Dividend Payout and the Valuation Effects of Bond Announcements

Recent theoretical models suggest debt and dividends can serve as substitute free cash flow control or signaling devices. I examine share price responses to announcements of straight debt issues and test whether there are systematic differences between low and high dividend payout firms. Share price response is significantly positive for low growth-low dividend payout firms, and is negatively related to cross-sectional dividend payout. The results support arguments that debt and dividends are substitutes. The results also support arguments that debt provides free cash flow or signaling benefits, but suggest the benefits are significant only for firms with low levels of substitutes. I also document that low growth-low dividend payout firms enter capital markets less frequently, but find no relation between share price response and this frequency