Payout Policy with Legal Restrictions

58 Pages Posted: 14 May 2009 Last revised: 25 Feb 2011

See all articles by Sattar Mansi

Sattar Mansi

Virginia Polytechnic Institute & State University

John K. Wald

University of Texas at San Antonio

Date Written: February 22, 2011

Abstract

Research suggests that firms can use either debt or dividends as a commitment device to mitigate the free cash flow problem. We hypothesize that firms which face limitations on debt may use increased dividend payments as a second-best bonding device. Limitations on debt are implicit in state laws that restrict the firm from making payouts when the asset-to-liability ratio is low. Consistent with our hypothesis, we find that (i) firms incorporated in states with stricter payout restrictions pay more dividends, (ii) the probability of paying dividends or repurchasing shares decreases as firms approach their binding payout constraint, and (iii) bonding with dividends is less prevalent with increased managerial equity holdings. Further tests examining the relation between firm payout policy and payout restriction laws while controlling for antitakeover and director liability laws confirm our findings.

Keywords: Payout Policy, Capital Structure, State Laws, Bonding Mechanisms

JEL Classification: G35, K22

Suggested Citation

Mansi, Sattar and Wald, John K., Payout Policy with Legal Restrictions (February 22, 2011). Available at SSRN: https://ssrn.com/abstract=1404177 or http://dx.doi.org/10.2139/ssrn.1404177

Sattar Mansi (Contact Author)

Virginia Polytechnic Institute & State University ( email )

John K. Wald

University of Texas at San Antonio ( email )

1 UTSA Circle
San Antonio, TX 78249
United States
210-458-6324 (Phone)

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