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Dividend Policy, Agency Costs, and Earned Equity

34 Pages Posted: 28 Jun 2004  

Harry DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department

Linda DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department

René M. Stulz

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER); European Corporate Governance Institute (ECGI)

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Date Written: June 2004

Abstract

Why do firms pay dividends? If they didn't their asset and capital structures would eventually become untenable as the earnings of successful firms outstrip their investment opportunities. Had they not paid dividends, the 25 largest long-standing 2002 dividend payers would have cash holdings of $1.8 trillion (51% of total assets), up from $160 billion (6% of assets), and $1.2 trillion in excess of their collective $600 billion in long-term debt. Their dividend payments prevented significant agency problems since the retention of earnings would have given managers command over an additional $1.6 trillion without access to better investment opportunities and with no additional monitoring. This logic suggests that firms with relatively high amounts of earned equity (retained earnings) are especially likely to pay dividends. Consistent with this view, the fraction of publicly traded industrial firms that pays dividends is high when the ratio of earned equity to total equity (total assets) is high, and falls with declines in this ratio, becoming near zero when a firm has little or no earned equity. We observe a highly significant relation between the decision to pay dividends and the ratio of earned equity to total equity or total assets, controlling for firm size, profitability, growth, leverage, cash balances, and dividend history. In our regressions, earned equity has an economically more important impact than does profitability or growth. Our evidence is consistent with the hypothesis that firms pay dividends to mitigate agency problems.

Keywords: Dividends, payout policy, agency costs, earned equity, earnings, retained earnings

JEL Classification: G35, G32, M41, K22, H3

Suggested Citation

DeAngelo, Harry and DeAngelo, Linda and Stulz, René M., Dividend Policy, Agency Costs, and Earned Equity (June 2004). Available at SSRN: https://ssrn.com/abstract=558747 or http://dx.doi.org/10.2139/ssrn.558747

Harry DeAngelo (Contact Author)

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States
213-740-6541 (Phone)
213-740-6650 (Fax)

Linda DeAngelo

University of Southern California - Marshall School of Business - Finance and Business Economics Department ( email )

Marshall School of Business
Los Angeles, CA 90089
United States
213-740-3868 (Phone)
213-740-6650 (Fax)

Rene M. Stulz

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

HOME PAGE: http://www.cob.ohio-state.edu/fin/faculty/stulz

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

European Corporate Governance Institute (ECGI)

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

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