Weak Institutions and Private Incentives: Evidence from Dividend Policies

Abstract

The literature on law and finance generally assumes that firms are passive recipients of the influence of weak investor protection. This paper empirically identifies a commitment mechanism through dividends that firms use to build reputation for fair treatment of outside shareholders. We show that growth firms initiate dividends earlier and pay more dividends in weak-protection countries than in strong-protection countries. More strikingly, in weak-protection countries, the well-known negative relationship between growth and dividends turns positive. A growth firm with a good dividend history raises more equity, attain higher valuation, and experience better stock performance during market downturns.

Keywords: Dividends, Investors Protection, Reputation, Governance, External Financing

JEL Classification: G34, G35, K10