Question

a)     Explain 5 reasons why investors often see a cut in a company's dividend payment as a negative signal.

Answer 1

The reasons for seeing cut in a company's dividend payment as a negative signal

1) Weakening earnings because of systematic financial stress like in 2008-09 financial crisis, Covid etc.

2) Many investors are dependent on dividend income as their source of income. So cut in dividend payment will disapoint them.

3) Comapny might not have enough funds to meet the upcoming short term obligations. So therefore the management might cut dividend payment that fiscal year to pay the obligation.

4) Company would cut dividend to pursue inorganic mergers and acquisition to hide its poor performance by acquiring companies which investors are suspicious of.

5) Low dividends payments will result in lower stock price as per Dividend discount model. As per dividend discount model the price is equal to discounted value of all the dividends. Cut in dividend payment will result in lower future dividend payment and low stock price.