Dividend cuts, firm profitability and financial characteristics

Abstract

This paper investigates the dividend decisions of firms in the UK reporting losses after sustained periods of profitability. It is found that loss-making firms are more likely to reduce dividends compared to firms that remain profitable, although a loss is far from a guarantee that the dividend payment will be reduced. A lower propensity to reduce dividends is found in the UK relative to the US, consistent with the stronger culture of dividend payments. The size of the loss is an important factor in a firm’s dividend policy. However, this is mitigated to some extent if it is the result of unusual accounting items because managers view these as a temporary fluctuation in profitability. Leverage is found to have some role in the dividend decision, with higher levels of debt consistent with a greater likelihood of a reduction in the distribution whilst also suppressing profitability in future years. Profit margins prior to the loss year are also a significant factor in dividend policy whereby low margin firms are more likely to cut dividends.

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