“Preparing” the Equity Market for Corporate Events: Theory and Evidence from Firms Cutting Dividends

摘要

This paper presents the first theoretical as well as the first empirical analysis of the choice of firms between preparing and not preparing the equity market in advance of a possible dividend cut. We use a hand-collected sample of dividend cutting firms that allows us to distinguish between prepared and non-prepared dividend cutting firms. In our model, a firm has assets in place (which will generate an intermediate cash flow), and a growth opportunity. Firm insiders have private information not only about the probability of their firm realizing a high intermediate cash flow, but also about the net present value of its growth opportunity. We characterize the firm insiders’ equilibrium choice between preparing and not preparing the market, as well as their decision regarding whether or not to cut the firm’s dividend (subsequent to the realization of the firm’s intermediate cash flow). In equilibrium, firms in temporary financial difficulties but good long-term growth prospects prepare the market in advance of dividend cuts, while those with permanently declining earnings are less likely to prepare the market. Our analysis generates several testable predictions. First, the abnormal stock returns upon the announcement of a dividend cut will be less negative for prepared compared to non-prepared dividend cutting firms. Second, the abnormal stock returns of firms preparing the market for a dividend cut will be negative on the market preparation day. Third, the long-run operating, dividend payment, and stock return performance of prepared dividend cutting firms will be better than that of nonprepared dividend cutting firms. Finally, firms with lower current profitability but higher longterm growth opportunities are more likely to prepare the market prior to dividend cuts. The results of our empirical analysis support the above predictions of our theory.