Flight-To-Dividends: The Role of Earnings in Periods of Capital Scarcity
50 Pages Posted: 10 Mar 2017 Last revised: 13 Aug 2018
Date Written: August 10, 2018
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: Suggested Citation