Stock reaction to dividend savings of convertible preferred calls: Free cash flow or price pressure effects? |
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Authors: | Palani-Rajan Kadapakkam Alex P. Tang |
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Affiliation: | aDepartment of Finance, University of Texas at San Antonio, San Antonio, TX 78249, USA;bDepartment of Accounting and Finance, School of Business and Management, Morgan State University, Cold Spring Lane & Hillen Road, Baltimore, MD 21239, USA |
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Abstract: | Calls of in-the-money convertible preferred stock typically induce dividend savings for the firm, since preferred dividends exceed common stock dividends. Prior research finds that these savings are negatively related to stock returns at call announcement and argues that the market expects managers to abuse the increased free cash flow. This paper finds that dividend savings are closely related to call size, suggesting other explanations. Larger calls experience a more negative announcement reaction. Consistent with temporary liquidity effects, there is a price reversal during the conversion period, which is greater for larger calls. |
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Keywords: | JEL classification: G14 G32 |
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