Skip to main content Accessibility help

“Preparing” the Equity Market for Adverse Corporate Events: A Theoretical Analysis of Firms Cutting Dividends

  • Thomas J. Chemmanur (a1) and Xuan Tian (a2)


This paper presents the first theoretical analysis of the choice of firms between “preparing” and not preparing the equity market in advance of a possible dividend cut. In our model, insiders have private information about their firm’s intermediate cash flow as well as about the net present value of its growth opportunity. We show that, in equilibrium, firms in temporary financial difficulties but with good long-term growth prospects are more likely to prepare the market in advance of dividend cuts, while those with permanently declining earnings are less likely to prepare the market. Our model generates several new testable predictions.



Hide All
Aharony, J., and Swary, I.. “Quarterly Dividend and Earnings Announcements and Stockholders’ Returns: An Empirical Analysis.” Journal of Finance, 35 (1980), 112.
Allen, F.; Bernardo, A. E.; and Welch, I.. “A Theory of Dividends Based on Tax Clienteles.” Journal of Finance, 55 (2000), 24992536.
Allen, F., and Faulhaber, G. R.. “Signaling by Underpricing in the IPO Market.” Journal of Financial Economics, 23 (1989), 303323.
Amihud, Y.Illiquidity and Stock Returns: Cross-Section and Time-Series Effects.” Journal of Financial Markets, 5 (2002), 3156.
Asquith, P., and Mullins, D. W. Jr. “The Impact of Initiating Dividend Payments on Shareholders’ Wealth.” Journal of Business, 56 (1983), 7796.
Bharath, S. T.; Pasquariello, P.; and Wu, G.. “Does Asymmetric Information Drive Capital Structure Decisions?Review of Financial Studies, 22 (2009), 32113243.
Bhattacharya, S.Imperfect Information, Dividend Policy, and ‘The Bird in the Hand’ Fallacy.” Bell Journal of Economics, 10 (1979), 259270.
Brennan, M. J., and Thakor, A. V.. “Shareholder Preferences and Dividend Policy.” Journal of Finance, 45 (1990), 9931018.
Chemmanur, T.; He, S.; and Nandy, D.. “The Going-Public Decision and the Product Market.” Review of Financial Studies, 23 (2010), 18551908.
Chemmanur, T., and Tian, X.. “Communicating Private Information to the Equity Market Before a Dividend Cut: An Empirical Analysis.” Working Paper, Boston College and Indiana University (2012).
Cho, I.-K., and Kreps, D. M.. “Signaling Games and Stable Equilibria.” Quarterly Journal of Economics, 102 (1987), 179222.
Chowdhry, B., and Nanda, V.. “Repurchase Premia as a Reason for Dividends: A Dynamic Model of Corporate Payout Policies.” Review of Financial Studies, 7 (1994), 321350.
Clarke, J., and Shastri, K.. “On Information Asymmetry Metrics.” Working Paper, University of Pittsburgh (2001).
Crawford, V. P., and Sobel, J.. “Strategic Information Transmission.” Econometrica, 50 (1982), 14311451.
DeAngelo, H.; DeAngelo, L.; and Skinner, D. J.. “Dividends and Losses.” Journal of Finance, 47 (1992), 18371863.
Easley, D.; Kiefer, N. M.; O’Hara, M.; and Paperman, J. B.. “Liquidity, Information, and Infrequently Traded Stocks.” Journal of Finance, 51 (1996), 14051436.
Farrell, F., and Gibbons, R.. “Cheap Talk Can Matter in Bargaining.” Journal of Economic Theory, 48 (1989), 221237.
Fudenberg, D., and Tirole, J.. “Perfect Bayesian Equilibrium and Sequential Equilibrium.” Journal of Economic Theory, 53 (1991), 236260.
Healy, P. M.; Hutton, A. P.; and Palepu, K. G.. “Stock Performance and Intermediation Changes Surrounding Sustained Increases in Disclosure.” Contemporary Accounting Research, 16 (1999), 485520.
Healy, P. M., and Palepu, K. G.. “Earnings Information Conveyed by Dividend Initiations and Omissions.” Journal of Financial Economics, 21 (1988), 149175.
John, K., and Williams, J.. “Dividends, Dilution, and Taxes: A Signalling Equilibrium.” Journal of Finance, 40 (1985), 10531070.
Kalay, A., and Loewenstein, U.. “The Informational Content of the Timing of Dividend Announcements.” Journal of Financial Economics, 16 (1986), 373388.
Kasznik, R., and Lev, B.. “To Warn or Not to Warn: Management Disclosures in the Face of an Earnings Surprise.” Accounting Review, 70 (1995), 113134.
Kothari, S. P.; Shu, S.; and Wysocki, P. D.. “Do Managers Withhold Bad News?Journal of Accounting Research, 47 (2009), 241276.
Milgrom, P., and Roberts, J.. “Price and Advertising Signals of Product Quality.” Journal of Political Economy, 94 (1986), 796821.
Miller, M. H., and Rock, K.. “Dividend Policy under Asymmetric Information.” Journal of Finance, 40 (1985), 10311051.
Oded, J.Why Do Firms Announce Open-Market Repurchase Programs?Review of Financial Studies, 18 (2005), 271300.
Ofer, A. R., and Thakor, A. V.. “A Theory of Stock Price Responses to Alternative Corporate Cash Disbursement Methods: Stock Repurchases and Dividends.” Journal of Finance, 42 (1987), 365394.
Ravid, S. A., and Spiegel, M.. “Optimal Financial Contracts for a Start-Up with Unlimited Operating Discretion.” Journal of Financial and Quantitative Analysis, 32 (1997), 269286.
Ross, S. A. “The Determination of Financial Structure: The Incentive-Signalling Approach.” Bell Journal of Economics, 8 (1977), 2340.
Shu, S. “Why Do Firms Issue Warnings in the Face of Earnings Disappointments: A Self-Selection Analysis.” Working Paper, Boston College (2005).
Skinner, D. J. “Why Firms Voluntarily Disclose Bad News.” Journal of Accounting Research, 32 (1994), 3860.
Soter, D.; Brigham, E.; and Evanson, P.. “The Dividend Cut ‘Heard ’Round the World’: The Case of FPL.” Journal of Applied Corporate Finance, 9 (1996), 415.
Stein, J. C. “Cheap Talk and the Fed: A Theory of Imprecise Policy Announcements.” American Economic Review, 79 (1989), 3242.
Stein, J. C. “Convertible Bonds as Backdoor Equity Financing.” Journal of Financial Economics, 32 (1992), 321.
Watts, R.The Information Content of Dividends.” Journal of Business, 46 (1973), 191211.
Welch, I.Seasoned Offerings, Imitation Costs, and the Underpricing of Initial Public Offerings.” Journal of Finance, 44 (1989), 421449.
Woolridge, R., and Ghosh, C.. “Dividend Cuts: Do They Always Signal Bad News?Midland Corporate Finance Journal, 3 (1985), 2031.

Related content

Powered by UNSILO

“Preparing” the Equity Market for Adverse Corporate Events: A Theoretical Analysis of Firms Cutting Dividends

  • Thomas J. Chemmanur (a1) and Xuan Tian (a2)


Full text views

Total number of HTML views: 0
Total number of PDF views: 0 *
Loading metrics...

Abstract views

Total abstract views: 0 *
Loading metrics...

* Views captured on Cambridge Core between <date>. This data will be updated every 24 hours.

Usage data cannot currently be displayed.