We examine the consequences of unexpected dividend changes in the cost of debt using evidence from the credit default swaps (CDS) market. We find that CDS spreads substantially increase in response to dividend cuts, especially during recessions and among firms with high credit risk and worse past stock performance, suggesting that the information content effect of dividend cuts dominates the wealth transfer effect for debt holders. In addition, dividend cuts are followed by a higher probability of defaults and credit rating downgrades. We find little evidence that CDS spreads change in response to dividend raises or share repurchases.

Keywords: Credit default swaps, Dividend policy, Credit risk, Information content, Wealth transfer

JEL Classification: G12, G14, G15