Do Firms Use Dividend Changes to Signal Future Earnings? An Investigation Based on Market Rationality

Are dividend changes informative? If yes, do they convey information about future earnings? Given the
importance of the issue to corporate finance and because of the puzzling results of previous studies, we
investigate the association among dividend changes, stock returns, and future earnings. Following 928 French
and 995 German firms from 1991 to 2010, we expect that only those dividend changes will be positively
associated with future earnings that result in abnormal stock returns. Inconsistent with our expectations, we find
that the association between current dividend changes and future earnings changes for firms with the highest
abnormal returns in the dividend change direction is not stronger than the rest of the firms. These findings cast
doubt on the signaling theory, which claims that dividend changes convey information about changes in future
earnings.