Dividend policy is a key aspect of today's business activities. Set by the board of directors, dividends are tracked by potential investors as indicators of a company's health and may be used by investors seeking steady returns on their investment funds. Companies which are characterized by high rates of growth and which have high requirements for research and development are likely to have a low dividend payout because funds are needed for the continuation of the business. Companies which are already established in the market and which do not have immediate needs for funds may have higher payout ratios in order to attract investors and provide a higher rate of return to shareholders.
In their article, "Dividend Yields and Stock Returns: Evidence of Time Variation Between Bull and Bear Markets," Gombola and Liu suggest that there are persistent shifts in the relationship between stock returns and dividend yields among bull and bear markets. This research examines the article and considers the ramifications of the article on managers' decision-making process and capital budgeting techniques.
Gombola and Liu find that dividend yield is positively related to return during bear markets, but negatively related to return to bull markets. It is the time variance between the two markets which the authors suggest help explain the unusual results of earlier studies.
In order to conduct their study, the authors first set three definitions for bull (up) and bear (down) markets (307). The first measure suggests that if market returns exceeds the risk-free rate for the month, the month is considered a bull (up market) month. Since this is a month-by-month consideration of the market, it is a short-term measure.
The second measure groups months depending on the trend in neighboring months. Thus during recent times, most months would be categorized as bull markets, but a bull market month which occurred in the midst of several bea...