ࡱ> WYV^5@ ەbjbj22 4XX8t $$$88p8H:0:jjjjEEE9999999$;RJ>9E$EE9$$jj:$$$@$j$j9$9$$$rK0T$$1j$ %!06:0H:0V$?#|$?188$$$$$?$1E$|3fEEE9988dE$X88DIVIDEND INCREASE EFFECTS ON STOCK PRICE IN CROATIA Marko Mileti1, Branko Sori2 Joako Lozi3 B. Sc., Teaching Assistant B. Sc., Lecturer 3Lecturer, MSc University center for professional studies, Kopilica 5, Split, Croatia ABSTRACT Various studies present results indicating that stock market reacts positively to cash disbursements via dividend initiations and increases but negatively to dividend decreases or eliminations. One of popular theory which tries to explain why the stock reacts the way it does is dividend signaling theory. The market may reevaluate share value on the basis of a change in dividend payout policy because dividends signal future movements in cash flows. This paper examines share price reaction in Croatia stock market to announcement of changes in dividends. Our aim is to investigate how announcement of dividend increase is associated with positive stock return. This phenomenon is known as dividend announcement effect. 1. INTRODUCTION The role of dividends in the process of firm valuation is a popular topic in finance literature. Strong support exists for the view that dividends are important in firm valuation. The early arguments following the Miller and Modiglianis dividend irrelevance theory focused mostly on relaxing a rigid set of assumptions in the Miller and Modiglianis model. Other attempted to correct or improve measurement techniques involving for example, changes in dividend payout. Researches have advanced several theories to explain why stock market reacts positively to cash disbursements via dividend initiations and increases but negatively to dividend decreases or eliminations, two highly researched and competing theories are dividend signaling theory which is based on the information asymmetry that exist between managers and stockholders and free cash flow theory that finds own roots to the agency problem between corporate insiders and external investors. Dividend signaling theory argues that dividends reduce information asymmetry by acting as a credible signal from corporate insiders to the firms shareholders. Simply stated, dividend initiations or increases convey good news, while dividend reductions or omissions convey bad news. On the other hand free cash flow theory argues that characteristic of publicly held firm is divergence of interests between managers and investors and in this environment, managers, confronted with a low investment opportunity set, have the incentive to hoard excess cash benefit themselves at the expense of investors. Because managers are reluctant to cut dividends, a dividend initiation or increase means reducing excess cash at the disposal of managers, thereby reducing their ability to misuse these funds. Thus the market reacts positively to the prospect of the reduced agency cost. The informational role of dividends is complicated. Most of the evidence indicates that positive dividend changes (dividend increases) are associated with positive stock price reaction, while negative dividend changes (dividend decreases) are associated with negative stock price reaction. This phenomenon is known as dividend announcement effect and it is based on Miller and Modigliani's proposition that dividends may have informational content or communicate insider information to outsiders. This paper is focusing on the fact that dividend is more than just a part of net earnings which belong to shareholders and it will investigate does dividend conveys information to market and the purpose of this paper is to examine stock price reaction to dividend announcement of increase in cash disbursements on Croatian Stock Market. 2. METHODOLOGY AND DATA This study uses daily return data and employs a standard event methodology to examine the relationship between market responses to increases in dividends. Event study is commonly used methodology when examining stock market reaction to dividend announcement. Author in his work gives a brief description of time periods which are in focus of event studies. The analysis period is time interval made of daily stock returns on which the measurement of information content for an earnings announcement is based. The analysis period is made up of the announcement period and the comparison period, which are defined in relation to the event date. The event date is the date on which we expect the market reaction to the event, or the date around which diffused effect is presumed to be distributed. The event date is denoted as t=0. Researchers generally use the date on which the first public announcement of an event took place. However, it is not always possible to know with certainty the exact date on which a piece of information first reached the market. The information may become known to a wide segment of the market before the first public announcement through an informal way which can not be defined as a public announcement. Determining the event day is the first task of conducting an event study. This step is very important because determining the exact event day reflects detection of abnormal returns. Empirical studies suggest that event-date uncertainty affects the power of the tests which are designed to detect the presence of abnormal performance associated with an event, and that events, both treatment events and confounding events, can be hard to find and even harder to date. In this paper, publication of formal invitation to general assembly of stock company on the web pages of Zagreb Stock Exchange is denoted as event day. This document contains all the important information about the companys results: earnings and earnings allocation and dividend proposal. The length of the announcement period is an important methodological issue, closely related to event date uncertainty. In study we used the sixteen-day announcement period which includes the announcement date, the ten days prior to the announcement date, and the five days following the announcement date. To examine return behavior of selected shares around the event day, it is necessary to quantify the return which exceeds expected return in that period or we have to calculate abnormal returns. The abnormal returns are generated by the market model. In event study the actual share return is compared with expected share return to determine whether the stock market reaction occurred. If the information content theory is correct and the stock market is efficient, abnormal returns should be significantly different from zero. The hypothesis predicts that the shares of those companies which announce dividend increase should, on average, earn positive abnormal returns. Daily share price data are obtained form the Zagreb Stock Exchange. Share returns are calculated by following expression: Rit =ln(Pit / Pit-1 ) (1) Where Rit stands for actual return on share i on day t, Pit stands for actual price of share i on day t and Pit-1 for the price of share i on day t-1. One of most common methods to capture normal returns is the Capital Asset Pricing Model (CAPM). CAPM model was introduced by Sharpe and Litner and it assumes that the expected return of company is determined by its covariance with market portfolio. The use of CAPM is common in event studies. In the center of CAPM model is estimating of beta which describes association of company risk with market risk. Market risk is represented by share index CROBEX on Zagreb Stock Exchange. A stock with beta greater then 1.00 implies higher risk of specific security than the market risk and beta below 1.00 implies that the specific share brings lower risk than market risk. Expected return is calculated on the basis of market model and is based on the previous 30 days daily returns data. The betas and intercepts are calculated from a comparison period of 30 trading days prior to the event window. E(Rit) = i + i Rmt + eit (2) Where Rmt, the return on market, is approximated by CROBEX share index of Zagreb Stock Exchange and eit is the standard error. i and i are ordinary least square values estimated on the basis of historical data on daily share returns and the daily market returns. This paper examines dividend announcements for 14 companies that were selected on the basis of having announced dividend increase in 2007 and all daily share price data where available on Zagreb Stock Exchange. Our sample is small but includes all the shares that announced dividend increase in 2007 on Zagreb Stock Exchange. Abnormal returns are calculated for the each company from the sample in order to determine whether the event produces returns that can not be explained by CAPM model. Dividends are not included when estimating returns for the shares of the firms in our sample. Abnormal returns are calculated for every share according to the equation: ARit = Rit - E(Rit) (3) Where ARit is the normal return on security i in time t and E(Rit) is the expected return on security i on day t. Average abnormal return ARt on day t is calculated as follows: ARt = 1/n EMBED Equation.3  ARit (4) Where i is the number of observations. Cumulative abnormal returns (CAR) are calculated by aggregating daily ARs over time. Cumulative average abnormal daily returns for an event period are calculated as follows: CAR =  EMBED Equation.3  ARt (5) Our sample consists of 14 companies listed on the Zagreb Stock Exchange which announced dividend increase. The companies have been selected on the basis of their publication of dividend in 2007. Share returns are calculated from the daily closing prices which were obtained from the ZSE. The announcement day is defined as the day of the first official statement on dividends reported on web pages of Zagreb Stock Exchange. Our aim was to test the hypothesis if the announcement of dividends increase on Croatian stock market results in stock price movement. According to numerous previous researches we expect that dividend increases should result in significant positive reaction of stock prices. 3. EMPIRICAL RESULTS Our results for abnormal stock returns over the event window are summarized in Table 1. For our sample of 14 dividend increase announcements results in Table 1 show that reported dividend increase announcement on Croatian stock market in 2007 had effect on the stock prices on the day of announcement and abnormal return is significantly different from zero at level of 10%. On the day 0 abnormal return for our sample was 3,07%. Based on this results we can conclude that change in dividend, in this case, increase in dividend conveys the new information for investors on which they reevaluate their investment. We also find that other abnormal returns in the event window are not significantly different from zero. Our sample is quite small and consisted of only 14 stocks whose dividends are increased in compared with dividends from 2006. We do not intend to do any serious statistical conclusion based on such a small sample although it gives us some idea about possible market reaction. Although very small our sample comprises all shares which did not report changes in dividends in Croatian stock market in 2007. Table 1 Average daily abnormal returns for the event window DayMean t - statisticsSig. (2-tailed)-10-0,5992-0,96500,3520-9-0,8032-1,21600,2450-80,23290,26800,7930-70,41080,42200,6800-61,15871,53400,1490-51,03481,18400,2580-4-0,5289-0,50800,6200-31,23471,05900,3090-20,30520,33600,7420-1-0,7485-0,46100,652003,06632,03000,063011,09060,61700,548021,07460,86200,40403-0,3560-0,37700,71204-0,1788-0,19400,84905-0,0194-0,29100,7750Source: own calculations based on the data from Zagreb Stock Exchange Cumulative abnormal returns related to stocks which reported dividend increase in 2007 rose sharply after the announcement day as shown in figure 1. This means that there is no significant abnormal return prior to announcement and that there was no new information prior to the announcement. At the end of the 16 day event window cumulative abnormal returns of stocks that reported dividend increase amounted to 6,20%. Figure 1 shows that after announcement day stocks which increased dividends materialized high cumulative abnormal returns.  Figure 1 Cumulative abnormal returns for 16 day event window Source: own calculations based on the data from Zagreb Stock Exchange 4. CONCLUSION This paper has a number of shortcomings, mostly in relatively small number of stocks. Secondly it is not quite possible to determine the exact announcement date. But we can conclude as it is expected, the market reacts positively to the announcement of dividend increase. On the day of announcement abnormal return is positive and is significantly different from zero at level of 10% and it was 3,07%. Based on this results we can conclude that change in dividend, in this case increase in dividend, conveys the new information for investors on which they reevaluate their investment. Other day in event window didnt have statistically significant abnormal return. At the end of the 16 day event window cumulative abnormal returns of stocks that reported dividend increase amounted to 6,20%. Result concerning stocks that announced increase in dividends in 2007 compared with dividends distributed in 2006 gives empirical support to the dividend signaling hypothesis and the proposition that states that the magnitude of the market reaction is positively associated with the size of the dividend but we must report that the greatest restrain of this paper is very small market in terms of number of quality stocks which are in the same moment frequently traded and we cannot give any definite conclusion about dividend signaling theory because in this paper we didnt include companies which have decrease their dividends. References: [1] BAKER, H. K.: Dividends and dividend policy. - John Wiley & Sons, Inc., Hoboken, New Jersey, 2009. [2] JOHNSON, K. H.: Graphical Analysis for Event Study Design - Journal of Financial and Strategic Decisions, Vol1 1, No 1, 1998. p. 61-71 [3] MILLER, M. 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Available at:  HYPERLINK "http://www.zse.hr" www.zse.hr  Miller, M. H., Modigliani, F., Dividend policy, growth and the valuation of shares, Journal of Bussines, 34:4, 1961., 411-433  Baker, H. K., Dividends and dividend policy, John Wiley & Sons, Inc., Hoboken, New Jersey, 2009, p.145.  Johnson, K. 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