Investigating the China Stock market crashes and value of dividend signalling theory

Chapter 1.0: Introduction

China Stock market crashes and value of dividend signalling theoryCompany dividend policy is the strategy which allows deciding how earning of the company is to be paid to shareholders at the specific rate. To maximise the shareholders wealth, it is important that manager decided which dividend policy would allow retaining enough income for investment and amount of return for shareholders to determine the impact of their decision on stock prices (Baker and Weigand, 2015).

According to Higgins (2014) and Asquith and Mullins (2015) elaborated that the effect of dividend announcement showed that dividend enclosed information content along with cumulative abnormal returns. Williams and Paton (2014) added that stock prices are affected positively affected by the dividend announcement of the company based on the positive signals for the future cash flows of the company.

Pettit (2016) agreed with the theory of Watt and argued that difference between long-term earning and reported earnings should be large enough to contain dividend information about the future earning of the company. In addition, Aharony and Swary (1980) analysed the dividend information scenario and stated that dividend and earning announcement are closely related. The study used the naïve model to analyse the effect of two factors, which are earnings and dividend.

1.1 Implication of dividend policy for investors and managers

For investors, the value of dividend policy is also important because the dividend is important to the source of income but also allow estimating the value of the company from an investment perspective. According to Miller and Modigliani (1961), the increase in dividend sends a positive message to investors that future earning and reduce dividend means future earning will be reduced.

Bhattacharya (1979) added that despite paying dividends to have tax disadvantage, companies use dividend as the signalling tool to communicate future case expectation. Aharony and Swary (1996) used dividend expectation model and assumed no leakage of information before the dividend announcement days and deliberated examined the dividend timing as well as earning announcement. The result highlighted that dividend announcement have the direct effect on the share price.

For Managers, dividend policy decision is complex and uses of dividend policy to maximise the share of wealth has important implication (Karpavicius, 2014). According to studies of Linter (1956); Miller and Modigliani (1961); and Gordon (1959); dividends are treated as proxy to estimate the future earning of company and when managers want to communicate positive news about performance of their company, they increase the dividend of the company which result in an increase in share price.

Moreover, investors prefer to receive dividend more than future cashflows because of uncertainty and thy want to reduce risk. Morever, Gordon (1962) elaborated that there is the direct relationship between market value of share and dividend policy of the company. Dividend result in share price reaction and consequently leads to information asymmetry between the investors and managers.

In the Chinese context, two-third of firms are control by state and it has the ability to determine the dividend policy of firms. The dividend policy result in agency conflict as state increase case flows for taxes on cash dividend compare to stock dividends. For investors, cash dividends are taxable for shareholders whereas stock dividends are not taxable and i.e. shareholders need to sell their shares for capital gains.Investors have no cash dividend but use share as a vehicle to manage capital gains (Nguyen and Wang, 2013).

Therefore, the purpose of this study is to focus on exploring the effects of the dividend announcement in the china stock market. Specifications focus on evaluation of the relationship and impact of signals on the China stock markets during the recent crashes of the market.

1.2 Research Context – China Stock Market Crash

China’s economy is the world second largest economy and changes in stock market shake the investors across the globe (Yang, 2016). For example, the market capitalisation of NASDAQ is $6.98 trillion USD and value of trading shares is $1.21 trillion. In comparison, Shanghai stock exchange market capitalisation is $4.125 trillion and values of trading shares are $1.69 trillion. Therefore, the efficiency of Chinese stock market is critical for allocation of capital and sustains growth. (Yao, Ma and He, 2014)

However, the first day of trading on 4th January 2016, Chinese stock market opens with big tumbles and market index flooded with green. (In China, when compared with western markets, red represent gain while green represent loss). The stock market crash highlights the volatility presented in the emerging stock markets.

Chinese stock market volatility remained evident with larger swings in share price and valuation. In the first half of 2015, the stock market was down by almost half and august sell off send ripple through market because of panic selling. Later in the autumn, the market was up by 20% before crashing again in 2016. Chinese is the world second largest economy and roller coast behaviour of share price send global ripples. The information content of dividend to signal to investors has remained questionable in Chinese financial market.

Chinese economy and company growth has not changed much and there is still growth and profitability. The financial market structure, volatility and effect of information based on future earnings of firms’ present complex scenario (Yueh, 2016; Riley and Barbieri, 2016).

1.3 Rationale of research – Testing dividend-signalling theory in Chinese’s stock markets

The rationale of this research is to test dividend-signalling theory in context of china stock markets. Dividend policy is used by the managers to communicate with investors and share price reflect the information content of the dividend announced. The dividend signalling theory is focused on the signal today and future performance of the firms.

However, Joyce (2008) stated that two Chinese stock markets Shenzhen (1990) and Shanghai (1991) was opened with the primary objective to raise money for the state as well as state-owned enterprises. The listing of shares in China is managed through ‘split share structure’ in which some shares are available for public while other shares are not.

For non-tradable shares, half belongs to various Chinese institutions while half belongs to government. Gul et al (2010) added that list firm’s tradable shares are directly or indirectly control by government. (Tao, Nan and Li, 2016)

The objective is to analyse dividends announcement impact on share price and connection with future performance in China market context. Dividend announcement highlights the information about the company future performance and i.e. dividends are the important tools to convey the information.

Despite the fact, dividend announcement impact has investiagted but impact of dividend chnages in different time period remain important issue. The research is an attempt to answer how dividend announcement impacts the stock market and does signal theory hold grounds in the china stock market.

The purpose is to investigate how dividend announcement affects the China stock market and signalling theory during recent stock market crashes. (Dedman, Jiang and Stark, 2015)

1.4 Research aim and questions

The research question is focused on exploring the effects of the dividend announcement in china stock market.

  • How the Chinese stock markets behaved on the dividend announcements?
  • What was the impact of unexpected dividend announcements on the share price and performance of the markets?

The research is focused on the two important stock markets of china, which are ‘Shanghai Composite Index’ and ‘Shenzhen Stock Exchange’.

The research examines the China stock market from the CSMAR Trading Database and the CSMAR Financial Database. The variables and information collected is market values, trading volume, market index, split factors, and dividend expectations.

In this research, the focus is on the dividend announcement not on the payment date of the dividend.

1.6 Structure of Study

The first chapter of study enclosed research context and question along with theoretical framework. The second chapter of study enclosed the historical perspective and distintive features of shares on Chinese stock markets. The third chapter of study enclosed the literature review and critically analysed the literature on dividend announcement and effect on the value of the firm. The fourth chapter of study enclosed the research methodology used and model and ffith chapter present the finding of the study. The final chapter enclosed the conclusion of the study.

Chapter 2.0: Background on Chinese Stock Exchanges

2.1 Overview of Chinese Stock Exchanges

When compared with developed stock markets, London Stock Exchange(LSE) as well as New York Stock Exchange (NYSE), China’ Shanghai stock exchange (SSE) is still in early phase of development. Despite the fact, SSE was formed in nineteen century but the communist revolution has restricted trading policies until 1990 has limited the market efficiency. However, the open door policy for foreign investment has led to growth and development of SSE as well as the development of Shenzhen Stock Exchange (SZSE) in 1991. (Howie, 2011)

There are different classes of listed shares on both SSE and SZSE. ‘A’ Class shares are associated with companies from mainland China and traded on both exchanges but are not available to non-Chinese investors.

Moreover, B class shares are available to foreign investors and dominated in the foreign currency mainly USD. B shares are traded on both SZSE and SSE exchanges and the important source of foreign capital for Chinese companies. Moreover, C class shares are also known as ‘Legal person shares’ which is held by any legal person status company or person. The important implication is that shares held by companies, which are owned by state, are classified as non-tradable shares. (Chong, Lam and Yan, 2012; Wei, 2016)

The distinctive feature of china stock market is that 80% of investors are retail investors and this shows that China has underdeveloped asset management industry. Moreover, both stock markets are order-driven when compared to western markets whereas stock markets are quote-driven.

There is daily price change limit of 10% on the stock price to reduce volatility, as well as both institutional and retail investors, have access to information in terms of the microstructure. Chinese stock has evolved recently retail and institutional investors are key driving force in equity market. (Zhang, 2011)

2.2 Reforms in Chinese stock markets

The reforms in Chinese stock market is consist of three phase. First phase is 1979-1993 which include massive economic which prompt the needs of stock market to support Chinese corporation. Economic reforms increase the demand of better resource allocation and market –orientated approach and thus gradual development of China’s capital markets.

The second phase of development is 1994-1998 which include establishment of China Securities Regulatory Commission (CSRC) and consolidation of capital markets. The reform in stock exchange was initiated in 2005, which introduced split shares structure as well as signalled the end for non-tradable shares. (Campello, Ribas and Wang, 2014)

The objective of these shares to achieve suboptimal payout decisions and allowed to help shareholders to liquidate shares in from dividends. The third phase is 1999-2008 which includes promulgation of securities law and legal status of Chinese stock markets. The reforms in the stock exchanges were based on financial reporting environment for listed companies.

The adoption of Chinese accounting standards (CAS) has allowed streamlining companies financial reporting with International Financial Reporting Standards (IFRS). The post-IFRS financial reporting has evident increases value relevance through earning per share (EPS). (Riccardi, 2015)

2.3 Governance and legal system – Capital markets

The recent development includes amendments to company law in 2005 to preserve interest of shareholders, companies and creditors. Moreover, securities law in 1999 involves trading and issuance of securities. The aim of security law is to ensure development of China’s capital as well as deliver growth for socialist market economy. These changes have provided sound regulatory framework and support market development and operations.

The diagram below shows growth in Chinese capital markets after legal and regulatory improvement in 2007. Capital market improvement through pragmatic approach offered liberalisation and institutional improvement has aligned unique social and economic situation in China.

China Stock market crashes and value of dividend signalling theory

2.4 China Securities Regulatory Commission (CSRC)

CSRC performs regulatory and supervisory function for securities market of China. CSRC is public institution located in Beijing and conduct supervision of stock exchange under ‘Securities law of the People Republic of China’. CSRC ensure operations and order of capital market acting as unified regulatory commission. CSRC is managed at ‘ministerial level’ and structure is composed of one chairman, four vice chairmen as well as disciplinary commission. CSRC has 36 provinces securities regulatory bureaus, municipalities, Shanghai Commissioner Office and Shenzhen Commissioner Office.

The supervision and administration of stock market performed by CSRC under relevant law and duties include drafting law for securities regulation, vertical administration, supervision of trading as well as management of bonds. The goal of CSRC is to improve governance of capital market, control malpractices, market efficiency and transparency and enhance regulator effectiveness. The table below summarised the regulatory organisation for capital markets in China. (Javvin, 2012)

Table 1: Regulation and Supervision Organisations

Chapter 3.0 Literature Review

3.1 Introduction

This chapter of study is enclosed the literature review and discusses the information effect of dividend on the value of the firm as well as the effect of dividend on the value of the firm.  The structure of this chapter is based on three main sections. The first section of study critically reviewed Information effect of dividend on the value of the firm. The second section enclosed the literature to review the effect of dividend on the value of the firm in the emerging market context. The third Section of Study reviews dividend effect on future performance in light of empirical research.

3.2 Information effect of dividend on the value of the firm

3.2.1 Information asymmetry and dividend policy

Miller and Rock (1985) suggested that changes in dividend policy of company communicate information about the future cash flow of the company. The model proposed that agency theory rises economic notion though information between investors and managers. The clientele effect suggests that the key reason investors attracted to the company is the dividend policy. The theory assumed that investors have rational behaviour, zero taxes and no transaction cost.

The finding of the study highlighted that under the perfect capital market the dividend policy of the does not include information about the future performance of the company. According to Baker (2009), manager of the firms cannot announce all information related to the firm because of a risk  of competition exploiting confidential information (Agarwal et al., 2015).

This creates asymmetry of information between the managers and investors. This rise agency conflict between shareholders and corporate insider (managers). The conflict of interest between the shareholders and managers does not result in best interest of shareholders.

Therefore, several studies analysed dividend policy hypothesis of the information asymmetry has been presented. The signalling theory proposed that dividend policy of firm enclosed important information content and thus dividend announcement contain information to communicate about alternative announcement (Lang and Litzenberger, 1989).

3.3 Information content of dividend and Signalling hypothesis

The asymmetric information has highlighted the importance signalling theory and known as information of the dividend hypothesis.  Miller and Modigliani (1961) hypothesised dividend announcements to examine shareholders reaction to the information content and its influence on the share price. The ‘information content of dividend’ and suggested that future earning expectation effect dividend payout decisions and changes in the dividend policy convey information regarding future earnings.

Miller and Rock (1985) highlighted that dividend information is the primary source of fund identity based on earning description. Dividend policy sends explicit signals to shareholders about the future cash flow. There changes in dividend policy (increase or decrease) result in changes in the stock price (increase/decrease) and thus, dividend communicates about the future earning of company and effect stock price (Friend and Puckett, 1964).

The three important implications associated with dividend information signalling hypothesis the first factor is unanticipated changes in the dividend need to accompany with the stock price in the similar direction. The second factor is dividend changes must be followed with earning changes of the firm in the same direction. The third implication involves unexpected changes in dividend policy must be revised according to future earning expectation in the same direction as dividend change (Wilson, 2015).

The signalling theory hypothesis implies that there is the positive relationship between price changes to dividend and dividend changes.in addition, there is a positive relationship between future earning of firm and dividend changes. Moreover, signalling hypothesis highlighted that analysts and dividend changes forecast the future earning of a firm (Dicle and Levendis, 2014).

3.4 Information content of dividend and emerging market

The literature in relation to corporate finance both empirical as well as theoretical examines the range of scenario beyond the dividend payment issue and their implication for the stock price. The reaction of the stock price is associated with investment opportunities and results showed that companies with superior investment opportunities have the positive effect on share price when compared with companies with inferior investment opportunities.

Company distribute a dividend in the form of stock or regular cash and payment depends on upon dividend policy. The investment decision and distribute stock capital effect the share price of the company. The dividend announcement and market reactions are rather heterogeneous which vary according to the country specific characteristic (Landsman, Maydew and Thornock, 2012).

3.4.1 Empirical literature content of dividend and Signalling in Chinese context

The evidence from the emerging market (table 1) highlights that not specific focus is given to the dividend announcement. Moreover, Pettit (1976) agreed on the efficient market hypothesis through estimating accuracy and speed to adjust the indicator for the information embedded in dividend announcements. The finding of the study shows that there is a quick reaction to the dividend announcement (Abdullah, Rashid and Ibrahim, 2004; Chowdhury, Reza and Zhang, 2014).

The purpose is to clarify two important aspects which are; 1) the effect of the announcement on stock prices changes in light of unanticipated dividend changes; 2) prediction of future earning and effect on stock prices in light of unanticipated dividend changes.

The table 1 below summarise the studies which evaluate the announcement effects in Chinese context to examine effect on share prices and unexpected dividends to test the signalling hypothesis of dividend (Joliet and Muller, 2015).

Table 2: Studies evaluate the announcement effects in Chinese context

AuthorMarket

Study

Chen, Firth and Gao (2002)Chinese marketRelationship between changes in profits and stock returns
Cheng, Fung and Leung (2007)Chinese marketprofitability and cash flow
Chen, Nieh, Chen and Tang (2009)Chinese marketEffect of cash dividend changes

3.5 Effect of dividend on the value of the firm

3.5.1 Dividend content and value relevance

Miller and Modigliani (1961) presented research paper with the assumption of perfect capital, which partly contradicts with Linter study. The study analysed optimal dividend payout ratio and stated in the scenario of perfect capital market transaction cost and taxation is relevant only. The finding of the study stated that dividend policy is irrelevant because share price is indifferent based on dividend payment in the future and i.e. dividend policy is irrelevant to determine the market price.

Miller and Modigliani (1961) highlight that under certain assumptions for the perfect capital market the dividend policy of the firm is irrelevant. In the perfect market, there is no reaction on the company share price and shareholders wealth is not affected by the dividend decisions of the firm, and investor is indifferent between the capital gains and dividend announcements.

Therefore, dividends are irrelevant and the share value is determined based on the investment decision and earning power of company (Michaely and Roberts, 2012).

3.6 Value Relevance and information content

Financial statements are the important source of information for investors to ascertain the value of the firm. The valuation of the firm from the financial statement allows the investor to evaluate the stock price of the firm. The financial reporting enables the investors to obtain information relevant to estimating the company value. The purpose of value relevance research is to identify the relevance of accounting information for the investor to estimate the value of the firm as well as sources of information to estimate the value relevance.

Huang and Zeng (2016) suggest that the lower cost of equity is associated with increased value of the firm. This attributed that investor concern with value relevance because it contributes towards lower information risk. The lower of cost capital result in increased level of investment and value relevance have the significant effect on the value of the company. The investor use of accounting information is optimal and value relevance is related to market efficiency.

The study of Hughes, Liu and Liu (2007) conclude that market efficiency affects investor and causes biases. The adjustment procedure is to correct market reaction and delayed market reaction in the market. The finding of study highlights that regression coefficient on book equity and earning increased when compared to unadjusted stocks.

Easton, Harris and Ohlson (1992) analysed the effect of information content with return earning associations. The finding of study highlight that lack of timeliness in the short-run but data showed positive correlation between cash flow and return in the long-term (Kane et al., 2015).

The value relevance literature for earning and cash flow elaborate how accounting changes influence market equity. The empirical studies on value relevance and cash flow highlight that value of the company is the present value of future cash flows. Valuation theory highlights that increase by one dollar in earning result increase in dollar value of stock by one dollar. The share price of the company adjusts according to goals and demand investors in reaction to a dividend policy of the company (Landsman, Maydew and Thornock, 2012).

The theory elaborates that investors are attracted to the company based on the dividend policy and when dividend policy changes investor adjust their share accordingly. When a company pays a higher dividend, it attracts the clients with the goal of high dividend payout. However, when the company changes the policy investors sell shares and buy shares of the company, which pay the higher dividend.

Ali and Hwang (2000) evaluate that tax rules affect the value relevance because of accounting regulation. Therefore, value relevance of earnings is accounting policies with accounting conservatism (Dedman, Jiang and Stark, 2015).

3.7 Dividend signalling and information environment

An investor can assess the information about the firm when improvement are made in the information environment. With the effective and reliable source of information, the investor can update knowledge of firm and cost of tolerance of signalling in good information environment is lower. The good information environment improves the effectiveness of signalling purpose and firm can communicate value relevance with investors. The improve financial reporting reduces the information shocks and firms can increase or decrease dividend payout without much effect on the share price of the company (De Cesari and Huang-Meier, 2015).

An investor in good information environment price the firm with weight average cost of capital compares to poor information environment in which investor price the firm above the weight average cost of capital. In poor information environment, the reaction of investors is high upon release of the signal. Therefore, in good information environment dividend announcement as signal reduce the cost of tolerance for the investor.

When investor can value the firm based on good information environment and it can avoid pooling, then signal is lesser effective and result in lower information asymmetries (Modi, 2015; Boubaker, Hamrouni and Liang, 2015).

3.8 Dividend information and performance signalling

3.8.1 Dividend content and performance of firm

The market reacts to changes in dividend payout and information content which is reflected in share price. The increase or decrease in the dividend sends information shocks through the market and i.e. cuts or omission in dividend lead to a subsequent decrease in the share price. On the other hand, movement in security prices which investor perceived result in value increase is taken as the good sign by the investors. Dividend is considered as an important source of information but there is also debate that earnings of the firm also send important signal investor and vital factor of dividend policy (Kale, Kini and Payne, 2012).

The future cash flows are important determinants of dividend decision of the firm. The imminent factor is that dividend signal about future cash flows and dividend signal about current and future cash flow of the company. According to Joliet and Muller (2015) stated that when dividend are announced the share price tends to go up and when companies cut the dividend the share prices falls.

3.9 Empirical studies on dividend content and performance

In the past, various studies have been conducted to examine the relationship between risk, profitability, earning and dividend changes. The result of studies conflicts to the extent because some studies support the notion that future earning are predicted by dividends while some studies stated that there is not enough data to draw conclusions. The study of Grullon et al (2005) examined a sample of 145 firms, which experienced the decrease in earning and found that 68% of the firms increase dividend while 31% has remained dividend unchanged. However, managers were reluctant to cut the dividend to communicate future cash flows.

DeAnglo et al (1997) examined the sample of 99 firms for increased dividend using random walk model and abnormal earnings. The result of the study showed no positive earnings surprises that increased the dividend. Moreover, the random walk model highlighted that there is no deviation in earning but negative earnings surprises. The companies increase the dividend despite reduction in earnings and therefore, result of study highlighted there is no positive correlation between dividend and positive earnings.

Dividend announcements are linked to market reaction and empirical data shows that investor react to dividend changes and thus information contents are useful communication tool to convey information about company performance (Bagdonavieus, Kruopis and Nikulin, 2013).

Landsman, Maydew and Thornock (2012) argued that the failure of dividend decisions to make the prediction about the future earnings of company attributes to managers for being overly optimistic about the future of the company and use the dividend to signal about future earnings to manage the share price. The use of dividend as signalling for future earnings are  own appraisal of the management of the company which decrease the information reliability for the investors. The overall increase in dividend is relatively small and has insignificant cost increase for the company.

Thus, the cost of signalling is low and increase the likelihood of the false increase signals. In addition, the study of Nissim and Ziv (2001) that to effectively predict the future earnings, it is important determinants such as Return on equity should be used. The result showed that increase in ROE is the indicator of reduce earning while low ROE results in increased earning of the company. Therefore, ROE and dividend payout are positively related and expected cash flows negatively correlated with changes in dividend.

Chapter 4.0: Research Methodology

This chapter of study enclosed research methodology used to collect and analyse the research question of the study. The research design is critical to answering the research questions and success of research depends on upon the design of research. The secondary data used in this research is collected from CSMAR Trading database and CSMAR financial database. (Krishnaswamy, Sivakuma and Mathirajan, 2009)

4.1 Data — CSMAR databases

CSMAR (China Stock Market and Accounting Research) database is developed and designed by GTA information technology. The database is known, as GTA CSMAR is a comprehensive source of data for China stock market and corporations. The database covers Chinese stock market, corporate governance and financial statements of listed companies. The database offers comprehensive data, which covers all A, B and C class shares of a company listed on both Shenzhen stock exchange and Shanghai stock exchange. The stock market data, as well as corporate data, covers data from 1990 to present through offering standardised data presentation.

The advantage of CSMAR database is that it offers comprehensive range of data for trading of all types of shares in both stock exchanges in cost effective manner. However, the legal aspect of use of CSMAR database is that offers limited support for academic use of data. (CSMAR, 2016) To overcome the limited use policy of the database, quantitative secondary data from yahoo and Google finance will be incorporated to validate and increased reliability of result of study.

4.1.1 Data Sample

The study evaluates the stock and cash dividend announcement to investigate the effect of announcement on stock return of the companies listed on Shenzhen stock exchange and Shanghai stock exchange. The sample size reduced to 400 companies who declared dividend during the stock market crash period. To test the dividend signalling theory, Chinese list firms declared stock dividend, cash dividend or both from July 2014 to April 2016 is selected. Ordinary least squares model (OLS) is used to test performed two test p-values (LOGIT) and t-statistics and regression test is performed using STATA.

For this study, day 1 is defined as hypothetical event on which dividend announcement is made. The methodology details enclosed below. The period selected to include the stock market crashes on 2015 and 2016. (Andrews, 2012) Data related to following variables are collected includes EPS (earning per share), expected dividend, split factors and adjusted values, trading volume as well as market values. In addition, data related to performance measures is collected which includes Return on equity (ROE).

The important data such as announcement of dividends not payment were collected from annuals reports because it is useful to manage the adjustment for dividend announcement. The market adjust for dividend on the data it announced rather on the payment of data and thus. Dividend announcement dates selected. The table 3 below summarised the primary data sample.

Table 3: Primary data sample


Source: Author calculations

4.2 Method, testing and model specification

4.2.1 Event study method

Event study method is useful to analyse announcement and market reaction because new information result informed the investor about particular event. The stock moves because the information is unexpected and important. The new information is likely to move the shares if it not known to investors. In case, information already known to investors, stock price are less likely to move as adjustment in the market already made.

Therefore, investors react to announcements which contain new information and reaction is based on content of information and expectations. The figure 2 below shows the ‘sample announcement’ for next dividend in terms of time of a company. (Cowan and Sergeant, 1996; Calin, 2015)

The event window represents the time when announcement is made and estimation period show normal return before the stock. The common approach is managing 150 observations for the estimation period and it is used in this study. The variance for the time period is calculated through statistical test and significant differences show that effect of particular event. To visualise the data for the event study, CAR graphs are used. The empirical studies I Chinese context highlight that investors react to announcement made in the fourth quarter with time frame of 5 days.

For this study, two specific event studied are 3 days (+1 or -1), 11 days (+5 or -5 days). The estimation is managed through calculating the normal return before the event and abnormal return. The abnormal return is studied as difference between estimation and actual return. (MacKinlay, 1997) The CAR model for the event announcement study to highlight the abnormal return (An) is given below

CAR represents the sum of the company present in the particular group and entire group is analysed to determine the performance. To analyse the event window, graphs are enclosed and elaborated using the descriptive statistics. (Barnes, 2016) The estimation formula is

4.2.2 Statistics test

To determine the impact of dividend signalling theory for Chinese companies, two parametric and two non-parametric tests are performed. These tests are performed using the Stata to derive the results with border perspective. (Pagano, 2008)

Parametric test are useful to measure the variances and for this study, it is useful to analyse the dividend announcements and investor expectation. Two tests are performed to adjust for the data and simple t-test is used for the event study.

The first performed is cross sectional dependence which assumes that residual interdependent is correlated between the return from the stock.  The test of announcement for stock represents zero on any day. The model is used to calculate t value for the specific event and equal the estimation period which is 150 days.

The t-value in the model for particular event and testing market reaction is shown. The result of test showed that in the dataset normality was not found and thus non-parametric test. The second parametric test performed was test of variance adjusted abnormal return. The purpose of this was to estimate the variance in estimation and abnormal return. Therefore, purpose was to examine the variance for particular event window. (Gravetter and Wallnau, 2007)

The non-parametric are useful in case the assumption for the parametric test is not met. The normality problem in cross-sectional dependent test is basis of selecting non-parametric test. The advantage of non-parametric test is that it does not assume the normality for the variables and in case of non-normality, this give results than parametric test.

The risk associated with parametric test is type I error and non-parametric test are useful to examine the small samples. The first test performed is rank test which is useful to study the asymmetry for the information content and check for the variance in the estimation period. The rank test is useful to analyse abnormal returns and standardised the missing values.

Nevertheless, the problem associated with rank test is that all values gain equal weight irrespective of size and differences. The second non-parametric test performed is generalised sign test and it is useful to allocate sign to abnormal event. In this context, negative sign gets 0 whereas positive sign gets 1. The adjustment made using the skewness and expected values are observed. (Bagdonavieus, Kruopis and Nikulin, 2013)

4.2.3 Regression analysis

The useful of regression analysis for this study is to explain the unexpected announcement for dividends. In the context, semi-strong market efficiency, market is likely to react to the unexpected information. The reaction of investor is to unexpected dividend which is expected minus the actual dividend. The difference defines the market sentiment and regression for this study includes the increase the no dividend or increase dividend. (Chatterjee and Hadi, 2013)

However, a decrease dividend perspective is ignored

The model show UP as increase in dividend, NO represent no dividend announcement and n is the dummy variable. Whereas UE shows the announcements of dividend at time (t). To examine the performance, a signal variable of ROE is examined which is represent as ROE (i, t)

Chapter 4: Empirical Results and discussions

This chapter of study present the descriptive statistics and empirical results. The sample size shows 400 events to represent either change in dividend or no change (announcement). The table below summarise the observations made under the two categories. There are four categories tested to see the market reaction and observe the market reactions. The aim is to examine the each group in isolation to ensure that wider perspective analysed.

The above data shows that CAR is positive for an increase in dividend but in the case of no dividend, CAR is negative which shows data does not reconcile with empirical results. Therefore, in China companies do not announce the dividend has dropped in their share price. The positive CAR shows that market reacts positively to the increase in the dividend. The imminent factor is that dividend signal about future cash flows and dividend signal about current and future cash flow of the company.

Therefore, dividend announcement is perceived positively by the investor but in groups without a dividend, the stock market shows value decreased. The CAR graph below shows the two events which are dividend increase and no change in the dividend. The figure 3 depicts the 11 days event (5,-5) dividend increase have the positive market reaction. The result shows that dividend announcement perceived positive by the customers whereas no dividend gives negative sentiments. The fluctuation in the China market which highlights the random increase and decrease depicts the effect of positive market sentiments.

Figure 3: Event Widow Days – Cumulative CAR

The result table 3 shows the reaction to the announcements has influence on the share price of the Chinese firms. The two categories are tested which are dividend announcements and no change in the dividend and confirms the effect of dividend signalling theory in the Chinese market. This study examine the data in the context of announcement date and statistics of parametric an non-parametric tests are shown below

Table 4: Dividend increase — P-value and t-value

Dividend increase – Statistics results (10 observations)

The result shows that CAR is negative in case company has not announced the dividend but unexpected announcement shows the positive market reaction. To check the reason behind the positive and negative CAR, a regression is useful to unfold the events.

Aharony and Swary (1996) used dividend expectation model and assumed no leakage of information before the dividend announcement days and deliberated examined the dividend timing as well as earning announcement. The result highlighted that dividend announcement have the direct effect on the share price.

The result shows that stock market reacts to dividend announcement and in China stock market stock index seasonality is associated with information content of dividend. The regression analysis is performed for both event and groups and results is summarise in the table below

Table 5: Dividend increase and regression analysis

The positive result for the dividend increase show the consistency and show support the dividend signalling theory in Chinese context. Nevertheless, the sample size is small but finding shows positive relationship between signalling theory and investor reactions.

Lang and Litzenberger (1989) the signalling theory proposed that dividend policy of firm enclosed important information content and thus dividend announcement contain information to communicate. The regression analysis confirms the communication affect the value of company shares.

The Random fluctuation is evident from the positive relationship and random increase in the stock market index highlight the value of signalling theory.  Similarly, table 5 below summarise the t-test and p-values for the no change in dividend hypothesis.

Table 6: No change and Dividend — P-value and t-value

No change Dividend – Statistics results (10 observations)

The table 5 above summarise the information content for the no dividend. The results show that positive value for the no change in the dividend. This represent that no new information does not prompt the reaction of the investor. Dividend policy sends explicit signals to shareholders about the future cash flow. There changes in dividend policy (increase or decrease) result in changes in the stock price (increase/decrease) and thus, dividend communicates about the future earning of company and effect stock price.

Dividend policy is used by the managers to communicate with investors and share price reflect the information content of the dividend announced. This validates the fact the dividend policy of firm affects the value of firm and information content affect the reaction of investors. The negative results are consistent with the literature and show new information for the investor reduces the share price of the company. To examine the factor behind the change in the prices, the table 4 below summarised the regression results.

Table 7: No Dividend and regression analysis

The regression analysis shows that no dividend announcements have negative CAR and signalling theory suggest investor react to market sentiment rather the value of the firm. The sample size is smaller but findings show support for the signalling theory. The above table summarises the response of investor for the announcements. The results confirm the study of Chen, Nieh, Chen and Tang (2009) and stated that dividend communication affect the stock price of company.

The reaction to dividend increase and no change is evident semi-strong efficiency and new information content emerged, the market reacts to the news. The table 7 below summarised the regression analysis for the unexpected announcements of dividend for the two event windows selected for this study.

Table 8: Unexpected Dividend and CAR

The result for the dividend table 7 shows a positive result for the selected event window and it confirms the theory. The positive result shows that announcement affects the investor and random fluctuation represents the quarter where Chinese firms declared the dividends.

The insignificant p-values show the effect of unexpected dividend announcements in the Chinese stock market context. This shows the value of the signalling theory in the Chinese context and firms with announcement has the positive reaction from investors whereas no announcements send the panic signal in the market.  Similarly, the table 8 below summarise the coefficient values for no divided and effect on CAR.

Table 9: No change in dividend and CAR

The table 8 shows the negative CAR values in case of no dividend announcements which highlight stock market collapse in case investor cannot value the firm. The low R values and t-value shows that investors use the information content to value the firm and consequently, it affect the stock price. The random fluctuation enclosed the period when company announced dividend and stock index gains whereas in subsequent prompt the decrease in share price because of lack of information.

The information content and value of firm have significant exploratory factor of dividend. The announcement affect the price of the stock and signalling theory validate as investor perceived positive value attached to the information content. The no information shows negative sentiment of investors and in quarter there are no announcements or information for the investor, the price of stock dropped and negative index. Therefore, signalling theory explains the random positive and negative fluctuation during different quarters and theory validates the finding in the Chinese market context.

The study of Hughes, Liu and Liu (2007) conclude that market efficiency affects investor and causes biases. The investor use of accounting information is optimal and value relevance is related to market efficiency. The two specific events examined are dividend announcements and increase firm value as well as dividend announcement and no change in the value of firm. The table below summarise the descriptive for value and dividend.

Table 10: Value Relevance and information content

The table 9 above summarise the result of announcements and is effect on the value of firm. The announcements and firm value have strong positive relationship and CAR result shows that how three groups outperform each other in the market. The effect of dividend on firm value is higher when with other groups. Dividend announcement highlights the information about the company future performance and i.e. dividends are the important tools to convey the information.

The positive CAR for the no value change between there are no empirical evidence to support the fact. The table highlight in certain cases dividend has no relationship with value of firm but affect the share price of company. To specially elaborate the impact of dividend and firm values t-values and p-values are observed. The table below summarise the results for dividend announcements and no change in firm value.

The results show that announcement has a positive association with the value of firm and information content. The accounting information has no direct market reaction investors sell shares and buy shares of the company, which pay the higher dividend. Unexpected announcement has affected the share price but significant p-value shows the stronger relationship between announcements and value but no empirical data existing to support. The information content affects both stock price and value of the firm.

The use of information content to signal the firm performance is examined in independent context but a limited number of observations are conducted. The information content of dividend increase/announcements and no changes in dividend is measured to analyse the performance perspective. The table below summarises the p-value and t-value for the return on equity and investor perception of firm future cash flows.

Table 11: Performance, unexpected dividend and Value of firm

The negative coefficient for the dividend increase shows that dividend increase is associated with the value of firm. The performance of the companies has no direct relationship with the stock price movement and thus no support for the theory. De Cesari and Huang-Meier (2015) added that in poor information environment, the reaction of investors is high upon release of the signal.

Therefore, the relevance of information and firm performance is lesser evident in China stock market context. Nevertheless, study examines the limited number of observation and larger dataset is useful to further validate the results. Company distribute a dividend in the form of stock or regular cash and payment depends on upon dividend policy Moreover, the similar test to determine the relationship between performance and performance of firm in case of no dividends are announced is explored below.

Table 12: Performance, no dividend and Value of firm

Landsman, Maydew and Thornock (2012) added that ROE and dividend payout are positively related and expected cash flows negatively correlated with changes in dividend. However, the results showsweaker relationship between the performance and dividend of compan. The decrease in the performance leads to reduce in the value of firm which is consistent with the literature.

On the other hand, significant t-value shows that increase in performance does not have a significant relationship with the increase in the stock price. The result clearly shows the relationship between the performance and stock price of the firm. In the Chinese context, improve firm performance does not a significant relationship with the stock price but dividend and signalling theory is valid in China stock market context. There is no relationship between the dividend announcements and performance of the firm.

Chapter 5: Conclusion

The objective of this study was to test the dividend signalling theory to elaborate the relationship between information content, firm value and performance of the firm in Chinese stock market. The parametric, non-parametric, as well as regression analysis, were used to explore and explain the relationship between the variables. The result shows the strong relationship between the information content and reaction of a market in China.

The random fluctuation in the market is associated with the announcement and during the period of dividend, stock market index have upwards trend. The theory holds valid in Chinese stock market context which allows explaining the variation in the stock market. The market reacts to information content to perceive the value of the firm and subsequently, it affects the stock price. In addition, regression analysis confirms the dividends have strong relationship and it is important variable to explain the reaction of market.

The information content of dividend is reviewed in this study using the event approach to examine the effect of dividend content and stock prices. To examine the relationship CAR is used to examine the event and employing multiple analysis has allowed examining the relationship from perspectives. In this study, CAR is dependent variable to elaborate the result positive as well as negative CAR values were calculated to estimated the relationship between a value of the firm, information content and performance.

The study has highlighted the mix results through examining the events. There is the strong positive relationship between dividend content and market reaction. On the other hand,  negative CAR has shown positive impact which is difficult to support the empirical data. The statistical analysis has found the positive relationship between the dividend content but does not hold for the performance of firm and dividend in Chinese context.

Miller and Modigliani (1961), the increase in dividend sends a positive message to investors that future earning and reduce dividend means future earning will be reduced. The result shows that dividend announcement perceived positive by the customers whereas no dividend gives negative sentiments. The fluctuation in the China market which highlights the random increase and decrease depicts the effect of positive market sentiments.

For investors, cash dividends are taxable for shareholders whereas stock dividends are not taxable and i.e. shareholders need to sell their shares for capital gains.Investors have no cash dividend but use share as a vehicle to manage capital gains. However, the study has highlighted that investors are more inclined to the dividend rather capital gains and thus dividend announcements affect the share price of companies in China.

For example, fluctuation in the market in 2015 first half and increase in autumn by 20% is explained by signalling theory. Chinese firm announcement dividend during the period which shows positive sentiments of the investors. The information environment in China affects the share price and release of information result higher reaction of investors.

The two important questions of the study were to explore the effect of dividend announcement on China stock market. The first question was how the Chinese stock markets behaved on the dividend announcements. This study answered the question through elaborating the reaction of the market in response to the dividend announcement. Company pays a dividend to reduce volatility and dividend signalling theory is valid in China stock market.

The second question of study was the impact of unexpected dividend announcements on the share price and performance of the markets. The study shows the relationship between the performance and firm value but no support for dividend changes and investor reaction. The test of signalling theory is managed from a different perspective including the correlation between the value of the firm as well as the performance of the firm and its effect on the stock price.

The regression analysis showed the stronger relationship between information content and market reaction but there is a weaker relationship between the performance of firm and market performance. The test of signalling hypothesis holds valid in Chinese stock market context to signal the market. The dividend policy and performance have no relationship and thus no empirical evidence for the dividend signalling hypothesis in Chinese context. However, stock price affect because of number of variables such stock repurchases and macro-environment variables and these variables set the future direction of research to examine the stock market in China.

 

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