Agency Conflicts and Corporate Payout Policies: A Global Study
Social Science Research Network
We investigate the roles of firm and country level agency conflicts in determining corporate payout policies. Based on a large sample of 29,610 firms in 43 countries from 2001 to 2006, we find that in high protection countries, investors are able to use their legal powers to extract cash from firms but their ability to do so can be substantially hindered when agency costs at the firm level are high. In poor protection countries, investors can seek refuge in firm level governance mechanisms to
... nce mechanisms to curb agency conflicts, suggesting a substitution between country and firm level investor protection. Finally, compared to repurchases, we find dividends are more likely to be the sole method of payout in high protection countries and in less closely held firms. Abstract We investigate the roles of firm and country level agency conflicts in determining corporate payout policies. Based on a large sample of 29,610 firms in 43 countries from 2001 to 2006, we find that in high protection countries, investors are able to use their legal powers to extract cash from firms but their ability to do so can be substantially hindered when agency costs at the firm level are high. In poor protection countries, investors can seek refuge in firm level governance mechanisms to curb agency conflicts, suggesting a substitution between country and firm level investor protection. Finally, compared to repurchases, we find dividends are more likely to be the sole method of payout in high protection countries and in less closely held firms. 1 Fifty years after Miller and Modigliani's seminal work on corporate financial policy, there is much about a company's payout policy that is still not well understood. Signaling future earnings and income taxes are widely believed to be two considerations when the board decides the payout. 1 We focus on a third, namely the role of dividends and other payouts in resolving agency-based conflict between insiders and outside shareholders (Jensen (1986)). All else equal, shareholders prefer the firm to pay out a larger fraction of its earnings since a lower retention rate reduces any opportunities for managers to squander money on unprofitable projects or to disadvantage outside shareholders in other ways. La Porta, Lopez-de-Silanes, Shleifer and Vishny ( (2000) ; hereafter LLSV) establish the importance of the quality of shareholder protection 2 as a country level proxy for lower agency costs in determining dividend payouts. Their results support the outcome model, which is based on the notion that minority shareholders in high protection countries can protect their interests by pressuring managers into distributing cash. Minority shareholders can do this because they have access to various legal mechanisms such as the right to vote on important corporate matters and the right to sue the firm for damages. The greater the minority rights, the more cash they can extract from the company, all else equal. 3 In this model, dividend policy reflects the level of investor protection. However, agency costs can differ substantially across firms within any one country. This implies that country level measures of shareholder protection, as an indicator of expected agency costs, are limited in 1 See DeAngelo, DeAngelo and Skinner (2008) , who synthesize a vast amount of research on corporate payout policy grounded in the pioneering work of Lintner (1956) and Miller and Modigliani (1961). This research has focused on signaling models (e.g. . 2 LLSV use two indicators of shareholder protection. One is based on a country's legal regime (common law or civil law) and the other on whether a country's index of antidirector rights is above or below the sample median. 3 The alternative view, which is presented by the substitution model, assumes corporate insiders have an incentive to pay dividends to minority shareholders in order to establish a good reputation and thereby reduce the cost of capital in future equity issues. Under this view, a negative relationship between shareholder protection and payouts is predicted. 2 the insights they can yield since they do not allow for and thus do not capture variation in agency costs at the firm level. We thus test whether differences in firm level agency costs within the same regulatory environment also have explanatory power, and how they interact with country level agency costs in determining corporate payouts. Our findings have important implications for understanding country versus firm level constraints on managers. Although both country level and firm level measures of agency conflicts have separately been found to matter in corporate payouts, the literature is surprisingly thin on their relative importance. Faccio, Lang and Young (2001) report higher dividend payouts in firms with lower agency conflicts, measured by the divergence between the controlling shareholder's ownership rights and its control rights, after accounting for country level investor protection. Our study differs from their work in a number of important ways. While Faccio, Lang and Young (2001) focus on 5 Western and 9 Eastern countries, our sample comprises 43 countries, thus increasing the generality of our findings on corporate payout decisions. Further, in light of the increasing use of share repurchases to disburse cash (Fama and French (2001) ), all our tests include the potentially important role of repurchases in the aggregate corporate payout; LLSV's study is based only on one year, 1994, which had relatively fewer repurchases compared to our much more recent and extended sample period (2001)(2002)(2003)(2004)(2005)(2006). 4 More importantly, unlike Faccio, Lang and Young (2001) , who treat country level investor protection as a control variable, we investigate the interplay between firm and country level agency cost measures in relation both to the total payout and to the choice of the form of payout (i.e., dividends versus stock repurchases). 4 LLSV acknowledge (p. 5) share repurchases are excluded from their study and briefly discuss possible effects on their results. The increasing significance of share repurchases as a form of payout is clearly evident in our time series. For the period up to and including 1994, the year on which LLSV's results are based, the world average (median) of repurchases as a percentage of net income (earnings) was 3.69% (0.95%). The proportion increased from 2000 onwards, reaching an average of 6.99% (median 4.5%) in 2006. Share repurchases averaged about 3% (median 1%) of total payouts in each year up to and including 1994, but averaged about 11% (median 9%) in later years.