The Informational Role of Debt and Dividends with Lender Holdup∗

It has been argued that when management is more concerned with the firm’s survival than with profitability, it is efficient to use a levered capital structure and thereby commit to the transfer of the liquidation decision to lenders. Our paper analyzes this view in a setting where lenders may behave opportunistically when they control the liquidation decision — i.e., when there is a lender holdup problem. We show that in this context, an optimal mix of debt and dividends can mitigate the twin moral hazard problems of the manager and the lender. Given an otherwise optimal capital structure, initiating a dividend policy is shown to increase firm value, lower debt payments, but raise total cash disbursements — interest and dividends — to investors. Numerous other empirical implications of our model are also discussed.