Investor protection and cost of debt: Evidence from dividend commitment in firm bylaws

Abstract

Research Question/Issue: This study seeks to explore a new type of investor protection mechanism-dividend commitment in firm bylaws-that has emerged from a new Chinese dividend regulation. Dividend commitment, forcing firms to make an explicit commitment to maintain a given dividend level, may affect the benefit and risk of debtholders and, accordingly, their required returns. Research Findings/Insights: Using a sample of Chinese listed firms between 2006 and 2017, we find a significantly lower cost of debt for high-commitment firms than for low-commitment firms. The differences are pronounced for firms that actively respond to the regulation, those that operate in a weaker information environment, those that suffer from higher agency costs due to insider control, and those with lower debt ratios. Theoretical/Academic Implications: This study provides empirical evidence of the economic consequences of dividend commitment. The results suggest that dividend commitment is associated with changes in the benefits and risks of debtholders and that such an association is conditional on firm-level factors; thus, the findings contribute to investor protection theory. Practitioner/Policy Implications: This study provides insights to policy makers interested in evaluating investor protection in an emerging economy. The results highlight the financial implications of an innovative investor protection mechanism.