The Effect of Future Earnings and Free Cash Flow on Dividend

Document Type : Original Article

Authors

• Maryam Farhadi ¹
• Masood Fooladi ²

¹ Department of Accounting, Mobarakeh Branch, Islamic Azad University, Mobarakeh, Isfahan, Iran

² Department of Accounting, Shahinshahr Branch, Islamic Azad University, Shahinshahr, Iran

10.22067/ijaaf.v3i3.89208

Abstract

In economics, and more specifically in contract theory, signaling refers to the act in which one party sends some meaningful information about itself to the other party. Signaling derives from the theory of information asymmetry, which implies a conflict of interest between managers and investors, which reduces the moderating role of dividends; because managers have asymmetric information compared to the investors on the earnings and future dividend policies. This study investigates the relationship between dividends paid and future earnings by considering the free cash flow. For this purpose, 82 companies listed on the stock exchange from 2002 to 2014 were examined. Using the simultaneous equation method, this study finds that increasing the rate of change in future earnings will reduce the annual rate of change in dividends paid. It is also found that the effect of changes in future earnings on changes in dividends is not a reason for the effect of changes in the dividend paid on future earnings.

Keywords

• dividend changes
• dividend signaling theory
• free cash flow theory
• future earnings changes

---

References

Alizadeh, A. (2001). Investigating the Relationship between Dividend Changes and Cash
Flow Changes. Master Thesis, Faculty of Management, University of Tehran. [In
Persion]
Amidu, M. and Abor, J. (2006). Determinants of Dividend Payout Ratios in Ghana, The
Journal of Risk Finance, 7 (2), 136-145.
http://ugspace.ug.edu.gh/handle/123456789/28831
Bahramfar, N. and Mehrani, K. (2004). Relationship between earnings per share,
dividends paid and investment in companies listed on the Tehran Stock Exchange.
Accounting and auditing reviews. (11) 36, 30-39. [In Persion]
Izadi Nia, N. and Soltani, A. (2010). Evaluation of Factors Affecting Dividend Policy in
Companies Listed on the Tehran Stock Exchange. Journal of Accounting Studies,
26 (4), 155-139. [In Persion]
Kadioglu, E. and Ocal, N. (2016). Dividend Changes and Future Profitability. Evidence
from the Turkish Stock Market. International Journal of Economics and Finance,
8(3), 196-207. Doi: 10.5539/ijef.v8n3p196
Liu, C. and Chen, A.S. (2015). Do firms use dividend changes to signal future
profitability? A simultaneous equation analysis. International Review of Financial
Analysis, 37 (1), 194-207. https://doi.org/10.1016/j.irfa.2014.12.001
Nazari, M. Parsaei M. and Nasiri, S.S. (2013). Relationship between information
asymmetry and dividend policies in companies. Journal of Accounting Knowledge
and Managerial Auditing, 1 (2), 113-103. [In Persion]
Nissim, D. and Ziv, A. (2001). Dividend changes and future profitability. The Journal of
Finance, 56(6), 2111-2133. https://doi.org/10.1111/0022-1082.00400
Rezvani Raz, K. and Rekabdar, Q. Ahmadi M.R. and Ahmadi, M. (2009). Investigating
the relationship between free cash flows and dividend policy in companies listed on
the Tehran Stock Exchange. Journal of Financial Accounting, 4 (1), 107-92.[In
Persion]