How Important are Dividend Signals in Assessing Earnings Persistence?†

Abstract

We build and test a Bayesian model that shows how investors revise their earnings persistence expectations after dividend announcements. When dividend changesconfirmpreceding earnings changes, our model predicts inverse u-shaped investor revisions conditional on the prior expectations for noisy dividend signals. As the dividend signal becomes more informative, our model predicts that investor revisions will become more skewed converging to a monotonically decreasing relation for perfectly informative dividend signals. When dividend changescontradictpreceding earnings changes, our model predicts u-shaped investor revisions. In empirical tests, we find results generally consistent with our model predictions.