Effect of dividend law changes and fair value accounting on dividend policy: evidence from Australia

This study examines the effect of fair value adjustments on firms' dividend distributions under two alternate dividend law settings, i.e. profit-test-based dividend law and net-assets-test based dividend law. This is important because both firms' dividend policy and fair value adjustments have an association with reported earnings. The study contributes to the literature by combining two variables, namely dividend law and fair value adjustments, to examine firms' dividend policy. Specifically, this thesis hypothesises that, (1) positive fair value adjustments have no distribution consequences under profit-test-based dividend law; and (2) that such adjustments are distributed under net-assets-test-based dividend law. The study uses Fama and Babiak's (1968) variation of Lintner's (1956) model and a sample of 185 ASX-listed financial sector firms with 1,496 firm-year observations to test the two hypotheses. The sample period of nine financial years from 2005−06 to 2013−14 enables an analysis in both dividend law settings because Australia changed from profit-test-based dividend law to net-assets-test-based dividend law in July 2010. Under the profit-test-based dividend law, contrary to the expectations, the results show that positive fair value adjustments are distributed. Managers' inability to differentiate between persistent and transitory fair value adjustments amid non-consideration of transitory nature of fair value adjustments, while setting dividend policy, provide some explanation of the results. Under the net-assets-test-based dividend law, the study expects, but did not find any effect of positive fair value adjustments on firms' dividend payouts. Firms' preference to pursue conservative dividend policy and to attach dividend payouts with permanent earnings, provide some explanation of the findings. The results show that the statutory detachment of earnings and dividends under net-assets-test-based dividend law has not affected the conventional link between these two variables.