Equity-Incentive Compensation and Payout Policy in Europe

Abstract

Given the increasing use of equity-incentive compensation in Europe, we examine the effects of executive compensation and investor protection on payout policy. We find a negative (positive) relationship between equity-incentive compensation and dividends (repurchases). In countries with weak investor protection, firms with high growth opportunities compensate their CEOs with more incentive compensation, thus aligning managers to shareholders’ interests. These firms also pay higher dividends consistent with maintaining a reputation with minority shareholders for distributing excess free cash flows. However, they reduce dividends payouts and increase repurchases at a greater rate in relation to increases in incentive compensation, thereby increasing financial flexibility. Considered together, our results are consistent with growth firms in weak investor protection countries using equity incentives as a substitute for dividends for reducing agency costs.

Keywords: Incentive Compensation, Payout Policy, Agency Costs

JEL Classification: G35, G30