Journal of Financial and Quantitative Analysis

Research Articles

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

Thomas J. Chemmanura1 and Xuan Tiana2

a1 chemmanu@bc.edu, Carroll School of Management, Boston College, 140 Commonwealth Ave, Chestnut Hill, MA 02467

a2 tianx@indiana.edu, Kelley School of Business, Indiana University, 1309 E 10th St, Bloomington, IN 47405

Abstract

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.

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