Flight-To-Dividends: The Role of Earnings in Periods of Capital Scarcity

50 Pages Posted: 10 Mar 2017 Last revised: 13 Aug 2018

See all articles by Nicholas M. Guest

Nicholas M. Guest

Cornell University - Samuel Curtis Johnson Graduate School of Management

S.P. Kothari

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Eric C. So

Massachusetts Institute of Technology (MIT) - Sloan School of Management

Date Written: August 10, 2018

Abstract

We show that scarcity of arbitrage capital elicits greater attention to firms’ earnings and dividend-paying ability. Our tests are motivated by the idea that the cost of financing levered investment strategies (i.e., investing with borrowed funds) increases in the amount borrowed and risk profile of the securities being traded, particularly when capital is scarce. As a result, levered traders face heightened incentives to tilt their portfolios in the direction of firms’ earnings as a signal of dividends because dividends signal lesser risk and are held by lenders as collateral. Our results show active investors become more responsive to earnings-based investment signals when capital is scarce, particularly among dividend paying firms. Moreover, market prices display a stronger reaction to earnings news and less post-earnings announcement drift. Together, our findings suggest the scarcity of arbitrage capital spurs both the use of, and responsiveness of market prices to, firms’ earnings news.

Keywords: Dividends, Earnings, Capital Scarcity, Active Investors

JEL Classification: M40, M41, G10, G11, G14, G24

Suggested Citation

Guest, Nicholas M. and Kothari, S.P. and So, Eric C., Flight-To-Dividends: The Role of Earnings in Periods of Capital Scarcity (August 10, 2018). Available at SSRN: https://ssrn.com/abstract=2929704 or http://dx.doi.org/10.2139/ssrn.2929704

Nicholas M. Guest

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

314 Sage Hall
Ithaca, NY 14853
United States

S.P. Kothari (Contact Author)

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

E52-325
Cambridge, MA 02142
United States
617-253-0994 (Phone)
617-253-0603 (Fax)

Eric C. So

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

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