Applied Financial Economics, 2006, 16, 535–549 Corporate scandals and the market response of dividend payout changes Taeyoon Sung a, *, Daehwan Kim b and Ludwig Chincarini c a Graduate School of Management, KAIST (Korea Advanced Institute of Science and Technology), Seoul, Korea b Economics, American University in Bulgaria, Blagoevgrad, Bulgaria c Robert Emmett McDonough School of Business, Georgetown University, Washington, USA This paper examines whether the dividend valuation changed after cor- porate accounting scandals such as that of Enron in October 2001 broke out. We find that dividend increasing firms experienced positive abnormal returns in the industry affected by corporate scandals up to four months after the first scandal in the industry became public. We interpret this finding in the context of the agency theory of Jensen (1986). To provide a perspective, we examine the dividend valuation from early 1980s to early 2000s, and find that the dividend valuation increased consistently for this time period. We also find that the dividend valuation was highest in the information technology industry after the year 2000. These findings fit well with the agency theory as well. I. Introduction A well-established fact on corporate dividends is that the change in dividend payout rates affects a firm’s value despite the irrelevance theory of Modigliani and Miller (1961). While numerous theories have been developed to explain this phenomenon, two theories stand out prominently: the signalling theory of Miller and Rock (1985) and the agency theory of Jensen (1986). The signalling theory of Miller and Rock suggests that dividend payout rates reveal inside information about future earnings prospects that should be reflected in a company’s stock price. Jensen’s agency theory sug- gests that the dividend payout rate affects the agency costs of free cash flow, which would in turn affect the stock price. Various empirical evidences have been presented supporting the signalling theory or the agency theory interpretation of the dividend valuation. However, the question of which theory is more relevant has not been settled yet. In this paper, we take up this question again empirically in an interesting new setting, i.e. in the context of the corporate accounting scandals of years 2001 and 2002. We hope to contribute to the literature in two ways. First, we want to add one more set of empirical evidence, in our opinion, supporting the agency theory of the dividend valuation. Second, perhaps more importantly, we present an analysis of how stock markets reacted to the series of corporate accounting scandals that broke out in years 2001 and 2002. As an evidence for the agency theory, our finding may not be the strongest evidence ever reported in the literature. Nonetheless, we believe our findings to be worth reporting as it is one of the first attempts to apply the theories of dividend valuation to the *Corresponding author. E-mail: econsung@kgsm.kaist.ac.kr Applied Financial Economics ISSN 0960–3107 print/ISSN 1466–4305 online ß 2006 Taylor & Francis 535 http://www.tandf.co.uk/journals DOI: 10.1080/09603100500426390