Question

A company with stable earnings announces a sudden, large cut in dividend despite strong retained earnings and no capital expenditure needs. Which interpretation is most consistent with dividend signalling theory and market practice?

Q: Answer-A company with stable earnings announces a sudden, large cut in dividend despite strong retained ear...

Dividend signalling suggests managers use dividend changes to signal private information about future earnings. An unexpected cut, especially with strong earnings and no investment need, is often interpreted as a negative signal.

A Market will view it positively—more cash for future projects.

B Market may interpret cut as signal of future earnings weakness, causing a negative reaction.

C No effect—dividends are irrelevant per Modigliani-Miller under all conditions.

D Market will only react if share buybacks announced simultaneously.

E The cut will cause immediate reclassification of debt to equity by lenders.

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A company with stable earnings announces a sudden, large cut in dividend despite strong retained earnings and no capital expenditure needs. Which interpretation is most consistent with dividend signalling theory and market practice?

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