Assume that a firm has a steady record of paying high dividends for years.A new management team decided to cut the current year's dividend in half without disclosing why.The market value of the stock fell 35% on the day the dividend cut was announced.Which of the following would best explain the stock market's reaction to the announcement?
A) Empirical theory
B) Dividend Irrelevance theory
C) Residual Dividend theory
D) Information effect

Question

Quizplus · Accepted Answer

The market value of the stock fell 35% on the day the dividend cut was announced, indicating that the market considered this as a significant negative news. The information effect theory suggests that any new information about a company, including changes in dividends, affects the stock price. Therefore, the best explanation for the stock market's reaction is the information effect theory.

Assume That a Firm Has a Steady Record of Paying