CDS Trading Initiation, Information Asymmetry, and Dividend Payout

Posted: 13 Apr 2021

See all articles by Wayne R. Landsman

Wayne R. Landsman

University of North Carolina Kenan-Flagler Business School

Chao Kevin Li

University of New South Wales (UNSW)

Jianxin (Donny) Zhao

Emory University

Date Written: April 13, 2021

Abstract

This study uses the information asymmetry framework of DeAngelo, DeAngelo, and Skinner (2008) to examine the effect of initiation of credit default swaps (CDS) trading on firm dividend payout policy. This leads us to consider three channels through which CDS initiation can affect dividends. We find evidence that CDS initiation is associated with increasing dividends, which is consistent with two channels: firms distributing excess free cash flow to mitigate exacerbated manager-equityholder agency conflicts resulting from reduced monitoring by banks following CDS initiation, and firms having a higher incentive to pay out free cash flow because external financing costs are lower as a result of information provided by CDS trading to the equity market. Additional findings corroborate the first channel by showing that the dividend increases are concentrated among borrowing firms whose lead arranger banks have a relatively less strong reputation in the loan syndication market, and firms whose loans are subject to less intense monitoring features, i.e., less restrictive loan covenants, following CDS initiation. Additional analyses suggest that dividend increases following CDS initiation are not attributable to a wealth transfer from debtholders to equityholders, and that inferences are robust to controlling for the potential effects of CDS initiation on capital structure.

Keywords: CDS trading, dividend payout, agency costs

JEL Classification: G30, G35

Suggested Citation

Landsman, Wayne R. and Li, Chao and Zhao, Jianxin (Donny), CDS Trading Initiation, Information Asymmetry, and Dividend Payout (April 13, 2021). Available at SSRN: https://ssrn.com/abstract=3825302 or http://dx.doi.org/10.2139/ssrn.3825302

Wayne R. Landsman (Contact Author)

University of North Carolina Kenan-Flagler Business School ( email )

McColl Building
Chapel Hill, NC 27599-3490
United States
919-962-3221 (Phone)
919-962-4727 (Fax)

Chao Li

University of New South Wales (UNSW) ( email )

high street
High St
sydney, NSW 2052
Australia

Jianxin (Donny) Zhao

Emory University ( email )

464 Goizueta Business School
Atlanta, GA 30322
United States

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