotheses, we run the panel regression with reputation variables and the control variables.Major Findings -We find that the reputation effect is strongest for reputation-established firms and a weaker reputation effect for reputation-building younger firms. After controlling the reputation effect and other relevant variables, we find that there does exist a significantly positive relationship between dividend yields and stock returns.Implications -The empirical results show that the reputation effect is higher for established firms with a good track record of dividend payments than for firms with a short history of dividend payments or for firms with an unreliable history of dividend payments. After controlling the reputation effect and other relevant variables, we find there exists a significantly positive relationship between dividend yields and stock returns. We also find that one year is not enough time for firms to build a dividend reputation.

Dividend reputation, dividend yield and stock returns in Korea

“…Although the coefficients of the yield are not significant, those of interaction terms between the reputation dummy and the yield have significantly positive coefficients, which means that only reputation-established firms among those with higher yields are expected to produce higher future returns. This result runs counter to Kang et al (2019) that show interaction terms between the reputation dummy and yields have significantly negative coefficients in the regressions of monthly excess returns in the USA. The document that firms with a dividend reputation tend to have less risk compared to firms without a dividend reputation and the expected return of firms with a dividend reputation will be lower given the dividend yield, taking the positive relationship between yields and returns in the USA into account.…”

“…On the other hand, Kang et al (2019) propose a measure for a dividend reputation, complementing this existing literature. They distinguish firms with a dividend reputation which pay non-decreasing dividends for several years (e.g.…”

“…Following Kang et al (2019), I divide the sample firms into two groups based on regular dividend streams:…”

“…In other words, if a firm maintains previous dividend payments or increases dividends for the latest five years in year t, RPT5 = 1 for year t þ 1. In their study using US stock data, Kang et al (2019) define firms that pay non-decreasing dividends for at least three years as reputation-established firms and Kang (1997) documents that it usually takes around three years for a firm to establish a reputation. As Korean companies make annual dividend payouts, they provide fewer dividend payments during the same period when compared to US firms, which generally pay regular quarterly cash dividends; I observe the reputation-building behavior of firms for five years.…”

“…As Korean companies make annual dividend payouts, they provide fewer dividend payments during the same period when compared to US firms, which generally pay regular quarterly cash dividends; I observe the reputation-building behavior of firms for five years. As a robustness test, I use other reputation-building periodsthree years following Kang et al (2019) or seven yearswith no change in the main results. This is discussed in more detail later.…”