Dividend reductions and signalling in an imputation environment

Abstract

In contrast to the double taxation system prevailing in the U.S., Australian firms operate under an imputation environment with respect to dividend payments. We argue that the dividend imputation tax system increases the signalling potential of dividend reductions and our findings support this view. We find that abnormal changes in profitability are negative in the year following dividend reductions and are negatively related to the dividend reduction. The relation is statistically significantly stronger for franked dividends. Overall, our study shows conclusively that dividend reductions in Australia constitute a strong signal regarding the future prospects of the firm and, as such, our results are at variance with the results obtained in the U.S.