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

• Author: Linyin Cheng,Lu Zhang,Yuetang Wang,Guojun Wang,Dan Yang
• DOI: http://doi.org/10.1111/corg.12332
• Date: 01 September 2020
• Published date: 01 September 2020

ORIGINAL ARTICLE

Investor protection and cost of debt: Evidence from dividend

commitment in firm bylaws

Dan Yang

1

| Linyin Cheng

2

| Guojun Wang

3

| Yuetang Wang

2

| Lu Zhang

4

1

Business School, Beijing Normal University,

Beijing, China

2

Business School, Nanjing University, Nanjing,

China

3

School of Management and Engineering,

Nanjing University, Nanjing, China

4

College of Economics and Management,

China Agricultural University, Beijing, China

Correspondence

Guojun Wang, School of Management and

Engineering, Nanjing University, 22 Hankou

Road, Nanjing 210093, Jiangsu, China.

Email: wangguojun@nju.edu.cn

Funding information

National Natural Science Foundation of China,

Grant/Award Numbers: 71602010, 71602085,

71802011, 71672082

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.

KEYWORDS

corporate governance, China, cost of debt, dividend commitment, investor protection

1|INTRODUCTION

Debtholders are the primary providers of long-term capital (Chava,

Livdan, & Purnanandam, 2009; Houston & James, 1996). Their

required returns are essentially based on how likely a firm is to default

and the degree of protection they have in the event of a default. The

prior finance literature (e.g., Fisher, 1959; Kaplan & Urwitz, 1979;

Weinstein, 1981) has documented certain characteristics of firms and

debt issuance in determining debtholders' required return (also known

as corporate cost of debt). However, a firm's likelihood of default and

debtholder protection during a default also depend on the availability

of symmetric information for evaluating the default risk, agency costs

due to insider control, and shareholder–debtholder conflicts

(Bhojraj & Sengupta, 2003; Bradley & Chen, 2011). Investor protec-

tion mechanisms can influence such factors; that is, the quality of

investor protection has been considered to reflect low information

asymmetry between insiders and outsiders and weak insider control

(La Porta, Lopez-de-Silanes, Shleifer, & Vishny, 2000a, 2000b), but

investor protection may also aggravate shareholder–debtholder con-

flicts due to the different incentives of these two parties (Jensen &

Meckling, 1976; Myers, 1977). Accordingly, investor protection mech-

anisms can affect a debtholder's required return.

Received: 18 January 2020 Revised: 29 May 2020 Accepted: 2 June 2020

DOI: 10.1111/corg.12332

294 © 2020 John Wiley & Sons Ltd Corp Govern Int Rev. 2020;28:294–308.wileyonlinelibrary.com/journal/corg