DIVIDENDS AND LOSSES

An annual loss is essentially a necessary condition for dividend reductions in firms with established earnings and dividend records: 50.9% of 167 NYSE firms with losses during 1980-1985 reduced dividends, versus 1.0% of 440 firms without losses. As hypothesized by Miller and Modigliani, dividend reductions depend on whether earnings include unusual items that are likely to temporarily depress income. Dividend reductions are more likely given greater current losses, less negative unusual items, and more persistent earnings difficulties. Dividend policy has information content in that knowledge that a firm has reduced dividends improves the ability of current earnings to predict future earnings.