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When are Dividend Omissions Good News?

A significant number of dividend omissions are actually good news, signaling a turnaround in the fortunes of the omitting firms after a period of poor performance, and frequently resulting in a resumption in dividend payments within five years of the omission. The market reaction, however, is similar for good and bad omissions, indicating that investors do not separately identify the two at the announcement of omission. We find two key determinants of whether an omission is good or bad. First, we find that good omitters have stronger fundamentals at the time of omission - they have higher profitability and lower levels of debt overhang. Our results suggest good omitters utilize the cash saved by the omission to reduce their (already low) overhang while bad omitters have persistent debt overhang and continue to perform poorly after the omission. Second, we find that an omission is more likely to be good if it occurred when market sentiment for dividend paying firms was high, i.e. the firm was penalized by the market more heavily as a consequence of the dividend omission. We posit that a good omitter is a firm that recognizes the urgency of taking the "bitter medicine" in order to heal itself of its operating and financial malaise.