This thesis empirically examines the post dividend-increase performance of financially constrained firms and seeks to explain this anomalous change in corporate payout policy. Five measures of financial constraint are utilised (WW Index, Size, Bond Rating, Paper Rating and KZ Index), and under each measure there exists a sample of firms that increase dividends. Pecking order theory and intuition suggests that constrained firms should retain internal funds to build ‘financial slack’ in order to smooth future investment (Myers, 1993). To explain this phenomenon an empirical investigation is undertaken to determine whether these firms time their dividend-increases to precede Seasoned Equity Offering (SEO) announcements, and whether the increase in dividends positively affects the underpricing of the new issue.
An empirical investigation of the U.S. market over the 1990 – 2011 sample period suggests that, under the majority of constraint measures, financially constrained firms experience poorer post dividend-increase stock and operating performance. This is especially the case for constrained firms that are in more competitive industries. Constrained firms that increase dividends are also subjected to greater financial distress risk than unconstrained firms. Results also indicate that financially constrained firms time their dividend increase announcements to precede SEO announcements. Further, evidence is documented that the dividend-increase declaration has a significantly positive effect on the market reaction to SEO announcements for financially constrained firms.
These results show that financially constrained firms utilise dividend increases for different purposes to that of financially unconstrained firms. Specifically, this thesis suggests that unlike unconstrained firms, financially constrained firms increase dividends to relieve the external financing costs of underpricing typically associated with SEO’s.
This study is the first to empirically investigate the ostensible phenomenon of financially constrained firms that increase dividends. Further, this thesis develops and tests the innovative hypothesis which conjectures that financially constrained firms time their dividend increases to precede SEO announcements, in order to positively affect the documented underpricing of new issues.