Dividends as a Signalling Mechanism: The Case of Illiquid Stock Markets

Abstract

Dividends payment is an important signalling device used by corporations. Through the dividend policy, firms can ‘separate’ themselves and let the market, in an environment of asymmetric information, correctly assess their value. However, it is not clear that this mechanism is effective in markets subject to liquidity shocks. We addressed this problem by developing a model where liquidity shocks occur with a certain probability and the stockholder must sell some illiquid assets at a discount in order to cover his cash needs. The results show that under certain conditions and except for the very extreme cases, dividends in fact can still be used as a signalling mechanism by companies in illiquid markets.

Keywords: dividends, signalling, emerging markets, liquidity shocks

JEL Classification: G3, G35