Overinvestment, Corporate Governance, and Dividend Initiations

41 Pages Posted: 3 Aug 2006  

Micah S. Officer

Loyola Marymount University - Department of Finance and Computer Information Systems

Date Written: April 2007

Abstract

Firms with high agency costs of overinvestment have significantly more positive dividend initiation announcement returns than other firms do. This paper presents the results from three experiments consistent with this conclusion: (i) dividend initiation announcement returns are significantly more positive for firms with low Tobin's Q and high cash flow; (ii) following an exogenous event (the dividend tax cut of 2003) which changed the equilibrium tradeoff between hoarding cash and paying it out, firms with weak governance (i.e. those that are more likely to overinvest) have significantly more positive initiation announcement returns; and (iii) firms with low Q significantly reduce their cash hoarding in the years following dividend initiations. Combined, these results are consistent with the hypothesis that initiating dividends reduces the agency costs of free cash flow and that the market reaction to dividend initiation announcements rationally anticipates the lower agency costs of free cash flow or overinvestment.

Keywords: Dividend policy, payout policy, initiation returns, governance, overinvestment

JEL Classification: G35, G34, G32, G14

Suggested Citation

Officer, Micah S., Overinvestment, Corporate Governance, and Dividend Initiations (April 2007). Available at SSRN: https://ssrn.com/abstract=921155 or http://dx.doi.org/10.2139/ssrn.921155

Micah S. Officer (Contact Author)

Loyola Marymount University - Department of Finance and Computer Information Systems ( email )

Los Angeles, CA 90045
United States

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