how product market competition affects dividend payments in a weak investor protection economy:...

Pacific-Basin Finance Journal 25 (2013) 21–39

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Pacific-Basin Finance Journal

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How product market competition affectsdividend payments in a weak investor protectioneconomy: Evidence from Taiwan☆

Lanfeng Kao a, Anlin Chen b,⁎a 700 University RD, Department of Finance, National University of Kaohsiung, Kaohsiung 81148, Taiwanb Department of Business Management, National Sun Yat-Sen University, Taiwan

a r t i c l e i n f o

☆ We appreciate the helpful comments from an anoConference and the 3rd Global Accounting and Organithe Republic of China, Taiwan for financially supportMelissa Morgan, and Valerio Puggioni are appreciated⁎ Corresponding author at: 70 Lien Hai RD, Depart

80424, Taiwan. Tel.: +886 7 5252000x4656; fax: +E-mail addresses: lanfeng@nuk.edu.tw (L. Kao), a

0927-538X/$ – see front matter © 2013 Elsevier B.V.http://dx.doi.org/10.1016/j.pacfin.2013.08.004

a b s t r a c t

Article history:Received 2 August 2012Accepted 1 August 2013Available online 13 August 2013

We examine the link between the intensity of product marketcompetition and the dividend models of agency conflicts in an economywith weak investor protection (Taiwan). Product market competitioncan substitute for governance mechanisms. Our results show that theoutcome agency model of dividends is applicable onlywhen the productmarket is highly competitive. However, the substitute agency model ofdividends is supported when the product market has low competitive-ness. Productmarket competition alleviates the effects of agency conflictsand corporate governance practices on dividend policies.

© 2013 Elsevier B.V. All rights reserved.

JEL classification:G34G35

Keywords:Agency conflictCorporate governanceDividend policyInvestor protectionProduct market competition

1. Introduction

Product market competition is considered a substitute for a governance mechanism, and influencescorporate financial strategies, such as dividend policies. Previous studies have focused on the relationshipbetween product market competition and dividend payouts in countries with strong investor protection.We instead investigate the link between product market competition and dividend policy in a countrywith weak investor protection.

nymous referee and the participants at the 7th Annual London Business Researchzational Change Conference 2012. We also thank the National Science Council ofing this research under Contract No. NSC100-2410-H-110-020-MY2. Ted Knoy,for their editorial assistance. All the remaining errors are ours.ment of Business Management, National Sun Yat-Sen University, Kaohsiung886 7 5254698.nlin@mail.nsysu.edu.tw (A. Chen)

All rights reserved.

22 L. Kao, A. Chen / Pacific-Basin Finance Journal 25 (2013) 21–39

Jensen (1986) and Gomes (2000) argue that dividends protect outside shareholders, particularlyminority shareholders. Whether a firm pays dividends depends on the jurisdiction of where the firm isdomiciled, particularly the enforcement of protections for minority shareholders and the effectiveness ofcorporate governance in situations involving agency conflicts. La Porta et al. (2000) address two dividendpolicy models from the agency conflict perspective: the outcome model and the substitute model. Theoutcome agency model argues that effective minority shareholders force managers to pay dividends,implying that the amount of dividendpaid increaseswith corporate governance. However, the substitute agencymodel argues that firms pay dividends to establish a decent reputation, so that they can raise capital in themarkets in the future. Therefore, firms domiciled in jurisdictions with strong corporate governance are notrequired to pay high dividends to show decency. Consequently, the substitute agency model implies that theamount of dividends paid decreases when the strength of corporate governance increases.

Product market competition is closely related to both managerial incentives and interest alignmentbetween controlling and minority shareholders. Hart (1983) and Shleifer (1985) argue that product marketcompetition reduces information asymmetry betweenmanagers and shareholders because shareholders caneasily benchmark a firm's performance to the performance of competitors (the yardstick competitionhypothesis). Schmidt (1997) indicates that intense product market competition increases firm default riskand liquidation risk, thereby reducing managerial agency conflicts. Shleifer and Vishny (1997) show thatcompetition reduces the agency costs of free cash flow by discouragingmanager investment in negative NPVprojects. Allen and Gale (2000) argue that product market competition serves as either a monitoringmechanism or a corporate governance mechanism to reduce agency conflicts. Bertrand and Mullainathan(2003) show that competition eliminates the “quiet life” to reduce input costs, overheads, andwages. Fee andHadlock (2000) and Raith (2003) indicate that competition increases CEO turnover, that CEOs aremore likelyto be replaced in a competitive market, and that they typically work harder during severe competition.Guadalupe and Perez-Gonzalez (2010) show thatmanagement interests alignwith shareholder interests in acompetitive product market.

Giroud andMueller (2011) indicate that if product market competition can force managers to maximizefirm value to survive, then corporate governance is unnecessary in intensely competitive markets.Corporate governance on manager monitoring is affected by product market competition. However, firmsin low-intensity competition markets require corporate governance to discipline managers. Because of thethreats of defaults and liquidation, and the interest alignment between insiders and outsiders, increasedproduct market competition forces managers to focus their efforts and reduce managerial slack to survive,even without strong corporate governance.

Schmidt (1997) argues that product market competition reduces the profit margin, and thus, firmprofitability. Consequently, firms facing intense product market competition cannot offer a sufficientlyattractive compensation scheme to fully motivate managers. Karuna (2007) argues that product marketcompetition can either substitute for or complement managerial incentives. Product market competitioncan act as a disciplinary mechanism and reduce the need for managerial incentives. However, firms mustprovide greater incentives to managers, to motivate them in a more competitive market. Therefore, firmsmight offer managers higher allowances in a more intensely competitive market. Consequently, the totaleffect of product market competition on managerial incentives should be ambiguous.

Beiner et al. (2011) show a nonlinear relationship between product market competition andmanagerialincentives which depends on the absolute level of competition. The rationale for Beiner et al. (2011) is abusiness stealing effect and a scale effect. The business stealing effect indicates that a more intensecompetition implies a higher demand elasticity, facilitating a firm with a cost advantage to lure businessaway from its competitors. The marginal benefit of reducing costs increases with competition intensity.Consequently, the firm offers higher managerial incentives to reduce marginal costs with increasingcompetition. The scale effect indicates that competition reduces the firm's profitability, resulting in lowergains from reducing costs. Thus, the firm offers lower managerial incentives with increasing competition.During low competition, the scale effect dominates because competition reduces the value of managerialdecisions, whereas during high competition, the business stealing effect dominates because competitionincreases the value of good managerial decisions. Beiner et al. (2011) state that the relationship betweenmanagerial incentives and competition intensity is dependent on the absolute level of competition; themarginal effect of competition on managerial incentives increases with competition, and competitionreduces the firm's profits.

23L. Kao, A. Chen / Pacific-Basin Finance Journal 25 (2013) 21–39

Grullon andMichaely (2008) indicate that the link between product market competition andmanagerialincentives has implications for corporate dividend policies. They argue that intense competition ispositively related to dividend payout in the outcome agency model of dividends. Intense competitionincreases firm liquidation risk, thus reducing overinvestment risk.With a reduced likelihood of overinvestment,firms havemore free cash flows for dividend payments.When competition is not fierce, firms aremore likely toinvest than to distribute cash to shareholders through dividends. The yardstick competition hypothesis impliesthat competition reduces information asymmetry between managers and shareholders, forcing managers todistribute excess cash flows to shareholders.

On the other hand, intense competition is negatively related to dividend payout in the substitute agencymodel of dividends, in which competition substitutes for external governance mechanisms. Under intensecompetition,firmmanagers are not required to pay dividends for alleviating agency conflicts betweenmanagersand shareholders. Grullon andMichaely (2008) show that in a country with strong investor protection, such asin the United States, the outcome agency model of dividends prevails. However, information is scant regardingthe relationship between the agency model of dividends and product market competition in countries withweak investor protection.

We explore the influence of productmarket competition on dividend policy in a countrywithweak investorprotection, particularly the influence of market competition on the effect of governance (agency conflict) ondividend policy. In economies with poor investor protection, minority shareholders are more likely toexperience serious agency conflicts, and are less able to alleviate such problems. The economics literatureindicates that product market competition is a disciplinary market force. However, studies examining the linkbetween product market competition and dividend policy in economies with weak investor protection arescant.1Wefill this gap by examining the effect of productmarket competition on corporate dividend policy in aneconomy with weak investor protection.

We focus on Taiwan because of its weak investor protection and emerging civil law jurisdiction. Klapper andLove (2004) indicate that investor protection is weaker in emerging markets than in the United States. La Portaet al. (2000) report that civil law jurisdictions do not offer strong investor protection, and show thatfirms in civillaw jurisdictions pay lower dividends than those in common law jurisdictions. Taiwan firms are likely to beaffiliated with controlling families or groups through pyramidal or cross-holding structures. Claessens et al.(2000) show that 49% of companies in Taiwan with ultimate control at the 20% level use pyramidal structures,and 8.6% of Taiwan companies have a degree of cross-ownership. Pyramidal structures and cross-holdingsincrease the divergence between controlling shareholder cash flow and control rights, potentially leading to thesevere expropriation of minority shareholders. Choy et al. (2011) characterize Taiwan as a country with highinvestor expropriation risk. We analyze 9448 Taiwanese firm–year observations during 1996–2010.

Our empirical results are summarized as follows. We find a nonlinear relation between dividendpayouts and product market competition. Piecewise regression analyses indicate that when competition islow, dividend payouts are negatively related to product market competition (supporting the substituteagency model of dividends), whereas when competition is high, dividend payouts and product marketcompetition are positively related (supporting the outcome agency model of dividends). Product marketcompetition substitutes for corporate governance. Firms tend not to pay dividends when governance isweak, and competition reduces the effect of weak corporate governance on dividend payments.

The remainder of this paper is organized as follows. Section 2 introduces our data source and variabledefinitions. Section 3 presents a discussion of industry characteristics related to industry-level competition.Section 4 provides the basic model specification of dividend payments. Section 5 details a piecewise modelspecification and an examination of whether the link between product market competition and dividends isdependent on competition. In Section 6,we discuss the effects of productmarket competition on agency conflict.

1 For South Korea, Byun et al. (2012) use the dividend payment as a partial internal corporate governance index, and find thatgroup firms tend to have high internal corporate governance, whereas standalone firms have low corporate governance in a non-competitive environment. However, they also report that, even without the dividend payment as a partial corporate governanceindex, they still obtain similar results, implying that dividend policy does not play an important role. For China, Liu and Yu (2009)show that the effect of product market competition on dividend policy is dependent on the strength of investor protection. They findthat the competition effect on dividends is stronger at a low level, than at a high level, of investor protection.

24 L. Kao, A. Chen / Pacific-Basin Finance Journal 25 (2013) 21–39

In Section 7, we investigate how product market competition interacts with governance mechanisms toinfluence dividend policy. Finally, Section 8 offers a conclusion.

2. Data source, variable definitions, and descriptive statistics

2.1. Data source

The sample data comprise all listed firms in Taiwan from 1996 to 2010. The sample period begins in 1996because the Taiwan Economic Journal (TEJ)2 established a corporate governance data set for Taiwanesefirms thatyear. All study variables are obtained from the TEJ database, including dividends, net income, book assets, bookdebt, book equity, market equity, operating income, retained earnings, cash, cash equivalents, R&D expenses,stock returns, market index returns, controlling shareholder ownership, blockholder ownership, directorownership, board structure variables, and equity structure variables. We discard observations with missingvalues for required variables from the sample, leaving 9448 firm–year observations.

2.2. Variable measurement

The measures of dividend payments, competition, corporate governance, control variables, and industrycharacteristics are detailed as follows.

2.2.1. Dividend variablesWe use two variables to measure dividend payments. DivNIit is the dividend payout ratio of firm i in

year t. The dividend payout ratio is the proportion of firm net income paid out as dividends. DivMVit is thedividend yield of firm i in year t measured using the ratio of dividends to market capitalization.3

2.2.2. Competition measurePublished studies typically use the Herfindahl–Hirschman index (HHI) to measure industry intensity

and industry competition. A high HHI implies a high industry concentration or a low industry productmarket competition. The HHI is the sum of the squares of individual firmmarket shares in an industry. Themeasure of product market competition (ONE_HHI) used in this investigation is calculated as 1 minus theHHI. ONE_HHIjt is the product market competition measure for firms in industry j in year t. Therefore,

2 The3 We

similar4 The5 Sha

ONE HHIjt ¼ 1−Xn j

i¼1

salesijtXn j

i¼1salesijt

!2

ð1Þ

Here, salesijt denotes the total sales of firm i in industry j during year t, and nj is the number of firms inindustry j.4

2.2.3. Corporate governance variablesThe level of controlling shareholder ownership influences the interests of minority shareholders.

Fan andWong (2002) show that on the one hand a higher controlling shareholder ownership results ina closer interest alignment of controlling and minority shareholders. Therefore, a high controllingshareholder ownership protects minority shareholder interests. We use ControlHoldit to represent thecontrolling shareholder ownership5 of firm i at the end of year t.

status of the TEJ in Taiwan is similar to that of the CRSP and Compustat in the United States.also use a payer dummy variable and dividends scaled by total assets to measure dividend payments, and reach qualitativelyresults.results are robust to the specification of assets, market value of equity, or sales as calculations of market shares.reholders are controlling shareholders if their direct and indirect voting rights exceed 20%.

25L. Kao, A. Chen / Pacific-Basin Finance Journal 25 (2013) 21–39

On the other hand, Fan and Wong (2002) also show that a higher ownership concentration throughpyramidal and cross-holding structures creates agency conflicts between controlling owners and outsideinvestors. We use a dummy variable (PYRAMIDAL) to capture the pyramidal structure of ownership.6

PYRAMIDALit = 1 if firm i is part of a pyramid in year t; otherwise, PYRAMIDALit = 0. CROSS is a dummy variablerepresenting cross-ownership.7 CROSSit = 1 iffirm i is subject to cross-holding in year t; otherwise,CROSSit = 0.

BOARDit represents the number of directors on the board of firm i at the end of year t. Large boards mayimpede communication, create difficulties in decision making, and reduce monitoring effectiveness.Jensen (1993) asserts that boards exceeding seven or eight members are less effective. Yermack (1996)shows that smaller boards of directors are more effective.

BoardHoldit represents the director ownership of firm i at the end of year t. Hermalin and Weisbach(1998) argue that directors are important for monitoring managers. Corporate governance motivatesdirectors to monitor firm managers, to protect the interests of outside shareholders. When directors havehigher ownership, they are better positioned to monitor managers, and ensure that they act in the interestof shareholders.

BlockHoldit represents the outside blockholder ownership8 of firm i at the end of year t. Edmans (2009)argues that blockholders exert governance, even if they cannot intervene in firm operations. Theincentives of outside blockholders to monitor the firm increase with their ownership.

CEO duality means that the CEO of the firm also serves as the chair of the board (COB). CEO dualityimplies a weak governance structure because the board is improperly monitoring managers. Brickley et al.(1997) argue that separating the CEO and COB reduces agency costs and improves corporate performance.DUALITYit = 1 if the CEO is also the COB of firm i during year t; otherwise, DUALITYit = 0.

2.2.4. Control variablesFollowing Fama and French (2001), Lie (2005), and Choy et al. (2011), we use the cash level, profitability,

historical prior income volatility, firm size, firm risk, investment opportunity, financial maturity, and taxregime as control variables for dividend policy. Because investment policy and leverage may also affectdividend policy, they are included as control variables.

CASHit denotes the cash level of firm i at the end of year t, measured as cash and cash equivalents scaledby total assets. Shareholders of firms with higher cash balances are likely to urge those firms to pay higherdividends.

Chen and Hu (2007) argue that the controlling shareholders of Taiwanese firms pledge their shares tofinance firm projects when firms lack funds. Consequently, a share pledge by controlling shareholders(PLEDGE) implies low dividends, and is measured by the percentage of shares owned by controllingshareholders pledged in banks.

OIit denotes the profitability of firm i in year t, measured as the operating income over lagged assets.Profitability influences the firm's ability to pay dividends.

Prior income volatility (stdOI) is the standard deviation of the ratio of the quarterly operating incometo total assets measured from 4 years before the event year through the event year. Firms with a higherhistorical volatility of operating income are less likely to distribute dividends to retain cash for future use.

We use systematic risk to measure firm risk. BETAit denotes the systematic risk of firm i in year tmeasured by the market model using daily returns in year t.9

DeAngelo et al. (2006) indicate that mature firms tend to pay dividends. Accordingly, we use the ratioof retained earnings to total assets as a proxy for financial maturity (RETA).

6 The existence of multiple layers between a controlling shareholder and a firm in the same business group is defined as apyramid. This describes the situation where a controlling shareholder owns the shares of a firm through another firm in the samebusiness group.

7 The situation where firms in the same business group own each other's shares is defined as cross-ownership. In contrast topyramids, firms in cross-ownership are linked in the horizontal cross-holdings of shares.

8 A shareholder holding more than 10% ownership but not serving as a director or manager is defined as an outside blockholder.9 The number of daily returns in a calendar year depends on the number of trading days in that year. During 1996–2010, the mean

of the trading days in a calendar year is 257.7, with a minimum of 244, a median of 250, and a maximum of 288 trading days.

26 L. Kao, A. Chen / Pacific-Basin Finance Journal 25 (2013) 21–39

Bernhardt et al. (2005) and Kao and Chen (2011) argue that the tax treatment of dividends influencescorporate dividend policy. Taiwan eliminated the double taxation of dividends after 1998. Therefore, weadopt a period dummy of elimination of double taxation of dividends (EDTD). EDTDt = 1 if year t is after1998; otherwise, EDTDt = 0.

Asset growth (AssetGrow), measured by the change of assets to lagged assets, serves as a proxy forinvestment policy. Firms with larger increases in asset investment tend to pay lower dividends to reduceoutside financing needs.

Previous studies report that financial leverage negatively affects dividend payments. More leveragedfirms pay lower dividends. We use the debt-to-asset ratio (DebtAsset) to measure leverage.

2.2.5. Industry characteristics related to competitionWemeasure the intensity of product market competition by using the level for the industry as a whole. In

a certain year, all firms in the same industry face the same industry competition intensity. Consequently,certain industry characteristics may drive both the industry competition intensity and dividend payouts,creating a correlation between product market competition and dividend payouts, even without the causallink from competition to dividends. To eliminate this possibility, our analyses control for several industrycharacteristics related to competition.10

Hou and Robinson (2006) indicate that a significant investment in assets deters competitor entry andincreases industry concentration while reducing competition; R&D expenditure decreases substantially withincreasing concentration, as does the ratio of R&D expenses to assets; profitability measures are alsopositively related to industry concentration. Hou and Robinson (2006) conclude that concentrated industriestend to be characterized by large assets, high unit profitability, and low risk-innovation investment (low levelof R&D).Weuse the logarithmof assets (logAsset)11 as a proxy for the barrier to entry, pseudoQ (Q) as a proxyfor unit profitability,12 and the ratio of R&D expenses to assets (R&D) as a proxy for risk-innovationinvestment to control for industry effects related to competition.

Table 1 lists the definitions of the variables.

2.3. Descriptive statistics

We divide the sample into 18 industries based on the classifications of the Taiwan Stock ExchangeCorporation. Table 2 lists the mean and median of product market competition, dividend payouts, totalassets, pseudo Q, and R&D expenditure for each industry in order of competition intensity. Table 2 showsthat the oil, gas, and utility industry is the least competitive in Taiwan, whereas the building material andconstruction industry is the most competitive. Oil, gas, and utility firms exhibit higher dividends, largerassets, and higher pseudo Q than building material and construction firms. The electronics industry is wellrepresented in the sample, with 4537 of the 9448 observations. On average, electronics firms pay 34.6% ofnet income as dividends, with a dividend yield of 2.5%, and have higher pseudo Q and R&D expenditure.This is because electronics firms, in a manner similar to other high-tech firms, must maintain high R&Dspending to support potential growth.

Tables 3 and 4 list the descriptive statistics for the study variables. Table 3 lists the statistics for firm–

year observations for the whole sample, whereas Table 4 lists the statistics for the firm–year observationsof firm subsamples from both high competition and low competition industries.

Table 3 shows that the average dividend payout ratio (DivNI) is approximately 33.8% (median = 22.8%),whereas the dividend yield (DivMV) is approximately 2.4% (median = 1.4%). The average competitionintensity (ONE_HHI) is 0.88, with a median of 0.921, a minimum of 0, and a maximum of 0.980. Thedescriptive statistics for the competition measure imply that Taiwan firms face intense competition. For

10 We thank the anonymous referee for this suggestion.11 The logarithm of total assets also serves as a proxy for firm size. Dividend payers are typically considerably larger than non-payers.12 Because operating income (OI) has been a control variable for dividend payouts, we use pseudo Q to proxy unit profitability,which is related to industry competition intensity. Pseudo Q is measured as follows: (book assets – book equity + market equity)/(book assets).

Table 1Variable definition.

Variable Definition

DivNI Dividend payout ratio measured by the proportion of net income paid out as dividend.DivMV Dividend yield measured by the ratio of dividend to market capitalization.ΔDivNI Change of dividend payout ratio.ΔDivMV Change of dividend yield.ONE_HHI Competition measure defined as 1 minus the HHI index based on the market shares of total sales.ΔONE_HHI Change of competition level.ControlHold Controlling shareholder ownership.PYRAMIDAL Dummy variable for pyramidal structure.CROSS Dummy variable for cross-ownership structure.BOARD Board size defined as the number of directors on board.BoardHold Board director ownership.BlockHold Outside blockholder ownership.DUALITY Dummy variable for CEO duality.PLEDGE Proportion of director shares collateralized at banks.CASH Cash position to lagged assets.OI Operating income to lagged assets.stdOI Standard deviation of quarterly OI during the past 4 years.Asset Total assets in million NT dollars. One U.S. dollar is approximately 32 NT dollars.logAsset Logarithm of total assets.BETA Systematic risk measured by market model using daily returns in a calendar year.Q Pseudo Q measured by (book assets-book equity + market equity)/(book assets).RETA Financial maturity measured by retained earnings to assets.EDTD Dummy variable for elimination of double taxation of dividends.DebtAsset Leverage measured by the ratio of debt to assets.AssetGrow Asset growth measured by the change of assets to lagged assets.R&D R&D expenditure measured by the ratio of R&D expenses to assets.

27L. Kao, A. Chen / Pacific-Basin Finance Journal 25 (2013) 21–39

corporate governancemeasures, the controlling shareholders (ControlHold) average 29.3% of firm ownership(median = 26.7%). In total, 25.2% of the sample firms have a pyramidal ownership structure (PYRAMIDAL),and 27.3% have a cross-ownership structure (CROSS). The average board size (BOARD) is 7.192 (median = 7).On average, board directors (BoardHold) hold 22.3% (median = 18.6%) ownership, whereas blockholders(BlockHold) hold 17% (median = 15.4%) ownership. In total, 29.0% of sample firms have their CEO alsoserving as the COB (DUALITY).

Table 4 lists the descriptive statistics for the firms by competition intensity. The competition measuremedian is used to distinguish industries with low and high competition. Table 4 shows that firms facing highcompetition pay higher dividends. The average dividend payout ratios (dividend yields) for firms facing lowcompetition and high competition are 33.2% (2.3%) and 34.4% (2.5%), respectively. Firms in high competitionindustries experience higher controlling ownership, higher blockholder ownership, and a higher percentageof CEOs also serving as COBs. There aremore instances of firms in an industry with low-intensity competitionhaving a pyramidal structure and cross-ownership and larger boards. Regarding the control variables, firms inhigh competition industries have a higher cash position than firms in industries with low competition, butthey are smaller, and have less systematic risk, growth potential, financial maturity, and financial leverage.Preliminary categorical analyses by degree of competitiveness indicate that firms in intensely competitivemarkets pay higher dividends.

Table 5 lists the correlation analyses for the dividend, competition, and governance variables. In contrastto the categorical analyses in Table 4, Table 5 shows a negative relationship between competition anddividend payments. The correlation coefficient between DivNI (DivMV) and ONE_HHI is −0.032 (−0.019),with a p-value = 0.000 (0.027). Firms in higher competition industries tend to pay lower dividends. Thecontradictory results listed in Tables 4 and 5 regarding the relationship between dividend payments andproductmarket competition imply a nonlinear relation between competition and dividend payments. Table 5also shows that a dividend payment is negatively related to the ownership of controlling shareholders, apyramidal structure, cross-ownership, board size, and CEO duality, and is positively related to director andblockholder ownership. Table 5 shows that in Taiwan, companieswhose controlling shareholders have largercontrolling stakes and/or face weaker corporate governance have smaller dividend payouts.

Table 2Descriptive statistics of competition and dividend payouts by industry.Mean and median [in the brackets] of competition, dividend payments, assets, pseudo Q, and R&D expenditure by industry in orderof competition intensity for a sample of 9448 firm–year observations in Taiwan during 1996–2010. All observations with missingvariable values are excluded.

Industry n ONE_HHI DivNI DivMV Asset Q R&D

Oil, gas and utilities 127 0.292[0.156]

0.635[0.709]

0.042[0.044]

21,142[3087]

1.209[1.100]

0.000[0.000]

Glass and ceramic 79 0.554[0.550]

0.16[0.000]

0.009[0.000]

12,333[6423]

1.092[0.999]

0.004[0.002]

Cement 111 0.693[0.685]

0.545[0.486]

0.023[0.019]

33,113[14,396]

0.983[0.899]

0.000[0.000]

Automobile 60 0.74[0.743]

0.46[0.477]

0.037[0.039]

39,548[33,282]

1.241[1.087]

0.024[0.026]

Paper and pulp 115 0.753[0.747]

0.189[0.000]

0.014[0.000]

14,905[10,092]

1.132[0.927]

0.001[0.001]

Trading and consumer goods 193 0.77[0.781]

0.451[0.436]

0.024[0.017]

13,572[8117]

1.486[1.299]

0.001[0.000]

Plastic 350 0.792[0.794]

0.376[0.270

0.026[0.019]

43,056[7360]

1.190[1.078]

0.005[0.002]

Electrical and cable 175 0.810[0.833]

0.388[0.248]

0.026[0.018]

14,110[6857]

0.932[0.877]

0.003[0.002]

Shipping and transportation 186 0.831[0.836]

0.471[0.411]

0.035[0.018]

25,712[5275]

1.256[1.064]

0.000[0.000]

Tourism 137 0.840[0.865]

0.361[0.107]

0.013[0.005]

5671[4268]

1.751[1.337]

0.000[0.000]

Rubber 152 0.844[0.841]

0.251[0.104]

0.02[0.005]

12,017[8652]

1.387[1.279]

0.006[0.005]

Iron and steel 421 0.860[0.860]

0.397[0.284]

0.03[0.020]

21,565[6844]

1.075[1.014]

0.002[0.000]

Electronics 4537 0.884[0.936]

0.346[0.300]

0.025[0.017]

55,737[3430]

1.534[1.269]

0.031[0.018]

Food 316 0.888[0.885]

0.356[0.250]

0.025[0.015]

11,771[4895]

1.128[1.007]

0.003[0.001]

Chemical, biotechnology, and medical care 623 0.936[0.939]

0.445[0.440]

0.029[0.024]

10,640[2525]

1.417[1.163]

0.018[0.011]

Textile 720 0.939[0.935]

0.199[0.000]

0.013[0.000]

14,887[3519]

1.011[0.903]

0.003[0.001]

Electric machinery 524 0.952[0.958]

0.411[0.397]

0.027[0.022]

10,248[3054]

1.216[1.065]

0.016[0.013]

Building materials and construction 622 0.961[0.961]

0.257[0.000]

0.024[0.000]

16,202[6412]

1.108[1.005]

0.000[0.000]

28 L. Kao, A. Chen / Pacific-Basin Finance Journal 25 (2013) 21–39

3. Competition and industry characteristics

Competition (or industry concentration) is related to industry characteristics, such as asset investments,unit profitability, and R&D expenditure.We use the followingmodel specification to examine the relationshipbetween industry characteristics and competition:

13 buil

ONE HHIjt ¼ β0 þ β1logAssetit þ β2Qit þ β3R&Dit þX17

k¼1φkIndustry dummyk

þeit ;ð2Þ

The study sample includes 18 industries. Therefore, the regression models adopt 17 industry dummyvariables.13

ding material and construction industry is selected as the base industry, with all industry dummy variables equal to 0.

Table 3Descriptive statistics.Descriptive statistics for a sample of 9448 firm–year observations in Taiwan during 1996–2010. All observations with missingvariable values are excluded.

Mean Std Min Median Max

DivNI 0.338 0.454 0.000 0.228 9.823DivMV 0.024 0.029 0.000 0.014 0.400ONE_HHI 0.880 0.127 0.010 0.921 0.980ControlHold 0.293 0.176 0.000 0.267 1.000PYRAMIDAL 0.252 0.434 0.000 0.000 1.000CROSS 0.273 0.445 0.000 0.000 1.000BOARD 7.192 3.023 1.000 7.000 31.000BoardHold 0.223 0.141 0.000 0.186 1.000BlockHold 0.170 0.117 0.000 0.154 0.863DUALITY 0.292 0.454 0.000 0.000 1.000PLEDGE 0.118 0.215 0.000 0.000 1.000CASH 0.094 0.110 0.000 0.054 0.885OI 0.037 0.087 −1.507 0.033 0.554stdOI 0.000 0.001 0.000 0.000 0.041Asset (million NT$) 35,877 188,771 32 4542 4,689,189BETA 1.006 1.402 −73.098 0.964 35.541Q 1.411 0.890 0.279 1.149 20.399RETA 0.012 0.306 −12.008 0.049 0.659DebtAsset 0.406 0.194 0.013 0.390 0.991AssetGrow 0.022 0.192 −1.866 0.032 0.922R&D 1.813 0.032 0.000 0.006 0.641

Table 4Descriptive statistics by competition intensity.Descriptive statistics for a sample of 9448 firm–year observations in Taiwan during 1996–2010 by product market competition level.All observations with missing variable values are excluded. An industry firm with a competition measure (ONE_HHI) lower than themedian of the competition measure is defined as a low competition industry; otherwise, it is defined as a high competition industry.***, **, and * represent the significance levels at 1%, 5%, and 10%, respectively.

Low competitionindustries

High competitionindustries

Mean Median Mean Median T test of mean Z test of median

DivNI 0.332 0.217 0.344 0.240 −1.58 −2.54**DivMV 0.023 0.012 0.025 0.015 −4.12*** −3.81***ONE_HHI 0.811 0.866 0.951 0.951 −83.99*** −108***ControlHold 0.285 0.259 0.301 0.276 −5.77*** −6.59***PYRAMIDAL 0.291 0.000 0.213 0.000 11.38*** 11.33***CROSS 0.307 0.000 0.238 0.000 9.86*** 9.82***BOARD 7.575 7.000 6.803 7.000 16.22*** 11.39***BoardHold 0.222 0.181 0.225 0.190 −1.50 −5.50***BlockHold 0.162 0.147 0.178 0.162 −8.62*** −9.30***DUALITY 0.258 0.000 0.324 0.000 −70.2*** −19.47***PLEDGE 0.136 0.000 0.100 0.000 10.53*** −13.84***CASH 0.091 0.053 0.096 0.055 −2.61*** −3.26***OI 0.036 0.031 0.038 0.035 −1.31 −2.65***stdOI 0.000 0.000 0.000 0.000 −1.01 −7.67***Asset (million NT$) 59,744 6442 12,135 3317 12.41*** 21.46***BETA 1.033 0.989 0.978 0.936 2.48** 3.64***Q 1.429 1.164 1.393 1.136 2.51** 4.41***RETA 0.017 0.048 0.008 0.051 1.85* −0.34DebtAsset 0.410 0.387 0.403 0.392 1.72* −0.11AssetGrow 0.023 0.031 0.020 0.031 0.84 0.21R&D 0.017 0.005 0.017 0.006 0.66 −0.79

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Table 5Correlation analysis.Correlation analysis of dividend payments, competition measure, and governance measures for a sample of 9448 observations inTaiwan during 1996–2010. All observations with missing variable values are excluded. The p-values are in parentheses.

DivNI DivMV ONE_HHI ControlHold PYRAMIDAL CROSS BOARD BoardHold BlockHold

DivMV 0.609(0.000)

ONE_HHI −0.032 −0.019(0.000) (0.027)

ControlHold −0.078 −0.096 −0.044(0.000) (0.000) (0.000)

PYRAMIDAL −0.028 −0.006 −0.046 0.190(0.001) (0.457) (0.000) (0.000)

CROSS −0.018 −0.025 −0.041 0.006 0.339(0.034) (0.004) (0.000) (0.440) (0.000)

BOARD −0.039 −0.002 −0.069 −0.117 0.202 0.109(0.000) (0.807) (0.000) (0.000) (0.000) (0.000)

BoardHold 0.066 0.086 −0.060 0.607 0.214 −0.096 0.051(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000)

BlockHold 0.031 0.055 0.006 0.333 −0.042 0.008 −0.163 −0.174(0.000) (0.000) (0.447) (0.000) (0.000) (0.286) (0.000) (0.000)

DUALITY −0.042 −0.037 0.039 −0.044 −0.187 −0.100 −0.189 −0.088 0.030(0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.000) (0.003)

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Table 6 shows that logAsset and Q are negatively related to competition intensity, and that R&D ispositively related to competition intensity. These findings are in agreement with Hou and Robinson(2006), who indicate that concentrated industries have poor innovation but have high profit and highbarriers to entry. We thus control for logAsset, Q, and R&D when examining the relationship betweendividend payouts and competition to avoid the possibility that industry characteristics drive both thecompetition intensity and dividend payouts.

4. Model specification of multivariate analyses of dividend payments

To examine the relationship between dividend payments and productmarket competition,we employ thefollowing multivariate model specification. Because dividends are non-negative, we use Tobit regression.

Dividendit ¼ β0 þ β1ONE HHIjt þ β2ControlHoldit þ β3PYRAMIDALit

þβ4CROSSit þ β5BOARDit þ β6BoardHoldit þ β7BlockHoldit þ β8DUALITYit

þβ9PLEDGEit þ β10CASHit þ β11OIit þ β12stdOIit

þβ13BETAit þ β14Qit þ β15RETAit þ β16EDTDt þ β17logAssetit þ β18R&Dit

þβ19DebtAssetit þ β20AsseGrowit þX17

k¼1ϕkIndustry dummyk þ eit

ð3Þ

Table 7 lists the regression results for the effect of product market competition on dividend paymentsin a weak investor protection economy (Taiwan). Table 7 shows that ONE_HHI is insignificantly andnegatively related to the dividend payout ratio (coefficient = −0.024, t-value = −0.59) and dividendyield (coefficient = −0.001, t-value = −0.06). These results are inconsistent with both correlationanalyses in Table 5 and the categorical analyses in Table 4. A possible explanation for the insignificantONE_HHI listed in Table 7 is that the nonlinear relationship between dividend payouts and product marketcompetition requires further investigation.

For the governance variables, Table 7 shows that the pyramidal structure, cross-ownership, board size,and CEO duality are significantly and negatively related to dividend payments. These findings indicate thatweaker-governance firms are typically reluctant to pay dividends. In situations involving a pyramidalstructure, cross-ownership, a larger board, or CEO duality, firms pay lower dividends. However, dividendpayments are positively related to the board director and blockholder ownership. A higher director or

Table 6Relationship between industry characteristics and competition.Tobit regression analyses of industry characteristics on product market competition with a sample of 9448 firm–yearobservations in Taiwan during 1996–2010. All observations with missing variable values are excluded. The t-values inparentheses are adjusted by clustered standard errors (Petersen, 2009). *** and ** represent the significance levels at 1% and 5%,respectively. Pseudo R2 = 1 − (log LΩ) / (log Lω), where LΩ=the likelihood value of estimationwith all the exogenous variables, and Lω=the likelihood value of estimation with the intercept only.

ONE_HHI

Intercept 0.934***(99.61)

0.880***(233.72)

0.873***(266.01)

0.932***(94.33)

logAsset −0.007***(−6.31)

−0.006***(−5.52)

Q −0.003***(−3.10)

−0.005**(−2.44)

R&D 0.172***(3.81)

0.156***(3.28)

Industry dummies Yes Yes Yes YesPseudo R2 40.27% 40.33% 40.26% 40.46%

31L. Kao, A. Chen / Pacific-Basin Finance Journal 25 (2013) 21–39

blockholder ownership leads to greater power in monitoring controlling shareholders, forcing them to paydividends.

For the control variables, Table 7 shows that firms pay higher dividends when they have higher cashpositions, profitability, retained earnings, asset size, or R&D expenditures. Firms may reduce dividendpayments when they face high uncertainty regarding earnings, systematic risk, asset growth, or leverage.After eliminating double taxation on dividends, firms in Taiwan pay higher dividends.

Table 7Competition and governance effects on dividend payment.Tobit regression analyses of competition and governance characteristics on dividend payments with a sample of 9448 firm–yearobservations in Taiwan during 1996–2010. All observations with missing variable values are excluded. The t-values in parenthesesare adjusted by clustered standard errors (Petersen, 2009). ***, **, and * represent the significance levels at 1%, 5%, and 10%,respectively. Pseudo R2 = 1 − (log LΩ) / (log Lω), where LΩ = the likelihood value of estimation with all the exogenous variables,and Lω = the likelihood value of estimation with the intercept only.

DivNI t-value DivMV t-value

Intercept β0 −0.139** −2.25 −0.008** −2.12ONE_HHI β1 −0.024 −0.59 −0.001 −0.06ControlHold β2 −0.014 −0.31 −0.001 −0.13PYRAMIDAL β3 −0.017* −1.69 −0.002*** −3.06CROSS β4 −0.055*** −5.12 −0.003*** −3.99BOARD β5 −0.004** −2.04 −0.002* −1.67BoardHold β6 0.242*** 4.38 0.017*** 5.19BlockHold β7 0.233*** 4.57 0.019*** 5.95DUALITY β8 −0.015* −1.69 −0.001* −1.65PLEDGE β9 −0.064*** −2.90 −0.008*** −6.24CASH β10 0.284*** 5.57 0.017*** 5.61OI β11 1.177*** 15.37 0.162*** 34.68stdOI β12 −12.997*** −3.23 −0.830*** −3.39BETA β13 −0.039*** −7.02 −0.003*** −9.98Q β14 −0.018*** −2.50 −0.006*** −13.97RETA β15 0.079*** 5.02 0.001 0.97EDTD β16 0.259*** 10.36 0.016*** 10.73logAsset β17 0.048*** 10.95 0.003*** 13.11R&D β18 0.408** 2.48 0.047*** 4.72DebtAsset β19 −0.431*** −14.50 −0.021*** −11.46AssetGrow β20 −0.089*** −3.32 −0.005*** −3.35Industry dummies Yes Yes Yes YesPseudo R2 17.98% 29.74%

Table 8Piecewise effect of competition on dividend payment.Tobit piecewise regression analyses of competition on dividend payments with a sample of 9448 firm–year observations in Taiwan during 1996–2010 to examine if the relation betweencompetition and dividends depends on competition (D = 1 if ONE_HHI N median of ONE_HHI; D = 0 otherwise; for dividend change, competition change is ΔONE_HHI, D = 1; ifΔONE_HHI N median of ΔONE_HHI; D = 0 otherwise). Columns 1 and 2 are for the entire sample; Columns 3 and 4 are for competition change on dividend change; Columns 5 and 6 are thedividend payers only; Columns 7 and 8 are the non-electronics only. All observations with missing variable values are excluded. The t-values in parentheses are adjusted by clustered standarderrors (Petersen, 2009). ***, **, and * represent the significance levels at 1%, 5%, and 10%, respectively. Pseudo R2 = 1 − (log LΩ)/(log Lω), where LΩ = the likelihood value of estimation with allthe exogenous variables, and Lω = the likelihood value of estimation with the intercept only.

(1) (2) (3) (4) (5) (6) (7) (8)

DivNI DivMV ΔDivNI ΔDivMV DivNI payers DivMV payers DivNInon-electronics

DivMVNon-electronics

Intercept β0 −0.108*(−1.73)

−0.005(−1.40)

−0.195***(−3.28)

−0.010***(−3.17)

0.495***(4.11)

0.031***(4.65)

−0.738***(−6.60)

−0.049***(−7.67)

ONE_HHI β1 −0.115**(−2.49)

−0.008***(−2.85)

−0.387***(−3.15)

−0.018***(−2.79)

−0.070*(−1.66)

−0.006*(−1.68)

−0.135*(−1.76)

−0.005**(−1.84)

(ONE_HHI − median ofONE_HHI) ∗ D

γ1 1.397***(4.39)

0.121***(6.25)

0.750***(4.84)

0.040***(4.89)

0.159**(2.33)

0.052**(2.05)

2.718***(2.76)

0.161***(2.87)

ControlHold β2 −0.018*(−1.71)

−0.002*(−1.67)

0.005(0.10)

−0.002(−0.80)

−0.000(−0.01)

−0.005*(−1.71)

−0.122**(−2.02)

−0.010***(−2.76)

PYRAMIDAL β3 −0.017(−1.42)

−0.002***(−3.10)

−0.001(−0.04)

−0.001(−0.44)

−0.019*(−1.69)

−0.009(−1.04)

−0.023(−1.38)

−0.002**(−2.14)

CROSS β4 −0.053***(−4.94)

−0.002***(−3.74)

−0.000(−0.02)

−0.000(−0.16)

−0.040***(−2.60)

−0.018*(−1.85)

−0.056***(−3.81)

−0.002***(−2.75)

BOARD β5 −0.004**(−1.98)

−0.000(−0.66)

−0.000(−0.14)

−0.000(−0.71)

−0.013*(−1.85)

−0.009(−1.55)

−0.001(0.52)

−0.000**(−2.25)

BoardHold β6 0.235***(4.27)

0.017***(5.03)

0.014(0.20)

0.004(1.01)

0.166**(2.20)

0.010**(2.38)

0.405***(5.44)

0.027***(6.38)

BlockHold β7 0.232***(4.55)

0.018***(5.92)

0.062(0.99)

0.001(0.34)

0.153**(2.03)

0.016***(3.86)

0.357***(4.99)

0.023***(5.58)

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DUALITY β8 −0.015*(−1.69)

−0.001*(−1.65)

0.000(0.00)

0.001(0.81)

−0.024**(−1.98)

−0.021*(−1.66)

−0.036**(−2.45)

−0.001*(−1.71)

PLEDGE β9 −0.063***(−2.86)

−0.008***(−6.19)

0.008(0.30)

0.000(0.23)

0.067*(1.85)

0.004**(2.02)

−0.055**(−1.96)

−0.008***(−5.22)

CASH β10 0.310***(6.04)

0.020***(6.29)

0.124**(1.97)

0.009***(2.85)

0.499***(7.45)

0.019***(5.09)

0.058(0.57)

0.016***(2.76)

OI β11 1.168***(15.25)

0.161***(34.55)

0.275***(2.91)

0.056***(11.22)

0.590***(4.41)

0.159***(21.43)

1.421***(11.16)

0.206***(28.27)

stdOI β12 −12.454***(−3.1)

−0.783***(−3.20)

0.259(0.05)

0.106(0.41)

−11.451(−1.35)

−1.345***(−2.86)

−12.036**(−2.24)

−1.172***(−3.82)

BETA β13 −0.039***(−6.93)

−0.003***(−9.86)

−0.013*(−1.87)

0.000(−0.59)

−0.041***(−4.57)

−0.003***(−5.32)

−0.040***(−5.11)

−0.003***(−6.97)

Q β14 −0.017**(−2.41)

−0.006***(−13.86)

0.001(0.09)

−0.005***(−9.70)

0.026**(2.45)

−0.015***(−26.15)

−0.021*(−1.71)

−0.005***(−6.94)

RETA β15 0.078***(4.94)

0.001(0.85)

0.008(0.41)

0.005***(4.59)

0.606***(6.11)

0.090***(16.35)

0.038*(1.66)

−0.001(−1.04)

EDTD β16 0.249***(9.95)

0.016***(10.16)

0.203***(6.56)

0.012***(7.35)

0.186***(3.42)

0.012***(4.12)

0.229***(7.61)

0.016***(9.53)

logAsset β17 0.051***(11.49)

0.004***(13.92)

0.007(1.25)

0.000(1.38)

0.009(1.51)

0.000(0.02)

0.071***(10.08)

0.005***(11.43)

R&D β18 0.525***(3.15)

0.057***(5.66)

−0.213(−1.05)

0.012(1.11)

0.002(0.61)

0.001***(2.62)

0.010(1.61)

0.001***(3.18)

DebtAsset β19 −0.430***(−14.48)

−0.021***(−11.43)

−0.117***(−3.20)

−0.005***(−2.73)

−0.343***(−6.52)

−0.007**(−2.31)

−0.563***(−13.38)

−0.032***(−13.17)

AssetGrow β20 −0.090***(−3.35)

−0.006***(−3.40)

−0.022(−0.66)

−0.009***(−5.20)

−0.597***(−12.21)

−0.018***(−6.79)

−0.085**(−2.02)

−0.002(−0.95)

Industry dummies Yes Yes Yes Yes Yes Yes Yes YesPseudo R2 18.49% 30.33% 1.45% 4.43% 9.55% 26.63% 19.20% 33.55%Test of β1 + γ1 β1 + γ1 = 1.282

F = 18.22,p-value = 0.000

β1 + γ1 = 0.113F = 38.18,p-value = 0.000

β1 + γ1 = 0.363F = 17.4,p-value = 0.000

β1 + γ1 = 0.022F = 22.81,p-value = 0.000

β1 + γ1 = 0.089F = 3.87,p-value = 0.049

β1 + γ1 = 0.046F = 4.10,p-value = 0.042

β1 + γ1 = 2.583F = 8.81,p-value = 0.003

β1 + γ1 = 0.156F = 4.10,p-value = 0.042

Number of observations 9448 9448 9106 9106 5199 5199 4911 4911

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Table 9Competition effect on governance characteristics.Tobit regression analyses of product market competition on governance characteristics with a sample of 9448 firm–yearobservations in Taiwan during 1996–2010. All observations with missing variable values are excluded. PYRAMDIAL, CROSS, andDUALITY regressions are run by logistic regressions in that dependent variables are either 0 or 1. The t-values in parentheses areadjusted by clustered standard errors (Petersen, 2009). ***, **, and * represent the significance levels at 1%, 5%, and 10%, respectively.Pseudo R2 = 1 − (log LΩ) / (log Lω), where LΩ = the likelihood value of estimation with all the exogenous variables, and Lω = thelikelihood value of estimation with the intercept only.

ControlHold PYRAMIDAL CROSS BOARD BoardHold BlockHold DUALITY

Intercept 0.526***(27.70)

−6.353***(−20.21)

−4.441***(−15.23)

0.782***(2.55)

0.359***(24.90)

0.340***(25.20)

1.541***(5.83)

ONE_HHI −0.058***(−3.72)

−0.237**(−2.50)

−0.461*(−1.94)

−0.911***(−3.62)

−0.015(−1.28)

−0.052***(−4.67)

−0.339*(−1.69)

BETA −0.017***(−8.23)

0.070**(2.08)

0.136***(4.37)

−0.151***(−4.49)

−0.012***(−7.41)

−0.011***(−7.15)

0.041(1.43)

Q 0.009***(3.70)

−0.173***(−4.37)

−0.412***(−9.52)

0.014(0.35)

0.008***(4.63)

0.010***(5.66)

−0.045(−1.32)

logAsset −0.018***(−13.61)

0.620***(28.31)

0.555***(26.81)

0.666***(30.86)

−0.013***(−13.23)

−0.013***(−14.01)

−0.269***(−13.53)

R&D −0.493***(−8.31)

4.929***(5.28)

−1.458(−1.24)

2.414**(2.52)

−0.216***(−4.80)

−0.139***(−3.30)

−0.485(−0.63)

Industry dummies Yes Yes Yes Yes Yes Yes YesPseudo R2 10.33% 13.05% 15.02% 20.26% 8.38% 5.53% 6.32%

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5. Piecewise regression specification

The correlation analyses, categorical analyses, andmultivariate regression analyses show inconsistentfindings. Therefore, we expect a nonlinear relationship between product market competition anddividend payments, dependent on the competition intensity. We use the following piecewise regressionto examine nonlinearity between dividend payments and product market competition, and to testwhether the outcome agency model or substitute agency model of dividends is valid in Taiwan.

14 We

Dividendit ¼ β0 þ β1 ONE HHIjt þ γ1 ONE HHIjt−median of ONE HHI� �

� Djt

þβ2 ControlHoldit þ β3 PYRAMIDALit þ β4 CROSSit þ β5 BOARDit

þβ6 BoardHoldit þ β7 BlockHoldit þ β8 DUALITYit

þβ9 PLEDGEit þ β10 CASHit þ β11 OIit þ β12 stdOIit

þβ13 BETAit þ β14Qit þ β15 RETAit þ β16 EDTDt þ β17 logAssetit þ β18 R&Dit

þβ19 DebtAssetit þ β20 AsseGrowit þX17

k¼1φkIndustry dummyk þ eit ;

ð4Þ

Djt = 1 if ONE_HHI N median of ONE_HHI; otherwise, Djt = 0.

entire sample, we also conduct tests to examine this relationship with changes in dividends and incompetition rather than in level variables. Moreover, the descriptive statistics of dividend payouts listedin Table 3 show firms with zero-dividend payments. These zero-dividend firms may be very young, thusdiffer in their governance properties compared to the rest of the market. Table 3 also shows that morethan half of the sample observations are in the electronics industry. Consequently, we further conducttests only for dividend payers and only for the non-electronics industries, rather than for the entiresample.14 Deleting zero-dividend firms from the sample reduces the sample size to 5199 firm–yearobservations, and excluding the electronics industry reduces the sample size to 4911 firm–yearobservations.

appreciate this suggestion from the anonymous referee.

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Table 8 shows the piecewise regression results. The coefficients of β1 indicate the relationshipbetween product market competition and dividend payment for firms in industries with low-intensitycompetition, whereas the coefficients of (β1 + γ1) indicate the relationship between competition anddividends for firms in industries with high-intensity competition. Columns 1 and 2 of Table 8 shows thatproduct market competition is negatively related to dividend payments in firms with low-intensitycompetition (β1 for DivNI = −0.115, t-value = −2.49; β1 for DivMV = −0.008, t-value = −2.85), butis positively related to dividends in industries with high competition (β1 + γ1 for DivNI = 1.282, F =18.22, p-value = 0.000; β1 + γ1 for DivMV = 0.113, F = 38.18, p-value = 0.000). In a weak investorprotection economy such as in Taiwan, the negative relationship between dividend payments andproduct market competition indicates that the substitute agency model of dividends holds whencompetition intensity is low. However, the positive relationship between dividend payments andproduct market competition indicates that the outcome agency model holds when the competitionintensity is high. Grullon and Michaely (2008) examine the relationship between product marketcompetition and dividends by using U.S. data, and support the outcome agencymodel of dividends. TheU.S. market provides stronger investor protection compared to emerging Asian markets (such as thatof Taiwan). Our findings confirm the outcome agency model of dividends when investors enjoyprotection from market competition. If investors do not enjoy protection from the legal system ormarket competition, the substitute agency model of dividends holds, rather than the outcome agencymodel.

Columns 3 and 4 of Table 8 show that competition change (ΔONE_HHI) is negatively related todividend change when the change in competition intensity is low, but that competition change ispositively related to dividend change when change in competition intensity is high. The relationshipbetween dividend change and competition change resembles that between the dividend level and thecompetition level.

Columns 5 and 6 of Table 8 list the relationship between dividend payouts and product marketcompetition only for dividend payers, whereas Columns 7 and 8 show the relationship only for thenon-electronics industries. Consistent with the whole sample results, Columns 5–8 of Table 8 showthat product market competition is negatively related to dividend payouts when industry competitionintensity is low, and positively related to dividend payouts when industry competition intensity ishigh.

Similar to Table 7, Table 8 shows that firms pay less dividends when governance is weak (apyramidal structure, a cross-ownership structure, and a larger board) and pay more when governanceis strong (a higher ownership of directors and outside blockholders), and that firms tend to increasedividend payments when they have more cash, higher profitability, lower leverage, or lower assetgrowth.

6. Competition effects on agency conflicts

Competition is an outside governance mechanism that eases agency conflicts. Under intensecompetition, controlling shareholders must work hard to survive, even without proper governance.However, competition reduces profitability and increases the cost of governance mechanisms. In thissection, we examine how competition affects the governance variables (the results are listed in Table 9),controlling for size, beta risk, unit profitability, asset investment, R&D expenditure, and industry dummies.

Table 9 shows that controlling shareholders and blockholders tend to hold smaller ownership positionsin high competition industries. Competition typically reduces firm profitability, lowering the demands ofcontrolling shareholders and outside blockholders on the firm. Firms in high competition industries arealso less likely to build business empires through pyramids or cross-holdings, have smaller boards, and alower incidence of CEOs serving as COBs, thus generating more effective management. Table 9 shows thatcompetition increases managerial effectiveness and reduces major shareholder preferences.

7. How competition interacts with governance to influence dividend policy

Section 5 shows that, in an economy with weak investor protection, the outcome agency model ofdividends holds once product market competition intensifies. However, the substitute agency model

Table 10Competition and governance interaction on dividend payment.Tobit regression analyses of interaction between competition and governance characteristics on dividend payments with a sample of 9448 firm–year observations in Taiwan during 1996–2010. Allobservations with missing variable values are excluded. D = 1 if ONE_HHI N median of ONE_HHI; D = 0 otherwise; for dividend change, competition is ΔONE_HHI, D = 1; if ΔONE_HHI N medianof ΔONE_HHI; D = 0 otherwise. Columns 1 and 2 are for the entire sample; Columns 3 and 4 are for competition change on dividend change; Columns 5 and 6 are the dividend payers only;Columns 7 and 8 are the non-electronics only. The t-values in parentheses adjusted by clustered standard errors (Petersen, 2009). ***, **, and * represent the significance levels at 1%, 5%, and 10%,respectively. Pseudo R2 = 1 − (log LΩ) / (log Lω), where LΩ = the likelihood value of estimation with all the exogenous variables, and Lω = the likelihood value of estimation with the intercept only.

(1) (2) (3) (4) (5) (6) (7) (8)

DivNI DivMV ΔDivNI ΔDivMV DivNI payers DivMV payers DivNInon-electronics

DivMVnon-electronics

Intercept β0 −0.484***(−6.60)

−0.035***(−7.82)

−0.259***(−2.92)

−0.013***(−2.82)

0.521***(4.71)

0.030***(4.92)

−0.748***(−6.67)

−0.051***(−7.92)

ONE_HHI β1 −0.113**(−2.35)

−0.009***(−3.15)

−0.496***(−3.73)

−0.022***(−3.1)

−0.062*(−1.83)

−0.007*(−1.94)

−0.189*(−1.68)

−0.006*(−1.93)

(ONE_HHI − median ofONE_HHI) ∗ D

γ1 1.303***(3.97)

0.113***(5.64)

0.764***(4.73)

0.038***(4.52)

0.202**(2.45)

0.147*(2.12)

2.639***(2.67)

0.169***(3.00)

ControlHold β2 −0.011(−0.24)

−0.001(−0.22)

0.009(0.16)

−0.002(−0.72)

−0.010(−0.16)

−0.006*(−1.65)

−0.126**(−2.06)

−0.010***(−2.97)

PYRAMIDAL β3 −0.016*(−1.70)

−0.002***(−3.09)

−0.000(−0.01)

0.000(0.43)

−0.046*(−1.95)

−0.007(−1.01)

−0.024*(−1.73)

−0.002**(−2.48)

CROSS β4 −0.053***(−4.88)

−0.002***(−3.65)

0.001(0.04)

0.000(0.20)

−0.042***(−2.71)

−0.012*(−1.63)

−0.053***(−3.65)

−0.002***(−2.64)

BOARD β5 −0.004**(−2.15)

−0.002*(−1.65)

−0.000(−0.09)

−0.000(−0.66)

−0.009*(−1.77)

−0.008(−0.91)

0.001(0.28)

−0.001***(−2.66)

BoardHold β6 0.223***(3.99)

0.017***(4.92)

−0.021(−0.31)

0.003(0.90)

0.148*(1.95)

0.011**(2.55)

0.420***(5.57)

0.030***(6.95)

BlockHold β7 0.225***(4.40)

0.018***(5.80)

−0.063(−1.01)

0.001(0.27)

0.156**(2.05)

0.017***(4.14)

0.349***(4.86)

0.023***(5.61)

DUALITY β8 −0.015(−1.49)

−0.001(−1.36)

−0.001(−0.05)

−0.001(−0.87)

−0.042*(−1.85)

−0.021*(−1.71)

−0.039***(−2.62)

−0.001*(−1.68)

ControlHold ∗ ONE_HHI γ2 0.467*(1.70)

0.017*(1.74)

−0.028(−0.04)

−0.013(−0.39)

0.142*(1.71)

0.120*(1.92)

1.015***(2.6)

0.034*(1.73)

PYRAMIDAL ∗ ONE_HHI γ3 0.049*(1.67)

0.010*(1.68)

0.010(0.05)

−0.001(−0.12)

0.182*(1.68)

0.215*(1.72)

0.028*(1.84)

0.012*(1.84)

CROSS ∗ ONE_HHI γ4 0.085*(1.68)

0.009*(1.66)

0.334(1.55)

0.018*(1.65)

0.177*(1.76)

0.213*(1.93)

0.184*(1.67)

0.005*(1.74)

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(1) (2) (3) (4) (5) (6) (7) (8)

BOARD ∗ ONE_HHI γ5 0.005*(1.69)

0.003**(1.99)

−0.004(−0.14)

0.000(0.10)

0.001*(1.65)

0.002**(1.99)

0.005*(1.69)

0.001*(1.72)

BoardHold ∗ ONE_HHI γ6 −0.550*(−1.67)

−0.051*(−1.65)

−0.557(−0.73)

−0.009(−0.22)

−0.777*(−1.77)

−0.615*(−1.67)

−0.452*(−1.75)

−0.047*(−1.94)

BlockHold ∗ ONE_HHI γ7 −0.318*(−1.94)

−0.018*(−1.69)

0.988(1.26)

0.026(0.63)

−0.726*(−1.68)

−0.631*(−1.72)

−0.584*(−1.82)

−0.006*(−1.91)

DUALITY ∗ ONE_HHI γ8 0.048*(1.66)

0.009**(1.98)

0.104(0.67)

0.017**(2.09)

0.180*(1.75)

0.197*(1.85)

0.069*(1.76)

0.004*(1.69)

PLEDGE β9 −0.064***(−2.89)

−0.008***(−6.23)

0.008(0.29)

0.000(0.21)

0.066*(1.82)

0.004**(2.05)

−0.054**(−1.91)

−0.008***(−5.06)

CASH β10 0.308***(5.98)

0.019***(6.20)

0.125**(1.98)

0.010***(2.89)

0.500***(7.43)

0.018***(4.94)

0.053(0.53)

0.016***(2.81)

OI β11 1.171***(15.27)

0.161***(34.59)

0.271***(2.87)

0.055***(11.16)

0.602***(4.48)

0.159***(21.40)

1.420***(11.15)

0.205***(28.25)

stdOI β12 −12.720***(−3.16)

−0.789***(−3.22)

0.269(0.05)

0.112(0.43)

−11.105(−1.31)

−1.337***(−2.84)

−12.650**(−2.35)

−1.186***(−3.86)

BETA β13 −0.039***(−6.93)

−0.003***(−9.85)

−0.013*(−1.88)

−0.000(−0.61)

−0.042***(−4.61)

−0.003***(−5.30)

−0.040***(−5.09)

−0.003***(−6.94)

Q β14 −0.018**(−2.48)

−0.006***(−13.90)

0.001(0.08)

−0.005***(−9.74)

0.025**(2.41)

−0.015***(−26.06)

−0.021*(−1.7)

−0.005***(−6.85)

RETA β15 0.079***(5.02)

0.001(0.84)

0.008(0.39)

0.005***(4.58)

0.599***(6.04)

0.090***(16.32)

0.040*(1.74)

−0.001(−1.13)

EDTD β16 0.250***(9.95)

0.016***(10.21)

0.201***(6.48)

0.012***(7.31)

0.178***(3.26)

0.012***(4.02)

0.228***(7.59)

0.016***(9.52)

logAsset β17 0.050***(11.28)

0.004***(13.67)

0.007(1.24)

0.000(1.42)

0.009(1.38)

0.000(0.09)

0.071***(10.09)

0.005***(11.64)

R&D β18 0.005***(3.18)

0.001***(5.69)

−0.002(−1.08)

0.000(1.06)

0.001(0.55)

0.001***(2.67)

0.010(1.58)

0.001***(3.22)

DebtAsset β19 −0.430***(−14.45)

−0.021***(−11.59)

−0.116***(−3.15)

−0.005***(−2.7)

−0.338***(−6.41)

−0.007**(−2.29)

−0.564***(−13.34)

−0.032***(−13.39)

AssetGrow β20 −0.091***(−3.39)

−0.005***(−3.35)

−0.022(−0.67)

−0.009***(−5.19)

−0.597***(−12.20)

−0.018***(−6.77)

−0.089**(−2.11)

−0.002(−0.94)

Industry dummies Yes Yes Yes Yes Yes Yes Yes YesPseudo R2 18.54% 30.44% 1.54% 4.54% 9.70% 26.75% 20.25% 35.58%Test of β1 + γ1 β1 + γ1 = 1.190

F = 14.63,p-value = 0.000

β1 + γ1 = 0.104F = 29.85,p-value = 0.000

β1 + γ1 = 0.268F = 7.09,p-value = 0.007

β1 + γ1 = 0.016F = 9.99,p-value = 0.001

β1 + γ1 = 0.140F = 5.21,p-value = 0.022

β1 + γ1 = 0.140F = 6.78,p-value = 0.009

β1 + γ1 = 2.45F = 8.63,p-value = 0.003

β1 + γ1 = 0.163F = 8.28,p-value = 0.003

Number of observations 9448 9448 9106 9106 5199 5199 4911 4911

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38 L. Kao, A. Chen / Pacific-Basin Finance Journal 25 (2013) 21–39

holds when product market competition is weak. We show that competition influences the severity ofagency conflicts and the strength of governance mechanisms. Controlling shareholders select theiractions in the principal–agent economy with respect to the intensity of product market competition.Consequently, competition intensity in product markets changes the corporate governance effect ondividends. We use the following model specification to examine the interaction between governancevariables and product market competition on dividend policy. To avoid multicollinearity between thegovernance variables and the interaction terms of governance variables and competition measure inEq. (5), we use a demeaned form for the governance and competition variables.

Dividendit ¼ β0 þ β1ONE HHIjt þ γ1 ONE HHIjt−median of ONE HHI� �

� Djt

þβ2ControlHoldit þ β3PYRAMIDALit þ β4CROSSit þ β5BOARDit þ β6BoardHoldit

þβ7BlockHoldit þ β8DUALITYit þ γ2ControlHoldit � ONE HHIjt

þγ3PYRAMIDALit � ONE HHIjt þ γ4CROSSit � ONE HHIjt

þγ5BOARDit � ONE HHIjt þ γ6BoardHoldit � ONE HHIjt

þγ7BlockHoldit � ONE HHIjt þ γ8DUALITYit � ONE HHIjt

þβ9PLEDGEit þ β10CASHit þ β11OIit þ β12stdOIit

þβ13BETAit þ β14Qit þ β15RETAit þ β16EDTDt þ β17logAssetit þ β18R&Dit

þβ19DebtAssetit þ β20AsseGrowit þX17

k¼1φkIndustry dummyk þ eit

ð5Þ

Tables 7 and 8 show that controlling shareholders retain cash rather than pay dividends when theyhave sufficient control or when governance is weak. However, Table 10 shows that product marketcompetition mitigates the corporate governance effect on dividend payout policy. In Columns 1 and 2 ofTable 10, the interaction between controlling ownership and ONE_HHI is significantly positive (γ2 forDivNI = 0.467, t-value = 1.70; γ2 for DivMV = 0.017, t-value = 1.74), indicating that intense competi-tion forces controlling shareholders to pay dividends. A pyramidal structure implies weaker governance,reducing firm incentives to pay dividends. However, a significantly positive interaction between PYRAMIDALand ONE_HHI (γ3 for DivNI = 0.049, t-value = 1.67; γ3 for DivMV = 0.010, t-value = 1.68) indicates thatproduct market competition pressures firms with a pyramidal structure to pay dividends. Cross-ownership,board size, and CEO duality show similar results: Product market competition raises the tendency of firmswith cross-holdings, larger boards, or CEO duality to pay dividends. However, director ownership and outsideblockholding are positively related to dividend payments. Increasing competition reduces the effect ofdirector ownership and block ownership on dividend payments. Our results confirm that product marketcompetition can substitute for corporate governance in its influence on dividend policy.

Columns 3 and 4 of Table 10 show that the interactions between corporate governance variables(except for CROSS and DUALITY) and competition change (ΔONE_HHI) are not significantly related todividend change. For the subsamples of only dividend payers and only non-electronics firms, Columns 5–8of Table 10 shows that competition intensity mitigates the effects of governance mechanisms on dividendpayouts.

8. Conclusion

La Porta et al. (2000) argue that agency conflicts have two contradictory implications for dividend policy:the outcome agency model and the substitute agency model. Other studies support the outcome agencymodel of dividends in theUnited States (an economywith strong investor protection). However, to the best ofour knowledge, no study has examined the effect of agency conflicts on dividends in a weak investorprotection economy.We employ a sample of Taiwanese data with poor investor protection, and find that thepositive relationship between dividends and product market competition (the outcome agency model ofdividends) holds in a weak investor protection economy only under intense product market competition. Ifproduct market competition is weak, the negative relationship between dividends and product marketcompetition (the substitute agency model of dividends) holds instead. Poor investor protection means thatthe controlling shareholders of firms in Taiwan are reluctant to pay dividends. Controlling shareholders who

39L. Kao, A. Chen / Pacific-Basin Finance Journal 25 (2013) 21–39

have secured control over firms through ownership, pyramids, cross-ownership, or CEO duality tend to retaincash rather than pay dividends. However, firms pay higher dividends once governance power increasesthrough director ownership or block ownership.

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