Announcements are essential for investors and shareholders in enabling them to determine the viability of their investments. According to the efficient market theory, stock prices in a semi-strong market factor all material public information. Therefore, any publicly issued financial announcement has the potential of influencing the demand for various stocks and subsequently affecting their prices. This paper examined whether the declaration of dividends results in significant changes in the price of stocks in Saudi Arabia. A sample of 5 public companies, whose stocks are traded in the Tadawul All Share Index (TASI) were examined. A 31-day window, 15 days post-declaration and 15 days pre-declaration, formed the period through which the testing for abnormal returns using event study analysis was done for each of the sample companies. The results showed that dividends have a positive relationship with stock prices in the TASI.
Keywords: dividend, stock prices, shareholders, market efficiency,
Table of Contents
Section 1: Abstract 2
Section 2: Aims and Context of the Project 4
Section 3: Contribution to Knowledge and Statement of Significance. 6
Contribution to Knowledge. 6
Statement of Significance. 7
Section 4: Literature Review and Conceptual Framework. 7
Event Study. 11
Section 5: Approach and Methodology. 13
Data Collection. 13
Data Analysis. 13
Formula for Expected Returns in Event Analysis. 15
Companies Dividends Announcements and Share Prices: Evidence on the Saudi Stock Market
This project aims at evaluating whether announcements of dividends by companies in Saudi Arabia have an effect on their stock prices on the Saudi Arabia stock exchange. This research will evaluate a sample of 5 companies in the Saudi Arabia Tadawul All Share Index (TASI) during the 31 trading day surrounding the announcement date, 15 trading days before the day of the announcement, and 15 trading days after the announcement day. The companies that will be assessed are Saudi Arabia Refineries Company (SARCO), National Petrochemical Co., Riyad Bank, Alwwal Bank, and Astra Industrial Group.
Information on a company’s financial performance is always essential for investors since it determines the value of stock prices and their potential future returns. In a stock market, the stock prices act as a barometer of all internal and external factors that affect a business. Accordingly, stock prices are not only indicators of the value of a company, but also representatives of the many economic and non-economic factors that may affect a particular business or sector. A company’s earnings and dividends usually indicate its profitability trend, and therefore gives investors vital information on whether they should buy or sell a particular stock. From this perspective, financial information acts as a yardstick in the capital market that assesses both the profitability and strength of a firm. Non-economic indicators, such as a change in management, are always indicators of the strategies adopted by a company. Since different strategies have varying effects on a business’ performance, these factors inevitably affect stock prices.
According to the efficient market hypothesis, which was established by Fama (1965), there are three types of market efficient: weak, semi-strong, and strong. In a weak market efficiency, the current stock prices factor in all past information. Further, changes in stock prices are random, and no investment strategy is applied. The semi-strong market suggests that current stock prices consider material public information and changes in the market. Therefore, changes in the stock prices in this market will result in unexpected public information, and investors may not get above average returns if they make investments based on such knowledge. Finally, in the strong form, insider trading is not rewarded since the stock prices factor all non-public information (Reilly & Brown, 2008). Market efficiency does not occur on its own, and it depends mostly on the interpretational abilities of investors and how they apply the price-sensitive information in their dealings.This paper provides an analysis of how price-sensitive information affects the price of stocks traded on the Saudi Arabia Tadawull All-Share Index (TASI).
Although there have been many research studies that have focused on the effects of announcements of various financial performances on stock markets, few have focused on Saudi Arabia. Matharu and Changle (2015), carried a study to evaluate stock prices’ sensitivity to dividend announcements for 25 companies that traded in BSE Sensex market. Similarly, Akbar and Baig (2010) carried out a study on stock prices react to dividend announcements in market efficiency in Pakistan. Stankevevicience and Akelaitis (2014) also investigated how the effects of public announcements on stock prices, concerning the value of stock prices and price changes, in the Lithuania stock market.
This research will be essential for regulators and investors interested in the Saudi Arabia stock market. Among the regulators, the understanding of the volatility of the Saudi stock exchange market, with respect to dividend announcements will enable them to supervise their portfolios more efficiently so that investors can maximize returns and minimize losses (Matharu & Changle, 2015). Additionally, the information from this study will give investors crucial insight on how they can profit from the Saudi stock exchange market. According to Pritamani, Singal, and Uloza (2005), investors always have a chance of succeeding from inefficiencies in stock markets, especially those that have semi-strong form efficiency. Finally, this paper will set a basis for further study on the performance of stocks in the Saudi stock exchange after major financial announcements.
One of the main importance of this research is in enabling individuals to understand the market trend of the Saudi Arabia stock exchange market. Unlike most countries, Saudi Arabia is Muslim-majority country, and accordingly, the faith of its citizens influences how they invest. In Islam, speculative income and interests earned from giving credit are highly admonished. In this regard, this paper will enable academicians to establish whether major financial announcements that occur in Saudi Arabia affect how people buy or sell stocks in Saudi Arabia, and also whether there are price changes.
Additionally, this study will expand the existing knowledge spearheaded by Fama (1965) of the market efficiency in weak, semi-strong, and strong markets. In particular, the study will be crucial in establishing the market efficiency of the Saudi stock exchange, the Tadawul All-Share Index (TASI). This information will be essential in determining whether investors can make more than market average returns by using past information and technical analysis when making their trading decisions on the Saudi stock market. Therefore, the results of this study can form a good basis for testing the weak, semi-strong, and strong form of the efficient market hypothesis (EMH) in Saudi Arabia.
This research will significantly contribute to the operations of investors in Saudi Arabia, particularly foreign investors. Unlike strict local religious investors, who may avoid the information from this research to speculate on potentially lucrative investment opportunities, foreign non-Muslim investors can exploit this opportunity. In particular, the knowledge of how stocks react in the TASI following major financial-related announcements presents opportunities for individuals to profit from inefficiencies in the market. Investors in stock markets usually benefit through capital gains or dividends (Angelovska, 2017). According to Keite and Uloza (2005), a semi-strong form of efficiency present opportunities for individuals to profit from the release of information in the stock market. Therefore, the knowledge of the behavior of the TASI relative to financial-related announcements will be beneficial to investors. For example, information on earning reflects the wealth and profitability of a company and indicates possible dividend incomes. As a result, the release of this information impacts the stock price movements (Hussin, Ahmed, & Ying, 2010).
It is agreed that capital markets always react to financial announcements such as those on earnings, dividends, annual general meetings, and a change in the composition of the board of directors or chief executive officer. The disclosure of a company’s earnings, in particular, has significant effects since it provides critical information on a firm’s past performance, which enables investors’ to forecast future performance and value of equity (Mlonzi, Kruger, & Nthoesane, 2011). Aharony and Swary (1980) opine that there is a positive correlation between the movements of stock prices and announcements, even after adjusting for contemporaneous earnings. In most countries, Saudi Arabia included, the provision of annual and seasonal financial statements such as balance sheet, cash flow, and income statement, of a company, is a legal requirement. Qureshi, Abdullah, and Imdadullah (2012) opine that the availability of financial information on a company’s earnings can cause a market response.
Since financial results contain a lot of critical information about the company, they play various important roles. Aharony and Swary (1980) espouse that managers use earnings for signaling, to convey various important information about a company’s prospects. Additionally, the researchers note that both earnings and dividends give essential information about a company’s performance, which lead to immediate changes in stock prices after their announcement. Research by Asquith and Mullins (1986) established that the first dividend announcement in a company after a 10-year interval results in a strong market reaction. Despite these findings, the relationship between stock prices and dividends is largely inconclusive. Whereas Graham and Dodd (1951) opine that investors prefer dividends, Miller and Modigliani (1961) suggest that if there are no transaction costs and taxes, dividends do not affect investors’ decision.
Linter (1956) opines that the management in a firm usually increases dividends if it is convinced that the positive trend in a company’s performance is permanent. In a study done by Dasilasa (2004), it was established that an increase in dividends is always followed by an increase in stock prices, while a decrease in price accompanies a decrease in dividends. Also, the researcher established that when dividends are steady, their announcements do not result in any significant movement in prices. Bhattacharaya (1979) notes that there exists asymmetric information between a company and its shareholders; therefore, a change in the dividends issued gives the shareholders price-sensitive information. Similarly, Miller and Rock (1925) establish that the announcements of dividends signal to shareholders about the underlying performance of a company. Allen and Michaely (1995) espouse that regardless of the direction of dividends, they are the least costly to other alternatives in signaling investors.
From agency theory, when a company increases its dividends payout to its shareholders, it issues them with the excess cash after financing all projects that have positive net present value. Accordingly, Black (1976) establishes that payment of dividends is essential in decreasing or increasing a firm’s agency costs. In this regard, positive changes due to dividend payout ratio increase stock prices, while there is a reduction when there are negative changes (Akbar, & Baig, 2010). A study by Lonie et al. (1996) on the dividend announcements of 620 companies from the United Kingdom from January to June 1991 showed that investors responded to increase and decrease in dividends. From the study, it was established that the average abnormal returns one day before the announcements were significantly different from zero. According to Bhattacharya (1979), dividends can signal expected cash flows if the stockholders have imperfect information about a firm’s profitability and if there is a tax rate differential between capital gains and dividends. A study by Docking and Koch (2005) also established that dividend announcement is sensitive to the direction or volatility of the stock market.
From the efficient market hypothesis, which was established by Fama (1965) in a semi-strong form market efficiency, the stock prices incorporate all expected future dividends. In this regard, the announcement of dividends should not result in abnormal earnings for investors since they are already factored in stock prices (Akbar & Baig, 2010). From this perspective, the abnormal mean returns and the cumulative abnormal mean returns during the periods of dividend announcement should remain zero. Further, Akbar and Baig (2010) note that stock prices adjust to unexpected material information, such as sudden increases or decreases in dividends.
A study by Hamid and Chowdhury (2005) on the impact of shareholder’s value using the daily market-adjusted abnormal returns (MAAR) and the cumulative abnormal returns (CAR) showed that dividends are not an efficient indicator of future performance, but have a positive relationship with stock prices. The researchers study was of the Dhaka Stock Exchange and used a sample of 137 countries that pay dividends. The MAAR represented the daily percentage of price change, and the CAAR was a measure of the investors’ total returns before and after the announcements of dividends. The researchers observed that the MARR was not statistically significant on the date of announcement of dividend. The CAAR results showed that investors lost more value in the period after issuance of dividends, than what they had gained. The study findings demonstrated that dividends are not an appropriate indicator of future earnings and cash flows of companies.
A study by Mollah (2001) was conducted to identify whether investors consider dividends announcements as signals of a company’s performance and prospects in Bangladesh. The research did not establish any significant impact of dividends announcements on the prices of securities. Further, there was no evidence to support the hypothesis that dividends are signaling devices. Interestingly, Mollah (2001) established that security prices decrease after increasing dividends, decreasing dividends, and maintaining dividends, which showed that the market is inefficient. These findings suggested that insiders usually begin buying shares before the general assembly meetings for higher voting rights and offload them after these meetings, which results in a higher supply of shares that subsequently result in a decline in stock prices. The study by Mollah (2001) further established that the dividend policy on the payout ratio in Bangladesh is determined by leverage, size, insider ownership, and collateralizable assets. Therefore, although the researcher’s study supported the agency cost and transaction cost hypothesis, it did not support the tax clientele, residual, or pecking order hypothesis (Matharu & Changle, 2015).
Few studies have focused on the investors’ sentiments and psychological state on stock price movements. A study by Bitok et al. (2011) established that there is a significant relationship between investor’s sentiments and psychology and stock price movements. Therefore, how shareholders’ react after announcements of dividends greatly determines how the stock prices move (Majanga, 2015). A study by Aamir and Zullfiqra (2011) established that there is a positive impact on stock prices for businesses a few days before and after the announcements of dividends. The high prices in share prices indicate there are high expectations among investors of earning high dividends, which results in the great demand stocks with the aim of earning more dividends when the payment times come. Accordingly, Majanga (2015) opines that the increase in stock prices follows a demand and supply theory. Similarly, research by Andres et al. (2011) in Germany’s stock market demonstrated that there is a significant increase in share price after dividend announcements.
Event studies help researchers to evaluate whether there are any relationships between an event and fluctuations in stock prices through monitoring of the changes in stock prices and the emergence of abnormal returns (Angelovska, 2015). The event study methods consider that since investors in the stockholders are rational, changes in the marketplace will be reflected immediately in security prices. This impact can then be assessed by examining the changes in the security prices that surround the event (Dolly, 1939). The original event study model was developed by Dolly (1939), after slight modification by Fama, Fisher, Jensen, and Roll (1969), the model format has remained the same. Therefore, the current model is based on the table layout and the classical stock split event study that was established by Fama et al. (1969). Further, this model focuses on sample securities’ mean and cumulative return during an event.
The underlying concept in the stock market is that investors are rational and they consider any new information in the market. If there is a lag in the response of prices to an event, it only occurs for a short period since investors notice there is an anomaly and respond appropriately by either buying or selling a stock (Angelovska, 2015). This view is supported by Shiller (2003), who asserts that when people who are irrationally optimistic buy stocks, the smart ones sell them and when the unreasonably pessimistic sell, the smart ones buy. This tendency has an overall effect of eliminating irrational traders and re-balancing the market, as postulated in Fama’s (1965) efficiency market theory. Nonetheless, Angelovska (2015) highlights that this system does not work perfectly in the real-world, as proven by many asset bubbles.
H0: Share prices react positively to annual financial results announcements of dividends.
H1: Share prices do not react positively to annual financial results announcements of dividends.
My research extends previous research studies by establishing whether investors’ cultures and traditions have an impact on whether stock prices increase or decrease after dividend announcements. From Bitok et al. (2011), Andre et al. (2011), and Majanga (2015) research, there is a significant relationship between investments sentiments and stock price movements. In the signaling hypothesis, dividends reflect expected future cash flows and thus influence how investors’ react, and the subsequent performance of stock prices (Aharony & Swary 1980). Despite the many studies on the impact of dividend announcements on stock prices, few studies, if any, have established whether they have any impact on conservative Muslim-majority countries like Saudi Arabia, whose citizens shun speculative income, such as that which may be occasioned by the rise in stock prices a few days near or after the announcement of dividends. Hakim and Rashidian (2002, p. 28) note that stock markets in predominantly Muslim countries have challenges since practices such as speculation and short selling are shunned. In this regard, an analysis of the impact of dividend announcement on changes in stock prices in the TASI will enable me to establish if the signaling hypothesis holds in Saudi Arabia, a Muslim-majority country.
I used daily data from January 2017 to December 2017 to determine the price sensitivity of stock prices to dividend announcements. My research focused on five major companies that are in the Saudi Arabia stock exchange, the Tadawul All-Share Index (TASI). I used the methodology proposed by Brown and Warner (1985) to tests the abnormal returns for the stocks in this study. The normal period in this study is defined as 15 days before the announcements and 15 days after the announcement of dividends. My null hypothesis is that share prices in Saudi Arabia react positively to annual financial results announcements of dividends.
The event study methodology will be used in this paper to analyze for abnormal performance in the stock market when dividends are issued. The event study methodology helps a person examine the changes in the price of stocks after the announcement of dividends. Since this study starts by examining the stock prices a few days before the actual announcement, it can identify whether there are abnormal returns that are due to the anticipated event.
This research is based on the Fama et al. (1969) study, which examines the excess returns for each day. The difference between the observable realized return in the market and the benchmark return is the abnormal return. Noteworthy, benchmark return refers to the possible incomes from stock when there are no events. Since the abnormal return is the difference of the observable realized return and the benchmark return, it is, therefore, the residual in a market model. It can be established in the following manner:
Rit = αi + βmt + εt
εit = ARit = Ri,t – α –βi Rmt
Ri,t is the return of stock i,
Rmt is the return of the market index,
βi is the systemic risk of stock i,
The coefficients of the market model are tested separately using the non-event return data for each event using the ordinary least square regression (OLS). Predication of Ri,t are established using the estimated coefficients α and βi. Therefore, the abnormal return of security i on event day t ARit is calculated using the following equation.
εit = ARit = Ri,t – α –βi Rmt
The mean abnormal return for observations in day t is the sum of individual abnormal returns on day t divided by the number of events (N). The parameters of the market model, such as the alphas and betas, which are based on the returns of stocks in the market index for the estimated period, are first estimated. The expected returns on the stock are later calculated using the market model. Each return is categorized into two; returns attributable to market movements and returns attributable to dividend announcement. To measure how the stock price responds to dividend announcement, I first eliminate the effects of the stock observed rate of return. The market model is based on the fact that stock returns are largely influenced market factors. This factor is captured through beta in the market model. In this regard, the market model relates the returns of any stock with market-linear fashion. The model applied for the analysis is CAPM for expected rate of returns for selected stocks.
E(R) = Expected returns,
ARit = Abnormal returns
εit = error term,
Rit = Actual returns
AAR = Average Abnormal Returns,
CAAR = Cumulative Average Abnormal Returns,
A paired t-test for varied event windows is used to test the final hypotheses.
The results of the abnormal returns showed a positive incidence from day one post announcement. The t-test value on average abnormal returns (AAR) and cumulative average abnormal returns (CAAR) show a general rising tendency especially in the first three days after announcements for the AR and six days in the CAR. In the 15-days post announcement and 15-days pre-announcement, the number of positive days are relatively equal (Appendix 1 and 2).
Studies on market efficiency in the semi-strong market suggest that stock prices reflect all past public information. Therefore, the use of this information should not result in above average returns. Various researchers have suggested that companies that have viable investment opportunities do not issue dividends since these funds are used to finance these projects. Additionally, the issuance of dividends reduces a business’ cash flow for reinvestments effectively minimizing a company’s future incomes. Since the value of an asset, including stocks, is that of its present cash flows and future cash flows, the issuance of dividends is expected to result in a decline in the value of a stock.
Another argument supporting a decline in stock prices after issuance of dividends is that since they are taxable incomes, investors prefer the company to reinvest these incomes. On the contrary, some studies suggest that issuance of stock reduces agency costs, should, therefore, trigger a positive response. This argument is also supported by one that suggests firms’ declaration of dividends signals future positive prospects to shareholders.
From my research, I found the AAR and CAAR in the 31-day window to be largely positive to stock dividend announcements. The AAR and CAAR of the stock dividend announcement were statistically significant at 1%, which implies that they react positively to stock dividend announcement. Since capital gains are not taxed in Saudi Arabia, the dividend incomes are received positively by shareholders in TASI (PWC, 2017). Given that companies in Saudi Arabia cannot issue dividends out of non-cash incomes, such as appreciation, the announcement of dividends signals positive business prospects, which increase the demand for shares and their subsequent prices. This factor implies that although most Saudi Arabians shun speculative income, they are still excited by the announcement of dividends and demand more shares a few days before and after announcements with the hope of making gains. The issuance of dividends also implies a reduction in agency costs, which increases share prices.
Aamir, M., & Zullfiqar, S. (2011). Dividend announcements and the abnormal stock returns for the event Firm and its rivals. Australian Journal of Business and Management Research, 1(8), 72-76.
Aharony, J. and Swary, I. (1980). Quarterly dividend and earnings announcements and stockholders’ returns: An empirical analysis. Journal of Finance, 35(l), 1-12.
Akbar, M., & Baig, H. (2010). Reaction of stock prices to dividend announcements and market efficiency in Pakistan. The Lahore Journal of Economics, 15(1), 103-125.
Akelaitis, S., & Stankeviciene, J. (2014). Impact of public announcements on stock prices: relation between values of stock prices and the price changes in Lithuanian stock market. Procedia – Social and Behavioral Sciences, 156(2014), 538 – 542.
Allen, F., Michaely, R. (1995). Dividend policy. In: Jarrow, R.A., Maksimovic, V., Ziemba, W.T. (Eds.), Operations Research and Management Science. Elsevier, Amsterdam.
Andres, C., Betzer, A., Bongard, I., Haesner, C., & Theissen, E. (2011). Dividend announcements reconsidered: Dividend changes versus dividend surprises. SSRN. http://dx.doi.org/10.2139/ssrn.1763201.
Angelovska, J. (2017). Investors’ behaviour in regard to company earnings announcements during the recession period: evidence from the Macedonian stock exchange. Economic Research-Ekonomska Istraživanja, 30(1), 647-660, DOI: 10.1080/1331677X.2017.1305768.
Asquith, P. & Mullins, J. R. D. (1983). The impact of initiating dividend payments on shareholders’ wealth. Journal of Business, 56, 77-96.
Bhattacharya, S. (1979). Imperfect information, dividend policy, and the bird in the hand bell. Journal of Economics, 10 (1): 259–270.
Bitok, J., Kiplangat, A., Tenai, J., & Rono, L. (2011). Determinants of investor confidence for firms listed at the Nairobi stock exchange, Kenya. Annual Conference on Innovations in Business & Management. London: UK.
Black, F. (1976). The Dividend Puzzle. Journal of Portfolio Management, 2, 5-8.
Dasilasa, A. (2004). Stock market reaction to dividend announcements: Evidence from the Greek stock market. Department of Accounting and Finance, University of Macedonia, Thessaloniki, Greece.
Dolly, J. C. (1939). Common stock split-ups motives and effects. Harvard Business Review. Boston, MA.
Fama, E. (1965). The Behavior of Stock Market Prices. Journal of Business, 38, 34-105.
Fama, E., Fisher, L., Jensen, M., & Roll, R. (1969). The adjustment of stock prices to new information. International Economic Review, 10, 1–21.
Graham, R., & Dodd, P. (1951). Security analysis. McGraw-Hill Book Company: New York.
Hakim, S & Rashidian, M. (2002). ‘October. Risk and return of Islamic stock market indexes.’ In 9th Economic Research Forum Annual Conference in Sharjah, UAE (pp. 26-28).
Hussin, B. M., Ahmed, A. D., & Ying, T. C. (2010). Semi-strong form efficiency: Market reaction to dividend and earnings announcements in Malaysian stock exchange. IUP Journal of Applied Finance, 16, 36–60.
Kiete, K., Uloza, G. (2005). The information efficiency of the stock markets in Lithuania and Latvia. SSE Riga Working Papers, 2005:7 (75).
Lintner, J. (1956). The distribution of incomes of corporations among dividends, retained earnings, and taxes. American Economic Review, 46, 97-113.
Lonie, A. A., Abeyratna, G., Power, D. M., & Sinclair, C. D. (1996). The stock market reaction to dividend announcement. AUK study of complex market signals. Journal of Economic Studies, 23, 32–52.
Majanga, B. (2015). The dividend effect on stock price-An empirical analysis of Malawi listed companies. Accounting and Finance Research, 4(3), 99-106.
Matharu, S. & Changle, R. (2015). An empirical study of stock prices sensitivity to dividend announcements. Pacific Business Review International, 8(3), 2015.
Miller, M. H. & Modgliani, E. (1961). Dividend Policy, Growth and the Valuation of Shares. Journal of Business, 34(4), 41 1-433.
Miller, M. H., & Rock, K. (1985). Dividend policy under asymmetric information, Journal of Finance 40 (4): 1031–1051.
Mlonzi, V. F., Kruger, J., & Nthoesane, M. G. (2011). Share price reaction to earnings announcement on the JSE-ALtX: A test for market efficiency. Southern African Business Review, 15, 142–166.
Mollah, A. (2001). Dividend policy and behaviour, and security price reaction to the announcement of dividends in an emerging market: A study of companies listed on the Dhaka Stock Exchange. Business School. Leeds, UK, University of Leeds: 284.
Pricewaterhousecoopers [PWC]. (2017). KSA: Capital gains, dividend income and other income tax amendments. Retrieved from https://www.pwc.com/m1/en/services/tax/me-tax-legal-news/2017/ksa-capital-gains-dividend-income-tax-amendments.html.
Qureshi, M., Abdullah, A., & Imdadullah, M. (2012). Stock prices’ variability around earnings announcement dates at Karachi Stock Exchange. Economics Research International, 2012(463627), 1-6. DOI:10.1155/2012/463627.
Reilly, F.K., & Brown, K.C. (2006). Investment analysis and portfolio management (8th Ed.). New York, NY: South Western Publishing, Company.
Shiller, R. (2003). From efficient markets theory to behavioural finance. Journal of Economic Perspectives, 17(1), 83-104.
|Event Time||Average AAR||Average CAAR||t- Statistic for AAR||t-Statistic for CAAR|