Hostname: page-component-78c5997874-g7gxr Total loading time: 0 Render date: 2024-11-02T20:29:46.014Z Has data issue: false hasContentIssue false

An Empirical Examination of Dividend Policy Following Debt Issues

Published online by Cambridge University Press:  06 April 2009

Abstract

This paper empirically examines the underinvestment problem and the use of dividends to expropriate lenders' wealth. Rather than analyzing the market's reaction to potential wealthexpropriating events, a different aspect of potential conflicts of interest is addressed: do managers who control dividends act in a manner consistent with wealth expropriation? If so, then debt issues should be followed by increases in dividends. Two samples of firms are used: those issuing straight debt and those issuing convertible debt. The study finds no evidence that firms manipulate dividend policy to transfer wealth from the bondholders to stockholders. Two possible explanations are suggested. First, wealth expropriation may be a potential problem, but existing bond covenants restricting a firm's ability to pay dividends are effective. Second, firms may believe that reputation has greater value than what can be transferred from creditors in a one-time expropriation of wealth. Since the paper fails to find support for the covenant argument, it concludes that reputation is the most plausible explanation.

Type
Research Article
Copyright
Copyright © School of Business Administration, University of Washington 1994

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Brickley, J. [Shareholder Wealth, Information Signaling and the Specially Designated Dividend: An Empirical Study.] Journal of Financial Economics, 11 (1983), 187209.CrossRefGoogle Scholar
DeAngelo, H., and DeAngelo, L.. [Dividend Policy and Financial Distress: An Empirical Investigation of Troubled NYSE Firms.] Journal of Finance, 45 (1990), 14151431.CrossRefGoogle Scholar
Fama, E. [Agency Problems and the Theory of the Firm.] Journal of Political Economy, 88 (1980), 288307.CrossRefGoogle Scholar
Handjinicolaou, G., and Kalay, A.. [Wealth Redistributions or Changes in Firm Value: An Analysis of Returns to Bondholders and Stockholders Around Dividend Announcements.] Journal of Financial Economics, 13 (1984), 3563.CrossRefGoogle Scholar
Healy, P., and Palepu, K.. [Effectiveness of Accounting-Based Dividend Covenants.] Journal of Accounting and Economics, 12 (1990), 97123.CrossRefGoogle Scholar
Jensen, M., and Meckling, W.. [Theory of the Firm: Managerial Behavior, Agency Costs, and Ownership Structure.] Journal of Financial Economics, 3 (1976), 305360.CrossRefGoogle Scholar
John, K., and Nachman, D.. [Risky Debt, Investment Incentives, and Reputation in a Sequential Equilibrium.] Journal of Finance, 40 (1985), 863878.CrossRefGoogle Scholar
Kalay, A. [Stockholder-Bondholder Conflict and Dividend Constraints.] Journal of Financial Economics, 10 (1982), 211233.CrossRefGoogle Scholar
Malitz, I. [On Financial Contracting: The Determinants of Bond Covenants.] Financial Management, 15 (1986), 1825.CrossRefGoogle Scholar
Smith, C., and Warner, J.. [On Financial Contracting: An Analysis of Bond Covenants.] Journal of Financial Economics, 7 (1979), 117161.CrossRefGoogle Scholar