Corporate dividend policy plays a pivotal role in capital allocation to shareholders in the realm of stock market investment. While the Modigliani-Miller theorem's ideal market assumptions may not fully hold up to reality, dividends and stock buybacks remain significant corporate decisions. This study investigates the effects of dividend policy changes on credit risk, utilizing data from the Credit Default Swap (CDS) markets.
The research explores two hypotheses: the wealth-transfer hypothesis and the information hypothesis. The results indicate that a reduction in dividends leads to a considerable increase in CDS spreads, particularly for financial companies. Moreover, the study examines the impact of government intervention, specifically the Troubled Asset Relief Program (TARP), on dividend decisions during the 2008 financial crisis. All these findings offer valuable insights for corporate decision-making and investor strategies.