Journal of Financial Services Research

, Volume 47, Issue 3, pp 381–410 | Cite as

Outside Director Stock Options and Dividend Policy

  • Anwar Boumosleh
  • Brandon N. ClineEmail author


Agency theory suggests that dividends can be used to mitigate agency problems between shareholders and managers. If director stock options are granted to align the interests of directors with shareholders, we anticipate that there will be less need for external governance mechanisms such as dividends. Examining the association between outside director stock options and dividend policy, we show that outside director option compensation indeed varies inversely with dividend distribution. This result suggests that incentivizing outside directors reduces the need for external market monitoring through dividends. Controlling for the sensitivity of options to changes in dividends, we illustrate that the lack of dividend protection for stock options is not a sufficient explanation for the reduction of dividends. We also show that while investment policy might dominate the decision to offer a dividend, director stock options play an important role in determining the level of dividend paid in firms that pay dividends.


Director compensation Dividend policy Agency problem Corporate governance 

JEL classification

G30 G34 G35 G39 


  1. Agrawal A, Knoeber C (1996) Firm performance and mechanisms to control agency problems between managers and shareholders. J Financ Quant Anal 31:377–397CrossRefGoogle Scholar
  2. Anderson RC, Mansi S, Reeb D (2004) Board characteristics, accounting report integrity, and the cost of debt. J Account Econ 37:315–342CrossRefGoogle Scholar
  3. Bebchuck LA, Grinstein Y, Peyer U (2010) Lucky CEOs and lucky directors. J Finance 65:2363–2401CrossRefGoogle Scholar
  4. Bhattacharya S (1979) Imperfect information, dividend policy, and “the bird in the hand” fallacy. Bell J Econ 10:259–270CrossRefGoogle Scholar
  5. Boumosleh A, Cline B, Yore (2013) Should Outsiders be Left Out? Director Stock Options, Expectations and Earnings Management. Working Paper, Northern Illinois UniversityGoogle Scholar
  6. Brick IE, Palmon O, Wald J (2006) CEO compensation, director compensation, and firm performance: evidence of cronyism. J Corp Finan 12:403–423CrossRefGoogle Scholar
  7. Bryan S, Hwang L-S, Klein A, Lilien SB (2000) Compensation of Outside Directors: An Empirical Analysis of Economic Determinants. Working Paper, Baruch College, CUNYGoogle Scholar
  8. Core J, Guay W (1999) Estimating the value of stock option portfolios and their sensitivities to price and volatility. J Account Econ 28:151–184CrossRefGoogle Scholar
  9. Easterbrook FH (1984) Two agency-cost explanations of dividends. Am Econ Rev 74:650–659Google Scholar
  10. Fama EF, French KR (2001) Disappearing dividends: changing firm characteristics or lower propensity to Pay? J Finan Econ 60:3–43CrossRefGoogle Scholar
  11. Fama EF, French KR (2002) Testing trade-off and pecking order predictions about dividends and debt. Rev Finan Stud 15:1–33CrossRefGoogle Scholar
  12. Fama EF, Jensen M (1983) Separation of ownership and control. J Law Econ 26:301–325CrossRefGoogle Scholar
  13. Fenn GW, Liang N (2001) Corportae payout policy and managerial stock incentives. J Financ Econ 60:45–72CrossRefGoogle Scholar
  14. Fich E, Shivdasani A (2005) The impact of stock-option compensation for outside directors on firm value. J Bus 78:2229–2254CrossRefGoogle Scholar
  15. Fluck Z (1999) The dynamics of the manager-shareholder conflict. Rev Financ Stud 12:379–404CrossRefGoogle Scholar
  16. Grullon G, Michaely R, Swaminathan B (2002) Are dividend changes a sign of firm maturity? J Bus 75:387–424CrossRefGoogle Scholar
  17. Guay W, Harford J (2000) The cash-flow permanence and information content of dividend increases vs. Repurchases. J Financ Econ 57:385–415CrossRefGoogle Scholar
  18. Hall B, Liebman J (1998) Are CEOs paid like bureaucrats? Q J Econ 103:653–691CrossRefGoogle Scholar
  19. Harford J (2003) Takeover bids and target directors’ incentives: the impact of a bid on directors’ wealth and board seats. J Financ Econ 69:51–83CrossRefGoogle Scholar
  20. Harford J, Mansi S, Maxwell W (2008) Corporate governance and a firm’s cash holdings. J Financ Econ 87(3):535–555CrossRefGoogle Scholar
  21. Hermalin B, Weisbach M (1998) Endogenously chosen boards of directors and their monitoring of the CEO. Am Econ Rev 88:96–118Google Scholar
  22. Hu A, Kumar P (2004) Managerial entrenchment and payout policy. J Financ Quant Anal 39:759–790CrossRefGoogle Scholar
  23. Jensen M (1986) Agency costs of free cash flow, corporate finance, and takeovers. Am Econ Rev 76:323–329Google Scholar
  24. Jensen M, Meckling W (1976) Theory of the firm: managerial behavior, agency costs and ownership structure. J Financ Econ 3:305–360CrossRefGoogle Scholar
  25. Jiraporn P, Chintrakarn P (2009) Staggered boards, managerial entrenchment, and dividend policy. J Financ Serv Res 36:1–19CrossRefGoogle Scholar
  26. Jiraporn P, Kim J-C, Kim Y-S (2011) Dividend payouts and corporate governance quality. Financ Rev 46:251–279CrossRefGoogle Scholar
  27. Jiraporn P, Chintrakarn P, Liu Y (2012) Capital structure, CEO dominance, and corporate performance. J Financ Serv Res 42:139–158CrossRefGoogle Scholar
  28. Jo H, Pan C (2009) Why are firms with entrenched managers more likely to pay dividends? Rev Account Financ 8:87–116CrossRefGoogle Scholar
  29. John K, Knyazeva A (2006) Payout Policy, Agency Conflicts and Corporate Governance. Working Paper, New York UniversityGoogle Scholar
  30. Ju Y, Zhao L (2012) Directors’ ownership and closed-end fund discounts. J Financ Serv Res. doi: 10.1007/s10693-012-0156-9
  31. Lambert R, Lanen W, Larcker D (1989) Executive stock option plans and corporate dividend policy. J Financ Quant Anal 24:409–425CrossRefGoogle Scholar
  32. Lang L, Litzenberger R (1989) Dividend announcements cash flow signaling vs. free cash flow hypothesis? J Financ Econ 24:181–191CrossRefGoogle Scholar
  33. Michaely R, Thaler R, Womack K (1995) Price reactions to dividend initiations and omissions: overreaction and drift? J Finance 50:573–608CrossRefGoogle Scholar
  34. NACD (2010a) Director Compensation and the Function of Equity. Custom Research Memo. National Association of Corporate Directors. Washington, DCGoogle Scholar
  35. NACD (2010b) 2009–2010 Director Compensation Report. National Association of Corporate Directors. Washington, DCGoogle Scholar
  36. Peni E, Vahamaa S (2012) Did good corporate governance improve bank performance during the financial crisis? J Financ Serv Res 41:19–35CrossRefGoogle Scholar
  37. Perry T (2000) Incentive Compensation for Outside Directors and CEO Turnover. Working Paper, Arizona State UniversityGoogle Scholar
  38. Ryan H, Wiggins R (2004) Who is in whose pocket? director compensation, bargaining power, and board independence. J Financ Econ 73:497–524CrossRefGoogle Scholar
  39. Sharma V (2011) Independent directors and the propensity to pay dividends. J Corp Financ 17:1001–1015CrossRefGoogle Scholar
  40. Sierra GE, Talmor E, Wallace JS (2006) An examination of multiple governance forces within bank holding companies. J Financ Serv Res 29:105–123CrossRefGoogle Scholar
  41. Smith C, Watts R (1992) The investment opportunity Set and corporate financing, dividend, and compensation policies. J Financ Econ 32:263–292CrossRefGoogle Scholar
  42. Vafeas N (1999) Determinants of the adoption of director incentive plans. J Account Audit Financ 14:453–474Google Scholar
  43. Weisbach M (1988) Outside directors and CEO turnover. J Financ Econ 20:431–460CrossRefGoogle Scholar
  44. Yermack D (1996) Higher market valuation of companies with a small board of directors. J Financ Econ 40:185–211CrossRefGoogle Scholar
  45. Yermack D (2004) Remuneration, retention, and reputation incentives for outside directors. J Finance 59:2281–2308CrossRefGoogle Scholar
  46. Zweibel J (1996) Dynamic capital structure under managerial entrenchment. Am Econ Rev 86:1197–1215Google Scholar

Copyright information

© Springer Science+Business Media New York 2013

Authors and Affiliations

  1. 1.Department of Finance and EconomicsMississippi StateUSA
  2. 2.Department of Economics and FinanceLebanese American UniversityBeirutLebanon

Personalised recommendations