An empirical investigation of the effect of LIFO adoption on dividend policies

This study investigated the effect of LIFO adoption on dividend policies. Many finance studies have postulated and supported a close association between dividends and reported earnings. LIFO adoption typically results in decreasing reported earnings below the levels that would have been reported without LIFO adoption. If firms have target dividend payout ratios, and apply the preexisting ratios to reported earnings, LIFO adoption will result in lower dividends than under non-LIFO methods.In this study, the potential impact of LIFO adoption on dividend decisions was documented by examining two forms of dividend-earning relations: the dividend payout ratio (using ANOVA analysis) and the coefficient relating earnings to dividend changes (in multiple regression analysis). In the ANOVA analysis, changes in dividend payout ratios in the LIFO adoption years were compared with those of control firms. The multiple regression analysis examined whether the coefficient relating earnings to dividend changes of the switch firms in a time-series dividend model shifted to reflect the earnings effect of LIFO adoption.Two samples were identified for the study. The first sample consists of firms that switched from non-LIFO to LIFO during the period 1971-1985. Two hundred and ninety-eight LIFO adoption firms were selected for the study. The second sample consists of control firms. The control firms were matched with the switch firms based on industry membership and the mean ratios of dividends divided by reported earnings for the three year period immediately preceding the switches.The potential effect of the accounting changes on earnings is generally greatest in the switch year and declines thereafter. The results suggest the switch firms adjusted dividend policies to offset the earnings effect of LIFO adoption in the switch years although adjustments could not be detected in multiyear post-change periods.