Disclosure and dividend signalling when sustained earnings growth declines

The purpose of this paper is to examine whether voluntary disclosure and dividends signal future earnings for decline earnings growth firms. It seeks to inform regulators (and managers) about the potential benefits of increased disclosure and increased dividends to investors for firms that suffer an earnings decline after a sustained period of annual earnings growth.

The event study methodology is used to examine the behaviour of 33 non‐financial UK firms after a decline of their sustained earnings growth. It also uses the computerised content analysis to count the number of forward‐looking sentences in the annual report narratives. It calculates changes in disclosure and dividends in the year of earnings growth declines and examine their association with the abnormal future earnings.

Consistent with prior research, it is found that increasing dividends does not convey value relevant information about future earnings for decline earnings growth firms. However, based on disclosure signalling theory, it is found that increasing levels of forward‐looking information in annual report narratives is an important mechanism for signalling future earnings for these firms.

For an effective communication with the stock market in the years of earnings decline after sustained period of growth, managers should give high priority to developing an appropriate and complete set of forward‐looking information in their annual reports. This will enable investors to better anticipate firms' future prospects. The results suggest that if forward‐looking statements in annual report narratives contain value relevant information for investors, then regulators should consider a compulsory narrative section (i.e. operating and financial review) in the annual report.

This paper is the first to study the value relevance of voluntary disclosure for decline earnings growth firms.