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

Abstract

We hypothesize that, in weak-institution countries, firms adjust the 'timing' of dividend payments by committing to distribute a percentage of current earnings as dividends, revealing the extent of firm-level agency conflicts to future investors and facilitating the raising of external capital. Consistent with this hypothesis, we find that, on average, firms in weak-institution countries have a higher speed of adjustment (SOA) to their target payout ratio, pay dividends earlier in the lifecycle, and are more likely to disclose a dividend policy committing to pay a minimum percentage of earnings. Within-country tests show that, in weak-institution countries, the firms with the highest SOA dividend policies have fewer agency problems and an increased ability to raise external capital. Finally, returns tests around earnings announcements show that high-SOA dividend policies are associated with larger market reactions to earnings in weak-institution countries. Collectively, our findings suggest that dividend policy helps to alleviate agency conflicts in weak institution countries between firms and (future) investors.

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

JEL Classification: G15, G32, G35