We extend Baker and Wurgler's [2004a. Journal of Finance 59 1125–1165] catering theory to include decreases and increases in existing dividends. Consistent with our extended model, we find that the decision to change the dividend and the magnitude of the change depend on the premium that the capital market places on dividends. We also find that the stock market reaction to dividend changes depends on the dividend premium. Thus, the capital market rewards managers for considering investor demand for dividends when making decisions about the level of dividends.

Implicit guarantees provided by financial intermediaries are a key component of China's shadow banking sector. We show theoretically that project screening by intermediaries, accompanied by their implicit guarantees to investors, can be the second-best arrangement and mitigate capital misallocation that favors state-owned enterprises (SOEs). Using a dataset of trusts’ investment products, we find, consistent with our model, that ex ante expected yields reflect borrower risks and implicit guarantee strength, and risk sensitivity is reduced by strong guarantees. Regulations in 2018 restricting implicit guarantees lead to a weaker relationship between yield spread and guarantee strength, and more credit rationing of non-SOEs.