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Corporate risk management and dividend signaling theory

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  • Dionne, Georges
  • Ouederni, Karima

Abstract

This article investigates the effect of corporate risk management on dividend policy. We extend the signaling framework of Bhattacharya [1979. Bell Journal of Economics 10, 259–270] by including the possibility of hedging the future cash flow. We find that the higher the hedging level, the lower the incremental dividend. This result is intuitive. It is in line with studies suggesting that cash flows’ predictability decreases the marginal gain from costly signaling through dividends and the assertion that corporate hedging decreases cash flow volatility. It is also in line with the purported positive relation between information asymmetry and dividend policy (e.g., Miller and Rock [1985. The Journal of Finance 40, 1031–1051]) and the assertion that risk management alleviates the information asymmetry problem (e.g., DaDalt et al. [2002. The Journal of Future Markets 22, 261–267]). Our theoretical model has testable implications.

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Bibliographic Info

Article provided by Elsevier in its journal Finance Research Letters.

Volume (Year): 8 (2011)
Issue (Month): 4 ()
Pages: 188-195

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Handle: RePEc:eee:finlet:v:8:y:2011:i:4:p:188-195

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

Related research

Keywords: Signaling theory; Dividend policy; Risk management policy; Corporate hedging; Information asymmetry;

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  1. Brav, Alon & Graham, John R. & Harvey, Campbell R. & Michaely, Roni, 2005. "Payout policy in the 21st century," Journal of Financial Economics, Elsevier, vol. 77(3), pages 483-527, September.
  2. Franklin Allen & Roni Michaely, 2002. "Payout Policy," Center for Financial Institutions Working Papers 01-21, Wharton School Center for Financial Institutions, University of Pennsylvania.
    • Allen, Franklin & Michaely, Roni, 2003. "Payout policy," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 7, pages 337-429 Elsevier.
  3. Dennis Frestad, 2009. "Why Most Firms Choose Linear Hedging Strategies," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 32(2), pages 157-167.
  4. Gerald D. Gay & Jouahn Nam & Marian Turac, 2002. "How Firms Manage Risk: The Optimal Mix Of Linear And Non-Linear Derivatives," Journal of Applied Corporate Finance, Morgan Stanley, vol. 14(4), pages 82-93.
  5. James Poterba, 2004. "Taxation and Corporate Payout Policy," American Economic Review, American Economic Association, vol. 94(2), pages 171-175, May.
  6. Miller, Merton H & Rock, Kevin, 1985. " Dividend Policy under Asymmetric Information," Journal of Finance, American Finance Association, vol. 40(4), pages 1031-51, September.
  7. Kenneth A. Froot & David S. Scharfstein & Jeremy C. Stein, 1992. "Risk Management: Coordinating Corporate Investment and Financing Policies," NBER Working Papers 4084, National Bureau of Economic Research, Inc.
  8. DeMarzo, Peter M & Duffie, Darrell, 1995. "Corporate Incentives for Hedging and Hedge Accounting," Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 743-71.
  9. Pinghsun Huang & Harley E. Ryan & Roy A. Wiggins, 2007. "The Influence Of Firm- And Ceo-Specific Characteristics On The Use Of Nonlinear Derivative Instruments," Journal of Financial Research, Southern Finance Association & Southwestern Finance Association, vol. 30(3), pages 415-436.
  10. Dichev, Ilia D. & Tang, Vicki Wei, 2009. "Earnings volatility and earnings predictability," Journal of Accounting and Economics, Elsevier, vol. 47(1-2), pages 160-181, March.
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