We distinguish among the signaling, free cash flow, and wealth transfer hypotheses in explaining the stock price reaction to specially designated dividend (SDD) announcements. In a direct test of the signaling power of SDDs, we find both a larger stock price reaction and a significant upward revision of earnings forecasts for firms with Tobin's q less than one, but not for other firms. Our results support the conditional signaling hypothesis, which predicts greater effects of favorable information for low q firms. Taken together, our results for stock price effects and earnings forecast revisions do not support either the free cash flow or wealth transfer hypotheses.

Classification schemes for financial ratios serve to aid understanding of empirical similarity among the ratios and to aid in the selection of critical financial variables for empirical research. Previous researchers, who defined cash flow as net income plus depreciation, found cash flow ratios highly associated with return ratios. In this study, cash flow is computed by adjusting net income for all accruals and deferrals. This more appropriate definition leads to classification schemes in which the cash flow ratios form a factor separate and distinct from the factor of return ratios.