The response of stock returns to unexpected earnings under different capital gain and ordinary income tax rates: an analysis based on the Ohlson valuation model

The dividend irrelevance proposition holds that current dividends result in a dollar for dollar reduction in a stock's price and expected future dividend payouts have no effect on a stock's current value (Miller and Modigliani 1961). A long running question in the literature is whether this state exists given tax favored treatment afforded to retained earnings over dividend payments. Given recent firm valuation models, with roots in Miller and Modigliani's work, based on accounting earnings and book value, this question takes on added importance to the accounting literature. This study analyzes the returns of "dividend" and "non-dividend" paying firms around their quarterh' earnings announcement date associated with a measure of unexpected earnings. The firms are sorted into risk groupings in the manner of Fama and French (1992). The results of the study are mixed. The results indicate no perceptible difference in reaction associated with unexpected earnings of the firms. However, the level of return around earnings announcements does exhibit some correlation with dividend paying status.