Bankruptcy law, creditors' rights and dividend policy: evidence from a quasi-natural experiment

Abstract

PurposeThe purpose of this paper is to examine how changes in creditors' rights affect the dividend policy behavior of corporate firms.Design/methodology/approachThe authors use the implementation of the bankruptcy and insolvency code (IBC) in India in 2016 as a quasi-natural experiment setup. Differential application of this law allows them to use the Difference in Differences approach to extract the marginal impact of change in creditors' rights on the dividend policy.FindingsThe authors show that firms responded to strengthening creditors' rights by decreasing their dividend payout. Further, the authors observe that this negative response is conditioned on firm leverage and the nature of the creditor, i.e. public or private. The firms with a greater leverage ratio and a greater proportion of private debt in the total debt in the pre-event period have shown greater response to the change in the law. Lastly, the authors show that stock markets positively respond to the observed decrease in dividends only when a corresponding decrease in the leverage accompanies such a decrease.Originality/valueThe authors contribute to the finance and law literature from several aspects. First, the authors extend this stream by bringing to light the dividend policy response of firms when they are subjected to a change in creditors' rights. Second, the authors also show how firm-level factors like financial policy and the nature of the creditor condition their response to IBC. Lastly, the authors also examine the market reaction to the dividend policy response of firms to the change in bankruptcy law.