Public Debt Markets and Dividend Policy

Abstract

One of the main arguments supporting a traditional Lintner style dividend smoothing policy is that high stable dividend payments solve agency and signalling problems. However, we argue that whether such policies are optimal or not depends crucially on the underlying contractual environment. In particular, we conjecture that there will be differences in dividend policy depending on whether the firm accesses uninformed public market debt (bonds) or informed private bank debt, since the different types of debt offer different mechanisms for resolving agency and signalling problems. We provide strong empirical support for our arguments based on an examination of the dividend policies adopted by U.S. companies over the period 1981 to 1999. We find that a firm's reliance on dividend policy depends critically on its use of public debt markets. In particular, we find that a firm's propensity to pay dividends and follow a dividend smoothing policy is much larger for rated firms than non-rated firms, and that these tendencies increase with the quality of the firm's bond rating. In contrast, firms without bond ratings are much less likely to pay dividends, and those that do, display very little dividend smoothing behavior.