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An Empirical Examination of Dividend Policy Following Debt Issues

Published online by Cambridge University Press:  06 April 2009

Michael S. Long ,
Ileen B. Malitz  and
Stephan E. Sefcik
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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
Information
Journal of Financial and Quantitative Analysis , Volume 29 , Issue 1 , March 1994 , pp. 131 - 144
Copyright
Copyright © School of Business Administration, University of Washington 1994

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