THE CORRELATION OF CATERING INCENTIVES TO STOCK RETURN – A TEST OF CATERING THEORY OF DIVIDEND
ARIANA RESTU HANDARY
This research investigates whether dividend catering theory can provide the answer to explain phenomenon of dividend policy in Indonesia. The theory argues that the decision to pay dividends is driven by investors demand. Managers pay dividend when investors put a higher price on the shares of dividend payers and not paying when investors prefer non-dividend payers. Dividend premium is used as the proxy for the investor sentiment for dividend.
The sample of this research is 337 non-financial firms listed within the Jakarta Stock Exchange, which is composed of 363 dividend announcements during the period 1999-2003. The correlation between catering incentives, measured by dividend premium, and the stock return shows a negative association between dividend premium and the stock return. Such a negative relationship might be caused by the relative growth opportunity of the firms showed by the decreasing number of dividend payers during period of observation.
Keywords: Dividend catering theory; dividend premium, dividend yield, abnormal return.
JEL Classifications: G11; G12; G14; G20; G34; G35
Padang, 23-26 Agustus 2006 K-INT 02 1
Several theories of dividend policy have been offered in the literature of corporate finance for firms to pay dividends. The first dividend theory; dividend irrelevance theory, proposed by Miller and Modigliani (1961) find that dividend policy is “only a financing decision”. The way of income is distributed (in the form of capital gain or dividend) does not affect the overall value of the firm, because of the two assumptions-given the firm’s investment decision and the existence of the perfect capital market. Then, the-bird-in-the-hand theory, suggest by Myron Gordon and John Lintner states that stockholders prefer dividend to retain earnings since dividend is less risky compared to retain earnings. Next, the tax preference theory hypothesizes that investors prefer a low dividend payment to a high pay-out because dividends are taxed at higher rates than capital gains. The dividend clientele theory states that the clienteles of investors becomes the consideration in changing the dividend policy. Meanwhile, the residual dividend theory hypothesizes that dividends are only paid when there are residual earnings after financing of the new investment.
The next theory is the dividend signaling hypothesis suggests that payout to shareholders convey valuable information to the capital market e.g. (Bhattacharya, 1979; Miller and Rock, 1985; John and Williams, 1985) in Lie (2004). The theory predicts that the announcement of changes in current dividend brings information about the future performance of a firm. The empirical evidences associated with this theory are still inconclusive. In the support of the signaling theory, Hanlon et al. (2006) investigates the information content of dividend: whether market can understand and predict future earnings for dividend paying firms.