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This paper analyzes the effect of unexpected dividend changes on the values of common stock, preferred stock, and bonds. Two potential effects are identified: a wealth transfer effect and a signalling effect. Previous studies have shown that positive (negative) dividend change announcements produce positive (negative) common stock price changes. Whereas these findings have been attributed to the signalling aspect of dividends, they are also consistent with the wealth transfer hypothesis. Based on the announcement day returns of common and preferred stock and bond holders, it is demonstrated that the primary factor influencing security returns in response to dividend changes is market signalling. A wealth transfer effect is not necessarily ruled out, but if it exists it is dominated by the signalling effect.
The Journal of Finance © 1983 American Finance Association