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Payout policy and the interaction of firm-level and country-level governance

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Abstract

For a panel of 1880 firms across 21 countries from 2004 to 2008, the impact of firm-level and country-level governance on payout policy is consistent with the La Porta et al. (J Finance 60(1):1–33, 2000) outcome model. In weak legal regimes, dividends increase in firm-level governance. In strong legal regimes, dividends decrease in firm-level governance while share repurchases increase, substituting tax-efficient, flexible share repurchases for rigid dividends. Consistent with the outcome model, payout decreases in growth opportunities when firm-level and country-level governance are high. These results are robust to an instrumental variable approach and alternative firm-level and country-level governance measures.

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Notes

  1. Gov41 is the sum of 41 firm attributes that span 4 areas: board, audit, antitakeover, and compensation and ownership. Aggarwal et al. (2011) find a relation between Gov41 and international institutional holdings, and Aggarwal et al. (2010) find a relation between Gov41 and valuations.

  2. Another option is cross-listing to a stock exchange with better country-level governance (Doidge et al. 2004, 2009).

  3. Chang et al. (2018, Table 12) consider repurchase payout ratios as an extension but do not find a statistically significant relation between firm-level governance and repurchase payout ratios.

  4. DeAngelo et al. (2008, §12) discuss dividend taxation.

  5. For example, Brav et al. (2005, Table 2) provide survey evidence that 88.1% of chief financial officers say reducing dividends has negative consequences, and 65.4% would not reduce dividends to fund a new project. Other advantages of share repurchases include exploiting share undervaluation, removing low valuation shareholders, increasing ownership concentration, removing block holders, and preserving executive stock option values. DeAngelo et al. (2008, §13) discuss the advantages of share repurchases relative to dividends.

  6. La Porta et al. (2000) motivate a large literature on country-level governance. For example, Pinkowitz et al. (2006) use Fama and French (1998) valuation regressions to determine the marginal value of cash and dividends worldwide. They hypothesize that, because minority shareholders fear expropriation by majority shareholders, minority shareholders in weak legal regimes value dividends more than cash. They find support for their hypothesis.

  7. Other studies consider other aspects of payout and governance. Lee (2011) examines the firm valuation effects of dividends in the context of firm-level governance. He finds that the market more highly values dividends paid by firms with greater antitakeover protections. Tanyi et al. (2021) find that higher dividend payout is associated with fewer negative or withheld votes during annual board of director elections.

  8. Many studies examine payout policy and governance in single-country studies around the world (e.g., Gugler (2003) in Germany, Chang and Dutta (2012) in Canada, and Shamsabadi et al. (2016) in Australia). However, as with U.S.-centric studies, the results of these single-country studies are mixed.

  9. RiskMetrics covers U.S. firms that are members of the following indexes: Standard and Poors’ (S&P) 500; S&P Small Cap 600; and Russell 3,000. RiskMetrics also covers non-U.S. firms that are members of the following major stock indexes: MSCI Europe, Australasia, and Far East Index (MSCI EAFE), which covers 1,000 stocks in 21 developed countries outside North America; FTSE All Share Index, which consists of FTSE 100, FTSE 250, and FTSE SmallCap indexes; FTSE AllWorldDeveloped index, which consists of the largest firms in developed markets; and S&P/TSX index of the Toronto Stock Exchange. The Gov41 data are available at https://novafinance.pt/download_file/view/196/191.

  10. Board measures board of directors characteristics such as board independence, the composition of committees, size, transparency, and how the board conducts its work. Audit measures the independence of the audit committee and the role of auditors. Antitakeover measures dual-class structure, the role of shareholders, poison pills, and blank check preferred. Compensation and ownership measures executive and director compensation on issues related to options, stock ownership and loans, and how compensation is set and monitored. RiskMetrics sets each of these 41 indicator variables to 1 if the firm exceeds some minimum level and 0 otherwise. Unlike the revised anti-director index and anti-self-dealing index (Djankov et al. 2008), Gov41 has cross-sectional and time-series variation within a country. Some attributes may matter more than others, but linear combinations of binary governance attributes have a foundation in the literature ( Gompers et al. 2003; Bebchuk et al. 2009). Any noise should make it more difficult to find a statistical relation between Gov41 and payout policy.

  11. One previous year is necessary to generate total asset and sales growth rates.

  12. Gov41 is available for many U.S. firms, but dropping U.S. firms prevents a “horse and rabbit stew” problem. Untabulated results for U.S. firms are similar to those for other common law country firms.

  13. I follow La Porta et al. (2000) and do not differentiate between civil law origins. Civil law countries are those without English legal origins.

  14. Untabulated results with firm random effects, year fixed effects, and standard errors clustered by firm are similar (e.g., von Eije and Megginson 2008).

  15. Note that Poisson regressions with fixed effects require variation in the dependent variable within fixed effect groups. Therefore, Poisson regressions drop fixed effect groups that are either singletons or have no variation in the dependent variable. As a result, Poisson regressions may include fewer than the 7,403 observations in Tables 1 and 2.

  16. My main results are similar if I use the leave-out average of Gov41 by country-industry-year, where I base industry on either one-digit SIC codes or Fama and French (1997, 12 industries). However, I use a U.K. director as an alternative firm-level governance measure in my robustness tests. The U.K. director indicator requires the leave-out average of Gov41 by country-year to identify regressions. For simplicity, I use the leave-out average of Gov41 by country-year level as my IV throughout.

  17. The Cragg and Donald (1993) statistic assumes iid errors, while the Kleibergen and Paap (2006) statistic is robust to non-iid errors.

  18. The control function IV approach addresses endogeneity by including the first-stage regression residuals as independent variables in the second stage ( Wooldridge 2010, §18.3.1). These results—and the probit results in Sect. 4.2—are similar to linear regression results. Linear regressions allow a conventional IV approach but do not consider that payout ratios are non-negative. Section 5.2 discusses these results, and Table IA.1A in the Internet Appendix tabulates them.

  19. Stock market development (market/GDP) is a static country-level variable and absorbed by firm fixed effects.

  20. Like Poisson regressions, probit regressions with fixed effects require variation in the dependent variable within fixed effect groups. Therefore, probit regressions drop fixed effect groups that are either singletons or have no variation in the dependent variable. As a result, probit regressions may include fewer than the 7,403 observations in Tables 1 and 2.

  21. None of the individual components of the anti-self-dealing index interacted with firm-level governance has a consistent relation with payout policy in untabulated results.

  22. It would be interesting to select several individual attributes, but Aggarwal et al. (2011) only provide aggregated Gov41. Chang et al. (2018, Table 11) test 7 of the 41 components of Gov41 and find that some matter more than others in setting dividend payout ratios. They find that more shareholder-friendly board structures and audit processes are associated with higher dividend levels.

  23. Hermalin and Weisbach (2001) and Adams et al. (2010) provide literature reviews.

  24. Table 7 only presents results for a U.K. director indicator as an alternative firm-level governance measure for brevity. Results are qualitatively similar with a U.S. director indicator, although with weaker statistical significance in some cases. This weaker statistical significance may be because U.K. directors are more common in my sample than U.S. directors by 2577 to 1423.

  25. In untabulated results, the correlations between Gov41 and U.K. director is 26.8% in levels and 0.2% in changes.

  26. Angrist and Pischke (2008, §4.6.1) and Wooldridge (2010, §15.7.3) discuss forbidden regressions.

  27. I omit the four second-stage coefficient estimates for the first-stage residuals to conserve space.

  28. I calculate dA/A marginal effects at a Gov41 value of 0.61, the 75th percentile for common law firms. Marginal effects are larger in magnitude at a Gov41 value of 1, the maximum possible value.

  29. Lin and Lee (2020) show that firms with smoother dividends have greater earnings persistence, earnings growth, and pricing multiples on earnings. Their results suggest that smoothed dividends have incremental explanatory power over dividend payout for signaling future earnings. However, I limit my analysis to payout smoothing in the context of governance.

  30. I trim the estimated speeds of adjustment at 2% and 98% instead of 1% and 99% to reduce outliers.

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Acknowledgements

This paper has benefited from the helpful comments and suggestions of Cheng-Few Lee, two anonymous reviewers, Jennifer Bethel, Donal Byard, Liqiang Chen, Jay Dahya, Jian Hua, Laurie Krigman, Kin-Wai Lee, Rajarishi Nahata, Jérôme Taillard, Joseph Weintrop, and seminar participants at Baruch College, the 2017 Financial Management Association Annual Meeting, and the 28th Annual Conference on Pacific Basin Finance, Economics, Accounting, and Management.

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  1. D’Amore-McKim School of Business, Northeastern University, 413 Hayden Hall, 360 Huntington Avenue, Boston, MA, 02115-5000, USA

    Richard Herron

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Herron, R. Payout policy and the interaction of firm-level and country-level governance. Rev Quant Finan Acc 58, 1–39 (2022). https://doi.org/10.1007/s11156-021-00986-1

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