Reactions to Dividend Changes Conditional On Earnings Quality

We investigate if market participants' reactions to dividend changes are related to "earnings quality," the extent to which a firm's past earnings are associated with its future cash flows. Consistent with predictions from analytical work (Holthausen and Verrecchia [1988]; Kim and Verrecchia [1991]), we find that, controlling for the firm's dividend change, information environment, investment opportunity set, operating risk, and dividend clienteles, the market reacts less to dividend increase announcements from firms with greater earnings quality. Controlling for the firm's dividend change, information environment, and the release of other information around the dividend declaration date, we also document that analyst forecast revisions are significantly lower for firms with higher earnings quality following dividend increases. In both the market reaction and analyst forecast revision tests, our results for dividend decreases are generally not statistically significant.