Dividends, stock splits and prospect theory – A case for limited attention?

Abstract

In this thesis I study how investors perceive dividend per share (DPS) changes. More specifically, I examine if the observed market reaction pattern (value function) towards different DPS change declarations is different, when the declared dividend is paid in post stock split distribution terms, compared to dividend declarations without a preceding stock split. I hypothesize that when the previous period DPS (the reference point) is not comparable in nominal terms to the declared DPS due to a stock split, investors might not assess the DPS change as accurately.

I find that the implied DPS change value function is different when the declared DPS is paid in post stock split distribution terms. In such events the implied value function is more flat towards small DPS changes. I also find that this behavior is more distinct when the institutional ownership of the firm is low. Moreover, I report that the differing implied value function observation vanishes in the subsequent DPS change event that does not include such reference point incompatibility.

The findings of the thesis complement the existing behavioral dividend signaling literature such as Baker, Mendel and Wurgler (2016). Moreover, this thesis provides empirical evidence on Brav, Graham, Harvey and Michaely (2005) survey results. According to their survey some interviewed managers believe that they can “sneak by” the market dividend cuts with lesser penalty by timing the cut with a stock split.