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What do dividend reductions signal?

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  • Jensen, Gerald R.
  • Lundstrum, Leonard L.
  • Miller, Robert E.
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    Abstract

    Dividend reductions have long been considered a "last resort" action for firm managers. Managerial reluctance to reduce dividends emanates from the view that dividend drops signal managerial pessimism regarding future earnings. Contrary to expectations, studies show that earnings rebound significantly following a dividend reduction; yet investors react negatively to the dividend-drop announcement. We present an explanation for the anomalous behavior of earnings and returns around the time of a dividend drop. Our evidence suggests that a reduction in a firm's established dividend coincides with a decrease in the value of the firm's real options. Earnings rebound following the dividend reduction due to the savings that result as the firm allows growth options to expire; however, announcement period returns suggest that investors recognize the lost value associated with the forthcoming expiration of growth options.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Corporate Finance.

    Volume (Year): 16 (2010)
    Issue (Month): 5 (December)
    Pages: 736-747

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    Handle: RePEc:eee:corfin:v:16:y:2010:i:5:p:736-747

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    Web page: http://www.elsevier.com/locate/jcorpfin

    Related research

    Keywords: Dividends Dividend changes Signaling Real options;

    References

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    Cited by:
    1. Chen, Zhijuan & Lin, William T. & Ma, Changfeng & Tsai, Shih-Chuan, 2014. "Liquidity provisions by individual investor trading prior to dividend announcements: Evidence from Taiwan," The North American Journal of Economics and Finance, Elsevier, vol. 28(C), pages 358-374.
    2. Balachandran, Balasingham & Krishnamurti, Chandrasekhar & Theobald, Michael & Vidanapathirana, Berty, 2012. "Dividend reductions, the timing of dividend payments and information content," Journal of Corporate Finance, Elsevier, vol. 18(5), pages 1232-1247.

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