The impact of technical defaults on dividend policy

This paper examines how loan covenant violations impact firm dividend policy. Using contract-level loan data for nonfinancial firms in the US, this study provides evidence that the occurrence of a covenant violation significantly increases the likelihood of a dividend reduction in the subsequent quarter. Moreover, we show that the degree of creditor–shareholder conflict and firm financial constraints are important determinants of dividend cuts upon technical default. Additionally, this paper finds the tendency of dividend cuts upon technical default weakened after the repeal of the Glass–Steagall Act. These findings suggest that loan covenants serve a critical role in mitigating creditor–shareholder conflicts.