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Research Proposal Event Study

This research proposal aims to investigate the impact of dividend announcements on stock market returns in the Chinese stock market in 2010. Specifically, it will conduct an event study of dividend announcements from the Shenzhen Stock Exchange to analyze the effect on abnormal stock returns. The literature review discusses major dividend theories and previous findings of positive stock price reactions to dividend increases. The methodology will use regression analysis to examine the relationship between dividend announcements and stock returns for a sample of 60 companies from 4 sectors, controlling for company growth rates. The results and conclusions will help understand the signaling effect of dividends in an emerging market context like China.

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Theodor Octavian Ghinea
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98 views

Research Proposal Event Study

This research proposal aims to investigate the impact of dividend announcements on stock market returns in the Chinese stock market in 2010. Specifically, it will conduct an event study of dividend announcements from the Shenzhen Stock Exchange to analyze the effect on abnormal stock returns. The literature review discusses major dividend theories and previous findings of positive stock price reactions to dividend increases. The methodology will use regression analysis to examine the relationship between dividend announcements and stock returns for a sample of 60 companies from 4 sectors, controlling for company growth rates. The results and conclusions will help understand the signaling effect of dividends in an emerging market context like China.

Uploaded by

Theodor Octavian Ghinea
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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Research proposal

Title: The Impact of Dividend Announcement on Market Returns in

Chinese Stock Market in year 2010

Aims:
An event study with a sample of dividend announcements from Shenzhen Stock
Exchange in China during the year 2010 was used to investigate the announcement
impact on abnormal returns. This research investigates the effect of different
dividend policy on stock market return. Empirical analysis results show dividend
increase normally followed by positive abnormal return. Investors’ expectation
amended according to different dividend policy. This project is trying to find whether
the same performance exist in Chinese stock market. China is experiencing significant
economic influence in globalization which can be shown by strong economic growth
rate and stock market performance. Therefore, a study of China’s stock markets and
investor behaviour can not only discover the effect of dividend announcement on
market return on an emerging market, but also provide a reference for investor
decision making and Chinese government policy making.

Literature Review:
Dividend policy has been a controversial issue in corporate finance for several
decades. Many researches have done on dividend policy through finding the
relationship between the dividend level and value of a firm. Ian W. Marsh and David
Power (1999) both find the same conclusion on their market based event studies that
dividend announcements affect share prices before and after the day of the
announcements. Gordon (1959) provides an approach to value firm value. Based on
his argument, increased dividend payout should followed by firm value increase.
Miller and Modigliani (1961) suggest that under assumptions of a perfect and
efficient market, firm value would not be affected by current and future dividend
decisions, if the net profits, investment opportunities and debt policy are fixed.

In real world, these perfect market assumptions hardly exist and individuals normally
cannot borrow or lend at the same rates as firms do. Some inconsistent dividend
theories have been developed sequentially to explain the relationship. The most
famous ones are tax clientele effect, information asymmetric/dividend signalling and
agency problems. As information asymmetry exists between insiders and outsiders,
dividend payout act as a signalling vehicle of a firm’s future cash flow, which
conclude the share price moves towards the same direction as dividends payout.
Signalling theory was developed by M. Spence (1973) which states that dividend is a
signal of current and/or future corporate profits. According to this theory, dividend
announcement and share price are positively correlated. Dividend increase is a signal
of favourable future performance, therefore followed by an increase in share price.
On the other hand, dividend decrease contains information of a worsening future
performance would lead to share price drop. The response of dividend
announcement is likely to be affected by which direction do dividend change,
increase, decrease or unchanged. Pettit (1972) discoved that no matter how earnings
performance were, share price rise after positive dividend announcement and drop
dramatically after a negative dividend announcement.

Most of the research result on stock market reactions shows dividend


announcements are act as signalling vehicle; especially unanticipated dividend
changes contain information of management’s attitude towards company’s future
investment opportunities, cash flows and firm value changes. As a result of
information asymmetry, outside investors who only obtain limited information about
firm’s future performance would regard dividend changes as an important signal of
firm value. Therefore, they make their investment decision partly on these dividend
announcements which lead to share price changes. Viera and Raposo, (2007) argue
that share prices have inverse relationship with dividend announcements based on
many practical cases. However, there is no further findings that support such opinion.
Moreover, their research result is inconsistent with the dividend signalling hypothesis
and the positive relationship between dividend announcements and future earnings.

Data Sources and Research Methodology:


Estimation period and Event Window
An event study is chosen to investigate the effect of dividend announcement and
share price changes. Announcement date together with pre and post event market
date are collected for the event study which is 10 days before the announcement
date and 10 days after it (figure 1). For every stock selected, the observation period
of 121 days is used for the event study. Days Start at -110 and end at day +10 of each
stock. The first 100 days of this period is from -110 to -10 which is designed as the
estimation window, and day -10 to day +10 is the event window. T-test is applied to
interpret and analyse the data on the twenty-one day event window.

Research Design
The research is designed around 2 variables which are independent variable – the
dividend announcement and dependent variable – the share price.
CAPM model is used to analyse normal returns and abnormal returns before and
after the dividend announcements. The company returns and market returns would
be calculated using the following formula;

Rit = ln (Pt / Pt-1)


Rit represent the return of security i at day t, Pt represent closing price at day t after
relevant adjustment like stock split and Pt-1 represent closing price at day t-1.

Rmt = ln (It / It-1)


Rmt is the average return of the market during day t, It is the closing price index at
day t and It-1 is the value of previous day index.

CAPM model is used to derive the relevant parameters.


Abnormal return of sample firms is estimated by market model which suggests linear
relationship exists between single security return and market return, or:

Ri = αi + βiRmt + εi
Where Ri is return of ith security during the trading day t, Rm is the return of the
whole market at trading day t, andεit is the random error associate with any factor
that only affect ith security. The intercept αi and the slop βi together show the linear
relationship between individual securities and the market return of sample firm in
the event window.

Abnormal Return is used to describe the return of an individual security or a portfolio


over a period of time after deducting the expected or predicted rate of return. In this
project the expected return is estimated based on the CAPM model.

AR ¿=R ¿−α i− βi Rmt


Abnormal Return = Actual Return – Normal Return

Signalling theory will be tested by examine the impact of dividend announcement on


stock market. Dividend is mainly determined by firm’s overall performance which
contains earnings and future cash flow (Andreas Charitou, Nikos Vafeas, 1998).
Therefore, firms with good performance are expected to distribute more dividend
than the previous period. A positive dividend announcement followed by positive
response increased stock price. The event being studied is the effect of dividend
announcement on share price. To discuss the adjustments brought by dividend
announcement on share price, a hypothesis is made as follows:
H0: significant association do exist between dividend announcement and share price
in Chinese stock market
H1: no significant association exist between dividend
announcement and share price in Chinese stock market.
Sampling
The sample was collected from all A-share firms listed on Shenzhen Stock Exchange
and dividend announcement during the year 2010. The dividend announcement days
and share price information are obtained from Thomson One Banker resources and
Yahoo Finance website. In order to make comparison between different industries,
securities are split into 4 sectors: IT, manufacturing, Social Services and Real Estate.
15 securities are selected for each sector, therefore 60 securities in total.

Data Analysis
I choose to use the regression model to derive relevant parameters by SPSS software.
Through regression analysis, the model will be discussed by concentrating on the
abnormal return and accumulated abnormal return. The significance of the dividend
announcement effect on stock return will be discussed. Sampled companies will be
split according to whether they have high, medium or low growth rate, and then
detailed analyse will made on different groups.

Structure of the Project


The rest of the project will be structured as follows. In Chapter 2, I will review the
theories and empirical evidence relating to the dividend announcement and firm
value, and then formulate relevant hypotheses on this paper. In Chapter 3, I will
describe the data collection method, data sources, and statistical issues. In Chapter 4,
I will describe how the methodology and models are applied. Most importantly the
research result will be presented in this Chapter 5. The final part is the research and
conclusion.

Reference:

[1] Acker, D. (1999). “Stock Return Volatility and Dividend Announcements.” Review
of Quantitative Finance and Accounting: 12(3), pp. 221-243.

[2] Adelegan, O. J. (2003). “Capital Market Efficiency and the Effects of Dividend
Announcements on Share Prices in Negeria.”

[3] Aharony, Joseph, and Itzhak Swary. 1980. “Quarterly Dividend and Earnings
Announcements and Stockholders’ Returns: An Empirical Analysis.” Journal of
Finance: 35 pp.1-12.

[4] Bar-Yosef, S. and R, Kogodny. “Dividend Policy and Capital Market Theory.” Review
of Economics and Statistics: 58 (2), pp. 181-190.

[5] Charest, G. (1978). “Dividend Information, Stock Returns and Market Efficiency.’
Journal of Financial Economics: 6 pp. 297-330.
[6] Eades, K.M. (1982). “Empirical Evidence on Dividends as A Signal of Firm Value.”
Journal of Financial and Quantitative Analysis: 17 (4), pp. 471-500.

[7] Elfakhani, S. (1998). “The Expected Favourableness of Dividend Signals, The


Direction of Dividend Change and The Signaling Role of Dividend Announcements.”
Journal of Applied Financial Economics: 8 (3), pp. 221-230.

[8] Gordon, Myron. 1959. “Dividends, Earnings and Stock Prices.” Review of
Economics and Statistics: pp. 99-105.

[9] H. Ramcharran. “An Empirical Model of Dividend Policy in Emerging Equity


Markets.” Emerging Market Quarterly; 2001, pp. 39-49.

[10] Mackinlay, A.C. (1979). “Event Studies in Economic and Finance.” Journal of
Economic Literature: 35: pp. 13-39.

Oludoyi, S. B. (1999). “Capital Market Efficiency and Effects of Earnings


Announcements on Share Prices in Nigeria.”

[11] Osei, K.A. (1998). “Analysis of Factors Affecting the Development of An Emerging
Capital Market: The Case of the Ghana Stock Market.” African Economic Research
Consortium Research Paper 76.

[12] Samuel, J.M. and N. Yacout (1981). “Stock Exchange in Developing Countries.”
Savings and Development: 5 (4), pp. 217-230
Wilkes, F. M. (1999). Mathematics for Business, Finance and Economics, 2 nd edition,
International Thomson Business Press, pp. 420-429.

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