Bond and stock market response to unexpected dividend changes

• Empirical studies on corporate bond market using transaction data from TRACE.
• This study examines the response in bond market to dividend announcements.
• The information effect dominates the wealth transfer effect in bond market.
• The relation between dividend changes and future profitability is weak.
• Speculative-grade bonds are more informative than investment-grade bonds.

We use comprehensive transaction data from Trade Reporting and Compliance Engine to study the response in corporate bond market to dividend announcements and compare that with the response in stock market. We find that the information content/free cash flow effect dominates the wealth transfer effect in bond market. The relationship between the magnitude of dividend changes and future profitability is weak. However, the reaction in stock and bond markets on announcement dates can be informative about the earnings one year after announcements. Additionally, the reaction of speculative-grade bonds on announcement dates is more informative about future profitability than that of investment-grade bonds.