Operating performance following dividend decreases and omissions*

Using quarterly data and benchmarks based on past performance-characteristics, I find little evidence that earnings change following 661 dividend decreases and 872 dividend omissions between 1980 and 1998. The exception is that earnings deteriorate during the quarter of dividend omissions, but they recover within a couple of quarters. My results further suggest that the lack of a more pronounced earnings decline is neither attributable to a contemporaneous and confounding increase in share repurchases, to earnings management, nor to improving investment opportunities, and the results are similar for firms that are not predicted to cut dividend payouts based on their financial flexibility. Instead, I find some evidence that the negative stock price reaction reflects the dismal performance during the quarter of the announcement, especially for firms that omit dividends, and that the market interprets the dividend announcements too pessimistically. * I thank Randy Heron, Heidi Lie, Roni Michaely, Wanda Wallace, and seminar participants at the College of Williams & Mary, the University of Iowa, and the University of Virginia (Darden) for helpful comments.