Show Me the Money! Dividend Policy in Countries with Weak Institutions

Abstract

Minority shareholders in countries with weak institutions face greater agency conflicts related to the separation of ownership and control. To mitigate these agency conflicts, we hypothesize that firms will return more of current earnings to investors as dividends, leaving fewer resources to be depleted due to these conflicts. Specifically, we show that firms in weak institution countries (i) have higher speed of adjustment (SOA) to their target payout ratio, (ii) are more likely to disclose a dividend policy specifying a minimum payout ratio, and (iii) pay dividends earlier in their life-cycle. Tests examining earnings announcement returns are consistent with these differences in dividend policy affecting the pricing of earnings. Finally, in within-country analyses, we find that firms benefit from high SOA dividend policies through greater ability to raise equity and investors are less likely to view these equity raises as expropriation.

Keywords: dividend policy, payout policy, earnings, institutional quality

JEL Classification: G15, G32, G35