Flight-to-Dividends: The Role of Earnings in Periods of Capital Scarcity

We show that institutional traders become more responsive to firms’ earnings news in periods when investment capital is scarce. During these periods, the composition of traders tilts toward more active investors who increase the amount of arbitrage capital applied to earnings-based investment strategies. Moreover, market prices display a stronger reaction to earnings news as well as less post-earnings announcement drift, particularly among dividend paying firms. These findings suggest that active traders become more responsive to earnings news as signals of firms’ ability to pay dividends because dividends signal lower risks and thus lower costs of financing levered strategies. Together, our findings suggest the scarcity of investment capital impacts both the composition of traders and responsiveness of market prices to firms’ earnings news.