Testing the Signaling Theory and Previous Earnings Theory in Relationship Between Dividend and Future Profitability

Managers may adjust dividend to signal stability of changes in previous dividends. On this basis, theory of previous dividends and signaling theory imply that, the dividend is a function of previous profits and serves as a tool for signaling anticipated profit. Since shareholders and investors use carious factors such as dividend for evaluating companies and hence making decisions, and given that company managers have access to inter-organizational information about profitability of the company and use the dividend as a tool for signaling to shareholders and investors, then the relationship between dividend and future profitability is an important empirical subject in financial affairs of a company. As such, the present research aims at investigating the relationship between dividend payout and future profitability of companies. Used in this research are the data on financial statements of 12 companies listed on Tehran Stock Exchange (TSE) during the financial years beginning in 2006 and ending in 2014. In order to determine relationships among the research variables, four hypotheses were designed, and correlation tests and multivariate regression were employed to have them analyzed. Results of the research indicate that, last year’s dividend payout ratio is significantly and negatively related to current year’s dividend payout ratio, and current year’s profitability ratio has a significant positive relationship with the current year’s dividend payout ratio. Moreover, a significant positive relationship was found between current year’s dividend payout ratio and profitability ratio, in one hand, and next year’s profitability ratio, on the other hand. These results are contrary to previous earnings theory and consistent with signaling theory.