The Impact of Firm-Specific Attributes on the Relevance of Cash Flow and Dividend Changes

This study is about the incremental information content of operating cash flow changes with regard to explaining dividend changes of given earning. Also, role of attribute of growth, leverage and size of the firms are discussed in the relationship between operating cash flow changes and dividend changes.Arguments are provided by Charitou and Vafeas (1998) to explain the advantages of cash flow over accruals in explaining dividend changes. First, managers may manipulate accruals to maximize their interests. To the extent that accruals are manipulated, the cash flow component of earning is expected to be a more reliable indicator of firm performance than the accruals component. Therefore, the cash flow component of earnings is expected to be a better predictor of dividend changes than the accruals components. Second, cash flows are a more direct measure of liquidity and liquidity is an important factor in dividend policy setting. Thus, cash flows are expected to be more useful than accrual in determining dividend changes. Research hypothesis: In order to achieve the objective of this research, the following hypotheses are developed and tested: H1: Operating cash flows changes are positively related to dividend changes, given earnings changes. H2: The relationship between operating cash flow changes and dividend changes is significantly positive for firms with moderate growth prospects. H3: The relationship between operating cash flow changes and dividend changes is significantly positive for firms that have high leverage. H4: The relationship between operating cash flow changes and dividend changes is significantly positive for small firms. We carried out a 329 firm-year study by analyzing the dividend changes-operating cash flow changes relationship on a sample of 47 quoted firms in Tehran Stock Exchange (TSE) over a wider testing period from 2000 to 2007. The models are estimated using the ordinary least squares (OLS) method. The tests of hypothesis will be done with cross-sectional and pooling data. The regression results for hypothesis 1 show that there is a significant relationship between dividend changes and operating cash flow changes unlike previous studies. The empirical results for hypothesis 2 reveal that the relationship between operating cash flow changes and dividend changes does not depend on growth opportunities. Also, the empirical results for hypothesis 3 and 4 indicate that this relationship between operating cash flow changes and dividend changes depend on the capital structure choice and size of each firm. Discussion and Based on finance literature one of the most important factors in determinant dividend payout policy is firm’s performance. Empirical evidence in International level showed that earnings capture firm performance and thus, earnings are highly related to dividend changes. Earnings, however, is the sum of an operating cash flow component and an accruals component. Researchers such as Adelegan (2003) argued that the accruals component of earnings measures firm performance less reliably than the cash flow component, because accruals are subject to manipulation, then the cash flow component of earnings. Therefore, cash flow component of earnings should have incremental power in explaining dividend changes, giving earnings. The findings of this study reveal such an effect. The correlation matrix and pooled cross-sectional time series regression test reveals that in Tehran Stock Exchange cash flow changes are a better measure of liquidity that are highly significant. We also investigated the importance of cash flow changes in setting dividend policy. In particular, we investigated contextual factors that are potentially important in mitigating the relationship between cash flows changes and dividend changes. The results revealed that in Tehran Stock Exchange the relationship between operating cash flow changes and dividend changes do not depend on growth opportunities. In conclusion, there is enough evidence to conclude that the relationship between operating cash flow changes and dividend changes depend on the capital structure choice and size of each firm, but firm growth potentials are not effective.