We examine the effects of the world’s first comply-or-explain dividend regulation in China’s Shanghai Stock Exchange, which requires firms to either pay at least 30% of profits as dividends or explain the use of funds. We find that many firms increased their payout ratio to comply, by increasing dividends or decreasing earnings. Firms with high profitability, state ownership, and fewer agency conflicts were more likely to comply. However, complying firms subsequently issued more debt and had a decline in accounting performance and firm valuation. The evidence suggests that the comply-or-explain regulation increased firms’ dividends at substantial costs.