Leverage and Dividend Regimes

Abstract

We study the leverage of firms making large dividend increases. Over the five years following the dividend increase these firms raise leverage by enough to finance the entire dividend increase for that period with debt. This behavior is not explained by trade-off variables or a standard interpretation of the pecking order. The effect is greatest for big firms with low-powered incentives, suggesting an agency effect whereby these firms make large dividend increases with the intention of paying for them with debt as a means of controlling the agency problem. This suggests that debt and dividends are complementary in controlling agency problems, not substitutes. We show that the mechanism of implementing the leverage increase is that these firms raise leverage in response to financing deficits much more than do other firms. The findings survive a large number of robustness checks.