corporate governance and dividend policy in emerging markets
TRANSCRIPT
Corporate Governance and Dividend Policy in Emerging Markets
Todd Mitton*
Marriott School Brigham Young University
May 2004
Abstract
In a sample of 365 firms from 19 countries, I show that firms with stronger corporate governance have higher dividend payouts, consistent with agency models of dividends. In addition, the negative relationship between dividend payouts and growth opportunities is stronger among firms with better governance. I also show that firms with stronger governance are more profitable, but that greater profitability explains only part of the higher dividend payouts. The positive relationship between corporate governance and dividend payouts is limited primarily to countries with strong investor protection, suggesting that firm-level corporate governance and country-level investor protection are complements rather than substitutes. JEL Classification: G35, G34 Keywords: Dividend policy, corporate governance, emerging markets * I appreciate the helpful comments of Jim Brau, Simon Johnson, Mike Lemmon, Grant McQueen, Sendhil Mullainathan, Mike Pinegar, David Scharfstein, and Jeremy Stein on earlier versions of the paper. All errors are mine. Todd Mitton, BYU Marriott School, 684 TNRB, Provo, UT 84602, Phone: (801) 422-1763, E-mail: [email protected].
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Corporate Governance and Dividend Policy in Emerging Markets
1. Introduction In the United States, the debate surrounding dividend policy has traditionally
centered on the question of why firms pay dividends, given that the tax disadvantage of
dividends appears to be large. But in countries where investor protection is weak, a more
fundamental question regarding dividend policy might be more relevant: How can
shareholders hope to extract dividends from firms, given that the legal environment of the
country and the governance mechanisms of individual firms offer investors relatively few
protections? Agency theory suggests that outside shareholders have a preference for
dividends over retained earnings because insiders might squander cash retained within the
firm (see, e.g., Easterbrook, 1984, Jensen 1986, Myers 2000). This preference for dividends
may be even stronger in emerging markets with weak investor protection if shareholders
perceive a greater risk of expropriation by insiders in such countries.1 La Porta, Lopez-de-
Silanes, Shleifer, and Vishny (LLSV, 2000) show that dividend payouts are higher, on
average, in countries with stronger legal protection of minority shareholders. This finding
lends support to what LLSV (2000) call the “outcome” agency model of dividends, which
hypothesizes that dividends result from minority shareholders using their power to extract
dividends from the firm.
If protection of minority shareholders does have a positive impact on dividend
payouts, then shareholder protection should help explain not just country-level differences in
dividend payouts, but also firm-level differences in dividend payouts within countries.
1 In a recent paper, Brav, Graham, Harvey, and Michaely (2003) find limited evidence for the agency theory of dividends in the U.S., at least from the perspective of corporate executives.
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Indeed, while country-level investor protection is an important factor in preventing
expropriation, firm-level corporate governance could carry equal or greater importance.
And corporate governance practices can vary widely even among firms in the same country
operating under the same legal regime. This paper uses firm-specific corporate governance
ratings developed by Credit Lyonnais Securities Asia (CLSA) for 365 firms from 19
emerging markets to study the impact of firm-level corporate governance on dividend
payouts. It is important to note, as do LLSV (2000), that the outcome model does not hinge
on investors holding specific rights to dividends. Rather, what is important is that the
country’s laws – or the company’s governance practices – allow minority shareholders more
rights in general, which rights may then be used to influence dividend policy. For example,
observers have noted that Russian firms are more commonly electing independent directors
to their boards, despite a legal system that does little to define or enforce board
independence (Nicholson, 2003). Mark Mobius, elected as an independent director to the
board of Russia’s LUKoil in 2002, later acted on behalf of shareholders to propose a
minimum-dividend policy that LUKoil’s board approved in 2003 (Investor Protection
Association, 2003).
Using the CLSA data, I first show that firms with higher corporate governance
ratings have higher dividend payouts. The effect appears to be economically meaningful as
well as statistically significant; regression results imply that a one-standard-deviation
increase in a firm’s corporate governance rating is associated with an average four-
percentage-point increase in dividend payouts (the average payout ratio is about 30%.) A
move from the worst governance (in this dataset, Indonesia’s Indocement) to the best
governance (in this dataset, Hong Kong’s HSBC) would imply, on average, a higher
dividend payout ratio of some 22 percentage points. This result is consistent with the
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hypothesis of the outcome agency model that investors that are afforded stronger rights use
those rights to extract dividends from the firm. This result is also complementary to the
findings of Faccio, Lang, and Young (2001). Interpreting dividends as a means for limiting
expropriation, they study East Asian and Western European firms and find that dividend
payouts are significantly impacted by the vulnerability of a firm’s minority shareholders to
expropriation by controlling shareholders.2
Even when shareholders are well protected, however, they may not prefer higher
dividend payouts if they believe the firm has good investment opportunities available for
excess cash. Indeed, LLSV (2000) find that in countries with strong investor protection,
there is a stronger negative relationship between growth opportunities and dividend payouts.
That is, it appears that when shareholders perceive that their rights are well protected, they
are more willing to let firms with good growth opportunities retain cash, being confident that
they will share in the payoff from good projects later on. In contrast, if shareholders know
that investor protection is poor, they may be more haphazard in their desire for dividends,
trying to extract whatever value they can – regardless of the firm’s growth opportunities –
before being expropriated. Complementary to the country-level finding of LLSV (2000), I
find at the firm level that firms with stronger corporate governance also show a stronger
negative relationship between dividends and growth opportunities. In other words, the
pattern of dividend payouts seems to make more sense among firms with good corporate
governance.
I next examine how dividend policy is impacted by the interplay of country-level
investor protection and firm-level corporate governance. I find first of all that across all
2 In a related finding, Gugler and Yurtoglu (2003) show, using data from Germany, that negative reactions to dividend reductions are stronger among firms where minority shareholders are more susceptible to expropriation.
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countries, both country-level investor protection and firm-level corporate governance have
explanatory power for dividend payouts. Of the two, the country-level measures have
perhaps greater explanatory power. Next, I find that firm-level corporate governance is
positively associated with dividend payouts primarily in countries that offer strong investor
protection (as measured by legal origin or antidirector rights). This suggests that firm-level
corporate governance and country-level investor protection work as complements rather
than substitutes. Firm-level improvements in corporate governance may be most effective
when the legal regime of the country also offers a higher level of protection for
shareholders.
The findings of the paper are robust to many different specifications (although I find
some specifications where they are not). The results hold when controlling for financial
variables that have been shown previously to be correlated with dividend payouts, namely
growth, size, and profitability (see Fama and French, 2001). I show separately that firms
with stronger governance have higher profitability, but improved profitability explains only
part of the connection between governance and dividends. The results also hold when
controlling for industry and country fixed effects. In addition, I show that the results hold
with or without financial firms, with or without mandatory-dividend countries, and when
controlling for the tax advantage of dividends. Nevertheless, as will be discussed further in
Section 4, because I lack a suitable instrument for firm-level corporate governance, these
results are subject to typical problems of endogeneity, and therefore any interpretations
regarding causality should be made cautiously.
I also use additional data to get a sense as to whether the result holds among a
broader sample of firms. Lacking governance ratings for a broader sample, I use variables
that have been used in previous work as indicators of good governance. These variables
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(whether or not a firm is diversified, has a Big Five international auditor, or is cross-listed in
the U.S.) are available for a much larger sample (over 14,000 firms). Although these
indicators are clearly not as refined as the CLSA ratings, they are generally supportive of the
results using the CLSA ratings, suggesting that the findings may be applicable to a broader
sample.
The results presented here add to the current literature in a few ways. These firm-
level findings add confidence to previous country-level findings regarding investor
protection and dividends. Because country-level measures of investor protection can be
correlated with other important variables, some uncertainty remains about which country-
level variables impact dividend policy. Showing that differences in shareholder protection
at the firm level also impact dividend policy helps confirm that investor protection is a
significant factor affecting dividend policy. In addition, the results add to a growing
literature that uses firm-level measures of governance to study the impact of corporate
governance on corporations around the world. Such papers (too numerous to list briefly)
include those that measure firm-level governance with ratings, with various measures of
ownership structure, and with other indicators of governance.3 Finally, the firm-level
findings suggest that individual firms are not entirely trapped by the legal regimes of their
home country. By improving corporate governance at the firm level, firms can demonstrate
a commitment to protecting investors that translates into real economic outcomes.
The next section describes the data used in the study. Section 3 presents the
empirical results. Section 4 discusses robustness and alternative interpretations. Section 5
examines the results with a broader sample using governance indicators. Section 6
concludes.
3 See Denis and McConnell (2003) for a discussion of many of these papers.
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2. Data and Methodology
To measure the strength of corporate governance at the firm level I use corporate
governance ratings developed by Credit Lyonnais Securities Asia (CLSA, 2001). CLSA
analysts assess the performance of emerging market firms on 57 issues in seven areas of
corporate governance.4 These ratings have been used in several other studies5 to examine
the impact of corporate governance on firm performance. In rating the firms, analysts are
required to give only binary (yes/no) responses to each of the issues, in an effort to reduce
subjectivity. Firms are then given a composite rating based on their scores in the areas of
management discipline, transparency, independence, accountability, responsibility, fairness,
and social responsibility. The first six areas have a 15% weighting in the composite score,
and social responsibility has a 10% weighting. The rating is on a scale of 1 to 100, with a
higher score indicating stronger corporate governance. I adopt CLSA’s composite score as
my primary measure of firm-level corporate governance.
A few issues regarding use of the CLSA scores should be addressed. First, it’s clear
that there is a selection bias in the set of firms covered. CLSA chooses firms to cover based
on whether the firms are of interest to international investors. Thus the results presented
should be thought of as applying particularly to larger, more visible, firms. Second, it’s not
clear that “social responsibility” should be included as part of the rating as it doesn’t relate
directly to minority shareholder protection. Also, the “management discipline” rating is a
concern because it includes one issue (out of nine) that is at least partially related to
4 See Durnev and Kim (2002) for a complete listing of all 57 issues addressed in the survey. 5 Examples include Durnev and Kim (2002), Khanna, Kogan, and Palepu (2002), Klapper and Love (2002), Chen, Chen, and Wei (2003), and Friedman, Johnson, and Mitton (2003).
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dividend payouts.6 To avoid discarding useful information and to avoid tampering with
CLSA’s rating, I stick with the CLSA composite score as a base case. The results presented
are robust to exclusion of either the social responsibility or management discipline rating
(see Section 4).
I match the firms in the CLSA study with financial data from the Worldscope
database. I use the October 2002 version of Worldscope, in which the latest data reported
for most firms is from 2001, which corresponds with the 2001 date of the CLSA report. The
primary measure of dividends I use from Worldscope is the dividend payout ratio, which is
defined as dividends per share/earnings per share*100. As secondary measures of dividends
I also calculate dividends/cash flow and dividends/sales (as in LLSV, 2000). Because
dividend payouts naturally change over the life cycle of a firm, I try to account for life cycle
properties of firms by controlling for firm size and firm growth rates. To measure size I take
from Worldscope the log of total assets of the firm, measured in billions of $U.S. To
measure growth I take from Worldscope the one-year growth rate in total assets, measured
in $U.S. In addition to size and growth, it has been shown that profitability is positively
correlated with dividend payouts (Fama and French, 2001), so I use profitability as an
additional control variable. (In section 4 I discuss the impact of profitability in more detail.)
Profitability is measured as return on assets and also comes from Worldscope. To avoid
undue influence of outliers, growth and profitability are both winsorized at the 5th and 95th
percentile.
The Worldscope database does not have a match for every firm rated by CLSA. Of
the 495 firms from 25 countries included in the CLSA ratings, I am able to match 447 (90%)
of the firms with Worldscope. Of that number, I exclude 45 firms from 4 countries
6 The exact wording of the question is as follows: “Over the past 5 years, is it true that the company has not
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identified by LLSV (2000) as mandatory dividend countries – Brazil, Chile, Colombia, and
Greece. (The results are robust to including these countries; see Section 4.) Finally, from
this number I exclude 37 firms that are missing necessary financial data in Worldscope. The
most common missing item is the growth rate, as it requires two years of available data
rather than one. After these adjustments, 365 firms from 19 countries constitute the base
sample.
Table 1 presents descriptive statistics of the data by country. The median corporate
governance rating of all firms in the sample is 55.4. The highest rating in the sample is 93.5
(Hong Kong’s HSBC Holdings), and the lowest rating in the sample is 13.9 (Indonesia’s
Indocement). The average dividend payout ratio for all firms in the sample is 30.1%. In
comparison, the average dividend payout ratio for listed U.S. firms from 1993-98 was 39.3%
(Fama and French, 2001). In addition to the financial data described above, Table 1 also
shows measures of country-level investor protection. The two measures presented are
antidirector rights and legal origin. As explained in LLSV (1997, 1998), antidirector rights
is a composite measure, on a scale of 1 to 5, where a higher number indicates that the
country offers more legal protections for equity investors. Legal origin is also important in
that common law countries have been shown to offer greater shareholder protection than
civil law countries (LLSV, 1997, 1998). I compile the country-level data from LLSV (2000)
and Claessens, Djankov, and Nenova (2000).
In the results that follow I estimate the effect of corporate governance on dividend
payouts using ordinary least squares regression. I present specifications with and without
industry fixed effects and country fixed effects, but the specification that I ultimately focus
on includes both industry and country fixed effects. Because tests detect heteroskedasticity
built up cash levels, through retained earnings or cash calls, that has brought down ROE?”
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of errors in some specifications, I report heteroskedasticity-adjusted standard errors (White,
1980) throughout the analysis.
3. Results
I first examine whether firms with stronger governance have higher dividend
payouts. Regressions results are reported in Table 2. In Table 2 the dependent variable is
the dividend payout ratio and the independent variable of interest is the corporate
governance rating. Column 1 of Table 2 shows the coefficient on corporate governance with
no control variables. The coefficient is 0.302, meaning that a one-point increase in the
corporate governance rating is associated with an increased dividend payout ratio of 0.3
percentage points. The coefficient on corporate governance is significant at the 1% level of
confidence.
In subsequent columns of Table 2 I add control variables in turn, adding first growth,
then profitability, size, industry dummies, and country dummies. The magnitude of the
coefficient on corporate governance decreases somewhat as controls are added, but always
remains significant at the 5% level or higher. The largest decrease in the magnitude of the
coefficient comes with the addition of profitability as a control. (The relative impact of
profitability and governance will be discussed further in Section 4.) In the final column,
with all controls included, the coefficient on corporate governance is 0.271 and is significant
at the 5% level. As mentioned earlier, the coefficient suggests that a one-standard deviation
increase in corporate governance is associated with a higher dividend payout of 4 percentage
points. In summary, Table 2 demonstrates that stronger corporate governance is associated
with higher dividend payouts, possibly reflecting the increased ability of shareholders to
limit expropriation by insiders.
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As will be typical in the tables that follow, in the final column of Table 2, the control
variables also have some explanatory power for dividend payouts, as would be expected.
The coefficient on growth is negative and significant, probably reflecting that firms with
higher growth retain cash for investme nt. The coefficient on profitability is positive and
highly significant, probably reflecting that profitable firms have more cash available for
dividends, all else equal. Finally, the coefficient on size is positive and marginally
significant in some specifications, indicating that larger firms have higher dividend payouts.
In Table 3, I turn to the secondary question of how dividends are affected by the
interaction of corporate governance and growth. As put forth by LLSV (2000), when
investors are well protected we should see a stronger negative relationship between
dividends and growth. LLSV (2000) demonstrate this with country-level variables, and in
Table 3 we examine the same with variables that vary at the firm level.
Our independent variable of interest in Table 3 is corporate governance interacted
with growth. As in LLSV (2000), I implicitly view past growth rates as a proxy for future
growth opportunities. Column 1 of Table 3 presents the coefficient on this interaction term
along with the main effects on corporate governance and growth and with no other control
variables. The coefficient on corporate governance interacted with growth is -0.012 and is
significant at the 5% level of confidence. The negative coefficient is as expected and
indicates that among firms with stronger corporate governance, the negative relationship
between growth and dividends is stronger.
In subsequent columns I progressively add control variables as before. In the
intermediate columns the coefficient on the interaction between governance and growth
declines and even loses significance in Columns 3 and 4. However, once all controls are
included in Column 5, the coefficient is again significant at the 5% level with a magnitude
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of -0.009. In addition, the separate coefficients on corporate governance and growth remain
significant and of the expected sign when the interaction term is included. In short, Table 3
shows that the pattern of dividend payouts makes more sense among firms with stronger
corporate governance.
Table 4 investigates the interaction of investor protection and corporate governance.
First, I investigate whether country-level variables or firm-level variables are more dominant
in their impact on dividend policy. Table 4 addresses this question by simply including
investor protection and corporate governance as right-hand-side variables simultaneously.
Of course this calls for a modified specification, as country fixed effects are now excluded
(but industry fixed effects are retained throughout).
Column 1 of Table 4 presents the coefficient on antidirector rights without corporate
governance. The coefficient on antidirector rights is 3.442 and is significant at the 1% level.
The magnitude of the coefficient implies that firms in countries with a higher score of one
point (the scale is from 1 to 5) have higher dividend payout ratios, on average, of more than
3 percentage points. This result is essentially a confirmation of the results in LLSV (2000).
In Column 2 corporate governance is also included in the regression. Here the coefficient
on antidirector rights falls to 2.396, but it remains significant, although now only at the 5%
level. Meanwhile, the coefficient on corporate governance is 0.282, also significant at the
5% level. In this case it doesn’t appear that either effect dominates the other; both country-
level investor protection and industry-level corporate governance have strong explanatory
power for dividend payouts. Columns 3 and 4 repeat the regressions of Columns 1 and 2 but
with profitability included as a control. Here similar relationships are seen, but the
coefficients on antidirector rights and corporate governance are smaller and of a lower
significance level.
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Columns 5 through 8 repeat the analysis of Columns 1 through 4, but with legal
origin as the country-level variable. The results are similar, except that now legal origin
appears to have stronger explanatory power than corporate governance, to the extent that
corporate governance loses significance in Column 8. On balance then, the evidence
suggests that both country-level investor protection and firm-level corporate governance
have significant explanatory power for dividends, but that the explanatory power of country-
level investor protection may be somewhat greater.
In Table 5 I turn to the next issue of the interaction of country-level investor
protection and firm-level corporate governance. The question I want to address here is
whether country-level investor protection and firm-level corporate governance act as
complements or substitutes. A priori, it is not obvious which to expect. On the one hand,
investor protection and corporate governance may be substitutes, meaning that when
investor protection is weak, firms can have a greater impact on strengthening the rights of
their shareholders when they improve corporate governance. On the other hand, investor
protection and corporate governance may be complements, meaning that the efforts of
individual firms to improve corporate governance may have little effectiveness if the
country doesn’t provide a legal environment that respects shareholder rights.
I address this question in Table 5 in two ways, by partitioning the sample, and with
interaction terms. First, I split the sample between countries with strong investor protection
and weak investor protection. As discussed previously, I use two measures of investor
protection, legal origin (with common law countries offering better protection) and
antidirector rights (with a higher score indicating better protection). In Columns 1 and 2 I
split the sample between common law countries and civil law countries. Throughout Table
5 I include all control variables. Column 1 shows that among firms in common law
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countries the coefficient on corporate governance is much greater than it is among all firms.
The coefficient is 0.515 (compared to 0.271 in Table 2), and is significant at the 1% level.
Meanwhile, Column 2 shows that among firms in common law countries, the relationship
between governance and dividends is actually negative (but not significantly different from
zero). Columns 4 and 5 tell a similar story with antidirector rights. Among firms in
countries with above-median antidirector rights the coefficient on corporate governance is
0.451, but among firms with below-median antidirector rights the coefficient on corporate
governance is 0.011. These results strongly suggest that, regarding dividend policy,
country-level investor protection and firm-level corporate governance are complements
rather than substitutes.
The second approach in Table 5 is to create interactions of investor protection and
corporate governance. In Column 3 corporate governance is interacted with a dummy
variable equal to one for common law countries. The coefficient on the interaction term is
positive and significant at the 5% level. Column 6 confirms this results with corporate
governance interacted with antidirector rights. Again the coefficient on the interaction term
is positive, although not significant at standard levels. The coefficients on the interaction
terms confirm what is demonstrated with the partitioned sample, that investor protection and
corporate governance are complements in their impact on dividend policy. This result
stands in contrast to the results of Klapper and Love (2002) and Durnev and Kim (2002),
who find that firm-level corporate governance and country-level investor protection are
substitutes in terms of their impact on firm value.
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4. Alternative Interpretations and Robustness
If we interpret the results presented in the previous section in the context of the
outcome agency model of dividends, then the interpretation is as has been discussed
previously. That is, when shareholders are afforded stronger rights by companies that have
stronger corporate governance, shareholders use that power to extract dividends. But other
interpretations of the results are possible. The first alternative to consider is that firms with
stronger governance have improved operating performance which then allows these firms to
pay higher dividends (irrespective of the power or wishes of shareholders). In particular, if
stronger governance leads to greater profitability, then it may be greater profitability that
leads to higher dividend payouts, not the exertion of influence by shareholders. Since a
positive correlation between governance and profitability has not yet been established, I first
address this issue in Table 6.
In Table 6 the dependent variable is profitability. Column 1 shows that corporate
governance does indeed have a positive effect on profitability, with a coefficient of 0.058
which is significant at the 5% level. Controls for growth and size are also highly significant,
and industry dummies are included throughout. The significance of corporate governance
remains if we add either country fixed effects or indicators of country-level investor
protection. (Neither antidirector rights nor legal origin has significant explanatory power for
profitability.) In sum, Table 6 establishes a positive association between firm-level
corporate governance and profitability. (Again, no causality can be inferred, it could be, for
example, that when firms become more profitable they have the luxury of improving
governance.)
Returning then to the question of whether improved profitability explains the
relationship between governance and dividends, previous tables already demonstrate that
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this explanation may have some relevance, because the coefficient on corporate governance
declines when profitability is included as a control variable. However, previous tables also
demonstrate that profitability is not the entire explanation, because corporate governance
retains significance even when profitability is included as a control. In sum, both the
indirect effect of profitability and the direct effect of governance have explanatory power for
dividend payouts. In subsequent robustness checks I present results with and without
profitability as a control variable.
An additional alternative interpretation of the results is that causality is reversed or
that both governance and dividends are jointly influenced by an omitted variable. Ideally, I
would like to use standard econometric techniques to deal with potential endogeneity. This
would involve identifying an instrument, that is, a variable that is correlated with the key
independent variable (in this case, the corporate governance rating), but that is otherwise
uncorrelated with the dependent variable (in this case, dividend payout ratios).
Unfortunately, I am unable to identify an appropriate instrument for this situation. This type
of problem is a recurring issue in studies of corporate governance. In one atypical case,
Black, Jang, and Kim (2002) are able to use an instrumental variables approach to establish
causation running from corporate governance to firm value, but their instrument is specific
to institutional details of Korea and is not suited to this cross-country analysis. The bottom
line for this study is that lacking a suitable instrument for corporate governance it is not
possible to rule out alternative explanations based on endogeneity.
In Table 7 I turn to some additional regressions to assess the robustness of the main
result along different dimensions. In each case I present results with and without
profitability as a control variable. In the first two robustness checks I alter the corporate
governance rating to exclude the discipline measure and the social responsibility measure
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respectively. The reasons for potentially wanting to omit these variables are discussed in
Section 2. Columns 1 through 4 demonstrate that the results are robust to excluding these
measures, as the coefficient on corporate governance retains significance at the 10% level or
higher whether or not profitability is included as a control variable.
In the next two robustness checks I use alternative definitions of dividend payouts,
dividends/cash flow and dividends/sales. While these are not standard definitions of
dividend payouts, they are used in LLSV (2000) as alternative definitions. These results are
presented in Columns 5 through 8 of Table 7. Here the robustness of the results does not
fare as well. With dividends/cash flow as the dependent variable, the coefficient on
corporate governance is significant in one specification, but with dividends/sales as the
dependent variable, the coefficient on corporate governance is not significant, although it
retains the expected sign.
In the next two robustness checks presented I change the sample in two important
ways. Columns 9 and 10 repeat the basic results but with countries designated as mandatory
dividend countries now included in the regressions. The coefficient on corporate
governance is significant in both of these specifications. Columns 11 and 12 repeat the
analysis with but with financial firms (SICs in the 6000s) excluded. Without financial firms
the results are even stronger than in the full sample. Finally, in Columns 13 and 14 I present
one more robustness check, where I control for a country’s tax advantage of dividends. This
measure is taken from LLSV (2000). The results are robust to inclusion of this variable,
which in itself has little explanatory power for dividend payouts.
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5. Tests Using a Broader Sample of Firms
As a final test of the robustness of the results, Table 8 presents results using
governance indicators in place of the CLSA ratings. These indicators are rougher measures
of governance than the CLSA ratings, but they have the advantage that they can be
examined for a larger set of firms. The intent from examining this data is to get an
indication as to whether the results presented previously apply to a broader set of firms. An
alternative, and sharper, way of expanding the sample would be to use as the governance
measure (or measure of susceptibility to agency problems) the divergence between cash-
flow rights and control rights, as has been done in a number of papers including Lins (2003),
Lemmon and Lins (2003), Harvey, Lins, and Roper (2004), and Faccio, Lang, and Young
(2001). Lacking this detailed data, I rely on financial data from Worldscope, but now using
indicators that allow the sample to include over 14,000 firms from 50 countries. I examine
three indicators of governance that are available for the large sample. The first is a dummy
variable that equals one if the firm operates in only one industry, with industries defined at
the two-digit SIC level. A focused firm is used as an indicator of good governance both in
the CLSA study and in previous research (see, e.g., Mitton, 2002 and Friedma n, Johnson,
and Mitton, 2003). The second indicator is a dummy variable that equals one if the auditor
of the firm is one of the Big Five international accounting firms.7 Having a Big Five auditor
has been used previously as an indicator of higher disclosure quality (Titman and Trueman,
1986, Reed et al, 2000, Mitton, 2002), which is an important element of corporate
governance (see LLSV, 1998). The third indicator is a dummy variable that equals one if
the firm’s stock is cross-listed on a U.S. exchange, either directly or with a Level II or III
depository receipt. Because such a cross-listing subjects the firm to a higher level of
7 The data come from 2001, prior to the breakup of Arthur Andersen.
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disclosure requirements and investor scrutiny, it may bond the firm to maintain a higher
standard of governance (see Coffee, 1999, Stulz, 1999, and Reese and Weisbach, 2002 for
examples of this view).
Table 8 presents results of regressions of dividend payout ratios on these indicators.
Column 1 shows that focused firms have higher dividend payout ratios than diversified
firms, even after controlling for growth, size, profitability, industry, and country. The
difference does not appear large (focused firms have higher payout ratios of just under one
percentage point) but it is statistically significant at the 5% level. Column 1 also shows that
the negative relationship between growth and dividends is stronger among focused firms,
suggesting that focused firms allocate capital more efficiently. This coefficient is significant
at the 1% level. Column 2 repeats the analysis for the Big Five auditor indicator. Firms
with Big Five auditors have higher payout ratios (by around two percentage points) and this
difference is significant at the 1% level. The negative relationship between growth and
dividends is also stronger among firms with Big Five auditors, although this difference is not
significant. Column 3 shows the same results for the cross-listed indicator. Here the results
are not as expected, as cross-listed firms have lower dividend payouts. But the negative
relationship between growth and dividends is still stronger among cross-listed firms (though
again not significant). Column 4 shows that the same results hold with all three indicators
included simultaneously. In summary, though the evidence is mixed for cross-listed firms,
on balance these results seem to support, in a broader sample, that stronger governance is
associated with higher dividend payouts and a stronger negative relationship between
growth and dividends.
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6. Conclusion
The ultimate goal of corporate governance is to ensure that suppliers of finance to
corporations receive a return on their investment (Shleifer and Vishny, 1997). While
suppliers of equity can receive a return through dividends or capital gains, agency theory
suggests that shareholders may prefer dividends, particularly when they fear expropriation
by insiders. The outcome agency model tells us that when shareholders have greater rights,
they can use their power to influence dividend policy. Shareholders can receive greater
rights either through a country’s legal protection or through a firm’s governance practices
that may not be mandated by government. This paper shows that firm-level corporate
governance, in addition to country-level investor protection, is associated with higher
dividend payouts, suggesting that both mechanisms help reduce agency problems. In
addition, stronger corporate governance is shown to be associated with a stronger negative
relationship between growth and dividends, demonstrating that the pattern of dividend
payouts makes more sense among firms with stronger corporate governance. The results
suggest that when shareholders are well protected, either by governments or by corporations
themselves, capital can be allocated more efficiently.
21
References
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23
Stulz, R., 1999, Globalization of equity markets and the cost of capital, NBER Working Paper #7021. Titman, S. and B. Trueman, 1986, Information quality and the valuation of new issues, Journal of Accounting and Economics 8, 159-172. White, Hal, 1980, A heteroskedasticity-consistent covariance matrix estimator and a direct test for heteroskedasticity, Econometrica 48, 817-838.
Country Obs
Total Asset Growth ($US) %
Total Assets ($Bil)
Profitability (ROA)
Dividends/ Cash Flow %
Dividends/Sales %
Antidirector Rights
Legal Origin
Mean Median St. Dev. Mean Median St. Dev. Mean Mean Mean Mean MeanARGENTINA 1 66.70 66.70 0.00 0.00 -7.34 6.633 0.71 0.00 0.00 4 civilCHINA 12 45.99 48.70 7.66 40.38 45.62 25.00 8.35 6.861 5.74 23.00 10.50 1 civilHONG KONG 39 62.46 67.30 13.20 42.52 43.14 27.40 -0.16 27.389 5.73 39.34 11.00 5 commonHUNGARY 1 60.40 60.40 0.00 0.00 51.74 4.005 7.50 0.00 0.00 3 civilINDIA 68 56.47 54.35 10.06 30.25 24.58 22.54 33.47 2.493 8.25 19.76 2.83 5 commonINDONESIA 17 38.39 36.40 11.43 25.25 27.65 22.60 8.84 1.615 8.29 28.64 4.23 2 civilKOREA (SOUTH) 22 47.71 46.50 6.91 15.76 12.43 16.65 8.44 17.790 2.85 7.15 1.09 2 civilMALAYSIA 40 56.19 59.40 14.47 33.49 30.52 25.39 9.61 4.370 6.20 21.00 5.10 3 commonMEXICO 7 64.50 67.10 8.61 16.68 10.77 18.29 10.71 17.654 5.33 8.98 2.48 1 civilPAKISTAN 9 33.90 30.70 14.45 52.06 63.49 28.65 -0.49 0.869 7.14 37.66 6.71 5 commonPERU 1 75.50 75.50 21.60 21.60 24.06 0.540 11.50 37.56 9.13 3 civilPHILIPPINES 20 43.87 38.65 12.67 17.39 5.29 20.01 -1.83 2.334 1.85 12.21 2.19 3 civilPOLAND 2 36.20 36.20 3.11 6.74 6.74 9.53 9.29 6.120 2.09 1.86 0.15 3 civilRUSSIA 1 15.40 15.40 14.58 14.58 32.28 15.673 18.31 12.00 2.94 civilSINGAPORE 30 65.78 64.65 9.24 30.97 28.18 23.38 6.61 8.436 4.36 30.97 5.16 4 commonSOUTH AFRICA 29 67.55 67.40 8.55 30.87 30.97 28.59 0.55 5.661 5.71 14.92 7.52 5 commonTAIWAN 40 54.06 52.90 9.20 27.67 32.44 25.68 10.25 6.689 5.04 9.73 2.62 3 civilTHAILAND 17 55.15 54.80 12.22 29.98 28.78 34.11 4.99 4.510 4.23 16.55 3.98 2 civilTURKEY 9 42.13 38.40 8.33 20.60 0.00 37.76 3.48 4.694 4.75 7.19 1.04 2 civil Total 365 55.10 55.40 13.87 30.07 28.50 25.95 10.89 9.916 5.75 20.42 4.76 3.11
Table 1Descriptive statistics by country
The table reports descriptive statistics of variables used in subsequent tables. Corporate governance ratings come from CLSA (2001). Financial data come from Worldscope. Country-level variables are compiled from LLSV (2000) and Claessens, Djankov, and Nenova (2000).
Corporate Governance Rating Dividend Payout Ratio %
Corporate governance 0.302 *** 0.323 *** 0.261 *** 0.245 ** 0.271 *** 0.271 **(0.105) (0.105) (0.098) (0.097) (0.104) (0.133)
Growth -0.135 ** -0.237 *** -0.252 *** -0.170 *** -0.129 *(0.062) (0.062) (0.062) (0.065) (0.068)
Profitability 1.397 *** 1.572 *** 1.537 *** 1.527 ***(0.211) (0.219) (0.251) (0.269)
Size 1.558 * 1.147 1.327(0.853) (1.098) (1.313)
Industry dummies No No No No Yes Yes
Country dummies No No No No No Yes
N 365 365 365 365 365 365R-squared 0.026 0.036 0.144 0.153 0.292 0.352The table reports regression coefficients of dividend payout ratios on corporate governance ratings and control variables. Corporate governance ratings come from CLSA (2001). Financial data come from Worldscope. Growth is the one-year growth rate in total assets, profitability is return on assets, and size is the log of total assets. Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks denote levels of significance (***=1%, **=5%,
(6)Dependent variable is dividend payout ratio
(1)
Table 2Firms with stronger governance have higher dividend payouts
(2) (3) (4) (5)
Corporate governance 0.293 *** 0.243 ** 0.230 ** 0.258 ** 0.260 **(0.102) (0.098) (0.098) (0.104) (0.130)
Growth -0.121 * -0.225 *** -0.240 *** -0.162 ** -0.120 *(0.063) (0.063) (0.063) (0.066) (0.068)
Corporate governance X Growth -0.012 ** -0.008 * -0.007 -0.006 -0.009 **(0.005) (0.005) (0.005) (0.005) (0.004)
Profitability 1.358 *** 1.526 *** 1.500 *** 1.491 ***(0.215) (0.226) (0.258) (0.269)
Size 1.457 * 1.085 1.443(0.863) (1.104) (1.325)
Industry dummies No No No Yes Yes
Country dummies No No No No Yes
N 365 365 365 365 365R-squared 0.049 0.150 0.158 0.295 0.358The table reports regression coefficients of dividend payout ratios on the interaction of corporate governance with growth and control variables. Corporate governance ratings come from CLSA (2001). Financial data come from Worldscope. Growth is the one-year growth rate in total assets, profitability is return on assets, and size is the log of total assets. Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks denote levels of significance (***=1%, **=5%, *=10%).
Dependent variable is dividend payout ratio(1)
Table 3Stronger governance is associated with a stronger negative relationship between dividends and growth
(2) (3) (4) (5)
Antidirector rights 3.442 *** 2.396 ** 2.853 *** 2.186 *(1.160) (1.219) (1.050) (1.123)
Common law 10.672 *** 7.551 ** 9.204 *** 7.126 **(3.266) (3.422) (2.944) (3.075)
Corporate governance 0.282 ** 0.186 * 0.257 ** 0.175(0.118) (0.111) (0.115) (0.107)
Growth -0.028 -0.058 -0.140 ** -0.156 ** -0.039 -0.063 -0.152 ** -0.164 ***(0.067) (0.067) (0.063) (0.065) (0.066) (0.066) (0.062) (0.063)
Size 0.663 0.405 1.734 1.521 0.884 0.591 1.847 1.616(1.182) (1.157) (1.138) (1.131) (1.162) (1.135) (1.127) (1.117)
Profitability 1.624 *** 1.558 *** 1.576 *** 1.525 ***(0.250) (0.255) (0.243) (0.248)
Country dummies No No No No No No No No
Industry dummies Yes Yes Yes Yes Yes Yes Yes Yes
N 364 364 364 364 365 365 365 365R-squared 0.199 0.215 0.295 0.302 0.205 0.219 0.297 0.303
Dependent variable is dividend payout ratio(8)
The table reports regression coefficients of dividend payout ratios on country-level measures of investor protection, corporate governance ratings, and control variables. Corporate governance ratings come from CLSA (2001). Financial data come from Worldscope. Growth is the one-year growth rate in total assets, profitability is return on assets, and size is the log of total assets. Country-level variables are compiled from LLSV (2000) and Claessens, Djankov, and Nenova (2000). Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks denote levels of significance (***=1%, **=5%, *=10%).
Antidirector rights Legal origin
Country-level measures of investor protection and firm-level measures of corporate governance both have explanatory power for dividend payoutsTable 4
(1) (2) (3) (4) (5) (6) (7)
Corporate governance 0.515 *** -0.226 0.223 * 0.451 ** 0.011 0.260 **(0.153) (0.222) (0.129) (0.227) (0.178) (0.130)
Corporate governance X 0.583 ** Common law (0.256)
Corporate governance X 0.164 Antidirector rights (0.107)
Growth -0.043 -0.271 -0.128 * -0.035 -0.213 -0.122 *(0.079) (0.166) (0.069) (0.090) (0.130) (0.069)
Profitability 1.093 *** 2.328 *** 1.536 *** 0.868 ** 2.277 *** 1.512 ***(0.365) (0.413) (0.270) (0.427) (0.387) (0.267)
Size 0.975 3.823 * 1.395 1.938 0.203 1.402(1.659) (2.304) (1.316) (1.942) (2.137) (1.321)
Country dummies Yes Yes Yes Yes Yes Yes
Industry dummies Yes Yes Yes Yes Yes Yes
N 232 133 365 176 188 364R-squared 0.391 0.549 0.363 0.368 0.453 0.357
Table 5Are country-level investor protection and firm-level corporate governance complements or substitutes?
The table reports regression coefficients of dividend payout ratios on corporate governance ratings, the interaction of governance with country-level measures of investor protection, and control variables. Corporate governance ratings come from CLSA (2001). Financial data come from Worldscope. Growth is the one-year growth rate in total assets, profitability is return on assets, and size is the log of total assets. Country-level variables are compiled from LLSV (2000) and Claessens, Djankov, and Nenova (2000). Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks denote levels of significance (***=1%, **=5%, *=10%).
(3)
Legal origin
All countries(6)
Antidirector rightsCivil law countries Above median Below medianAll countries
Dependent variable is dividend payout ratio(1) (2) (4) (5)
Common law countries
Corporate governance 0.058 ** 0.074 *** 0.061 ** 0.054 **(0.023) (0.027) (0.024) (0.026)
Antidirector rights 0.135(0.282)
Common law 0.278(0.757)
Growth 0.066 *** 0.057 *** 0.063 *** 0.066 ***(0.020) (0.021) (0.020) (0.020)
Size -0.691 *** -0.703 *** -0.716 *** -0.672 ***(0.220) (0.273) (0.223) (0.228)
Country dummies No Yes No No
Industry dummies Yes Yes Yes Yes
N 365 365 364 365R-squared 0.387 0.422 0.391 0.388The table reports regression coefficients of profitability (return on assets) on corporate governance ratings and control variables. Corporate governance ratings come from CLSA (2001). Financial data come from Worldscope. Growth is the one-year growth rate in total assets and size is the log of total assets. Country-level variables are compiled from LLSV (2000) and Claessens, Djankov, and Nenova (2000). Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks denote levels of significance (***=1%, **=5%, *=10%).
Firms with stronger governance have greater profitabilityTable 6
Dependent variable is profitability ratio(1) (2) (3) (4)
Corporate governance 0.336 ** 0.247 * 0.345 *** 0.239 * 0.278 ** 0.172 0.056 0.024 0.337 ** 0.224 * 0.471 *** 0.328 ** 0.456 *** 0.339 ***(0.131) (0.132) (0.123) (0.124) (0.135) (0.133) (0.035) (0.036) (0.134) (0.134) (0.155) (0.155) (0.114) (0.109)
Growth -0.036 -0.127 * -0.039 -0.127 * -0.028 -0.105 * 0.009 -0.016 -0.037 -0.135 ** -0.028 -0.135 * -0.069 -0.158 **(0.071) (0.068) (0.071) (0.068) (0.057) (0.054) (0.020) (0.018) (0.069) (0.066) (0.079) (0.076) (0.072) (0.069)
Size 0.274 1.364 0.234 1.315 -0.012 0.930 -0.133 0.175 -0.541 0.813 1.025 1.954 0.487 1.499(1.398) (1.321) (1.387) (1.316) (1.178) (1.153) (0.632) (0.584) (1.415) (1.284) (1.489) (1.402) (1.224) (1.181)
Profitability 1.550 *** 1.533 *** 1.350 *** 0.438 *** 1.642 *** 1.539 *** 1.457 ***(0.268) (0.269) (0.256) (0.077) (0.262) (0.272) (0.257)
Dividend tax advantage -7.126 -3.190(12.186) (11.766)
Country dummies Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes No No
Industry dummies Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes
N 365 365 365 365 359 359 365 365 402 402 278 278 339 339R-squared 0.268 0.351 0.271 0.351 0.373 0.436 0.337 0.409 0.259 0.349 0.313 0.408 0.226 0.303
Dependent variable is dividend payout ratio (except where noted)(5) (6) (7) (8)(1)
Table 7Robustness checks
(2)
Exclude discipline measure from rating
Exclude social responsibility measure from rating
Dividends/Cash flow as dependent variable Exclude financial firms
(11) (12)
Control for country's tax advantage of dividends
(13) (14)
The table reports regression coefficients of measures of dividends on corporate governance ratings and control variables. Corporate governance ratings come from CLSA (2001). Financial data come from Worldscope. Growth is the one-year growth rate in total assets, profitability is return on assets, and size is the log of total assets. Mandatory dividend countries added to the sample include Brazil, Chile, Colombia, and Greece. Financial firms are defined as those with primary SIC in the range 6000-6999. Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks denote levels of significance (***=1%, **=5%, *=10%).
(3) (4)
Dividends/Sales as dependent variable
Include mandatory dividend countries
(9) (10)
Focused 0.912 ** 0.933 **(0.443) (0.442)
Big Five Auditor 2.113 *** 2.144 ***(0.542) (0.542)
Cross-listed -5.451 *** -5.523 ***(1.047) (1.048)
Focused X Growth -0.042 *** -0.042 **(0.016) (0.016)
Big Five Auditor X Growth -0.023 -0.022(0.016) (0.016)
Cross-listed X Growth -0.056 -0.050(0.041) (0.041)
Growth -0.056 *** -0.057 *** -0.058 *** -0.056 ***(0.009) (0.009) (0.009) (0.009)
Size 2.511 *** 2.343 *** 2.587 *** 2.501 ***(0.112) (0.116) (0.114) (0.120)
Profitability 1.487 *** 1.484 *** 1.489 *** 1.483 ***(0.034) (0.034) (0.034) (0.034)
N 14766 14766 14766 14766R-squared 0.270 0.271 0.271 0.272
Dependent variable is dividend payout ratio
The table reports regression coefficients of dividend payout ratios on corporate governance indicators, interactions of the indicators with growth, and control variables. Focused means the firm operates in just one two-digit SIC industry. Big Five Auditor means the name of the firm's auditor is one of the Big Five international firms. Cross-listed means the firm's stock is listed in the U.S. (directly or as a Level II or III ADR). Financial data come from Worldscope. Growth is the one-year growth rate in total assets, profitability is return on assets, and size is the log of total assets. Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks denote levels of significance (***=1%, **=5%, *=10%). Also estimated but not reported are full sets of industry and country dummy variables.
Governance indicators in an expanded sampleTable 8
(1) (2) (3) (4)