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http://ssrn.com/abstract=951588
 
 

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


Thomas J. Chemmanur


Boston College - Carroll School of Management

Xuan Tian


Indiana University - Kelley School of Business - Department of Finance

July 7, 2011

Journal of Financial and Quantitative Analysis (JFQA), Forthcoming

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, a firm has assets in place that will generate an intermediate cash flow, and a growth opportunity. Firm insiders have private information about the intermediate cash flow as well as about the net present value of its growth opportunity. We characterize the firm’s equilibrium choice between preparing and not preparing the market, as well as dividend-cut decision (subsequent to the realization of its intermediate cash flow). In equilibrium, firms in temporary financial difficulties but 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 analysis generates several testable predictions, not only for the propensity of firms to prepare the market prior to dividend cuts, but also for the announcement effect (on the market preparation day, the dividend cut day, and the combined announcement effect over both days) as well as for the long-run operating, dividend payment, and stock return performance of prepared versus non-prepared dividend cutting firms.

Number of Pages in PDF File: 51

Keywords: Market Preparation, Dividend Cuts, Asymetric Information

JEL Classification: G35, M41

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Date posted: March 17, 2008 ; Last revised: May 14, 2014

Suggested Citation

Chemmanur, Thomas J. and Tian, Xuan, 'Preparing' the Equity Market for Adverse Corporate Events: A Theoretical Analysis of Firms Cutting Dividends (July 7, 2011). Journal of Financial and Quantitative Analysis (JFQA), Forthcoming. Available at SSRN: http://ssrn.com/abstract=951588 or http://dx.doi.org/10.2139/ssrn.951588

Contact Information

Thomas J. Chemmanur
Boston College - Carroll School of Management ( email )
440 Fulton Hall
Boston College
Chestnut Hill, MA 02467-3808
United States
617-552-3980 (Phone)
617-552-0431 (Fax)
Xuan Tian (Contact Author)
Indiana University - Kelley School of Business - Department of Finance ( email )
1309 E. Tenth Street
Bloomington, IN 47405
United States
812-8553420 (Phone)
824-8555875 (Fax)
HOME PAGE: http://kelley.iu.edu/tianx

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