Dividends, Noncontractibility and Corporate Law
William W. Bratton
Institute for Law and Economics, University of Pennsylvania Law School; European Corporate Governance Institute (ECGI)
Cardozo Law Review, Vol. 19, No. 2 (1997) (Symposium on the Essays of Warren Buffett)
Dividend and reinvestment policy has a history of chronic insusceptibility to direct regulatory improvement, whether by contract or mandate. This paper explains this result by reference to the economic literature that applies incomplete contracts analysis to the problem of optimal capital structure. These models teach, first, that intractable informational asymmetries prevent direct contractual solutions to the governance problem presented by dividend policy, and, second, that solutions can be structured only indirectly thorugh the control transfer provisions built into corporate capital structures. Unlike the standing agency explanation of dividend policy, this approach does not purport to offer a complete theoretical solution to the problem of suboptimal earnings retention. But it does explain the continuing absence of a tractable first-best solution: Given conditions of uncertainty, it follows from the nature of debt and equity that the precise measure of the optimal mix of the two will remain unknown. The paper also draws on the models to appraise the three items on the standing menu of governance reform proposals respecting dividend and reivestment policy--specifically, mandatory payout of earnings, institutional investor monitoring, and stepped up disclosure requirements.
JEL Classification: G32, G35, G38, K22Accepted Paper Series
Date posted: April 9, 1997
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