Is there a long-run cointegrating relationship between corporate dividends and earnings?

This study examines whether the earnings per share (EPS) and the dividend per share (DPS) exhibit a long-run equilibrium relationship.  The data employed in this study consist of monthly EPS and DPS for 28 of the DJIA companies obtained from Bloomberg over the past 10 years.  The companies under investigation have the EPS and the DPS available over the period studied. Dividends are generally paid out of earnings. The amount and timing of the dividend paid is a function of the respective company’s dividend policy. Therefore, the EPS_t can be expressed in terms of the DPS_t as follows: EPS_t = αDPS_t where α is a non-negative constant. The equation suggests that there is a linear relationship between the EPS_t and the DPS_t. The methodology employed is the cointegration technique developed by Engle and Granger (1987) who demonstrated that if two time series are nonstationary but their linear combination is stationary, they are said to be cointegrated. Empirical evidence seems to suggest that the EPS is cointegrated with the DPS for the companies investigated in this study. Out-of-sample forecasts, adjusted R², and the log-likelihood ratio test reinforce the superiority of the error correction model.