Dividend Policy and Its Relationship to Investment: Evidence from Korean Firms

Previous studies to test the empirical validity of the separation principle are mainly concerned with the test of causality between dividends and investment. A main drawback of the causality test is that the test requires sufficiently long time series to ensure the power of test. This study proposes an event study, which does not necessarily require longer time series, as an alternative way to test the separation principle. The motivation behind the event study lies on the recognition that tests of the separation principle are linked to the question whether firm's dividend decision influences investment effect on the firm's value. Event study is well known to be able to capture the effect of the event on the value of the firm. The study investigates 114 investment announcements made between 1998 and 2002 in Korea. The evidence shows that investment announcement effect is significantly influenced by dividend policy. The result remains unchanged even after controlling for the other variables such as investment amount, investment motivation, and market condition. The evidence is against the separation principle.