Journal zyxwvutsrqp of Business zyxwvuts Finance zyxwvutsrq &Accounting, 18(3), April 1991, zyxw 0306 686 zyx X $2.50 DIVIDEND OMISSIONS AND STOCK MARKET RATIONALITY CHINMOY GHOSH AND J. RANDALL WOOLRIDGE' INTRODUCTION This study reports new evidence on two issues relating to stock market rationality: (1) the market reaction to announcements of successive dividend omissions; and (2) the aggregate market reaction to all dividend announcements following an omission. These issues are interesting because (1) virtually all empirical studies on the valuation effects of dividend changes analyze announcements made by dividend-paying firms;' and (2) shareholder reaction to dividend announcements during periods of zero payout has special significance for the information content and the unbiased expectations A potential implication of the information hypothesis is that the signalling content of a dividend change depends upon the extent to which it is unanticipated. There have been two approaches to measure the unexpected component in a divdend change: (1) compare actual dividend payments with the expected levels; and (2) examine if dividends reveal more information than earnings by separating the information content of contemporaneous earnings and dividend announcements. Various specifications of expected dividends have been evaluated, with essentially similar result^.^ The second line of inquiry has yielded no definitive conclusions either.5 In this paper, it is argued that the stock market reaction to successive announcements of dividend omissions constitutes an alternative test of the information content hypothesis. Presumably, because of the unfavorable implications of dividend omissions, the subsequent performance of omitting firms is critically reviewed by the market. Therefore, investors can anticipate successive omissions more accurately than dividend increases, decreases or first omissions. To the extent that successive omissions are more predictable and less informative, the valuation impact of a dividend omission announcement should be proportionately less intense than the previous one. The authors are respectively, Assistant Professor of Finance at the University of Connecticut; and Associate Professor of Finance and Goldman, Sachs and Co. and Frank P. Smeal Endowed University Fellow in Business Administration at Pennsylvania State University. The first author acknowledges the financial support from the Corporate Associates Summer Research Grant from the University of Connecticut. Earlier versions of this paper were presented at the Finance workshop at the University ofConnecticut and the FMA meetings at New Orleans in 1988. Comments from the participants at these forums are appreciated. (Paper received November 1988, revised July 1989) 315