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E-MailJanis Berzins is Associate Professor of Finance; Øyvind Bøhren is Professor of Finance and Founding director of the Centre for Corporate Governance Research, and Bogdan Stacescu is Associate Professor of Finance at BI Norwegian Business School. This post is based on their recent article.
This article, which is forthcoming in the Review of Finance, studies empirically how the controlling shareholder uses the firm’s dividend policy to manage the relationship with other shareholders. There are two alternative views. The opportunistic hypothesis recognizes that the controlling shareholder may feel tempted to capture private benefits at the other shareholders’ expense. For instance, the controlling shareholder may make the firm trade at unfair prices with another firm he owns, hire family members at excessive salaries, and use the firm’s resources to build personal prestige. Such actions can reduce the firm’s ability to pay dividends.
The competing view is the conflict-reducing hypothesis, where the controlling shareholder uses dividends to mitigate conflicts and build reputation for being fair. This strategy may increase the access to new equity and reduce the cost of capital. Hence, dividends will be lower the more serious the potential shareholder conflict under the opportunistic hypothesis, but not under the conflict-reducing hypothesis. Our paper investigates which of these two very different governance strategies firms use in practice.
The controlling shareholder reaps all the private benefits, but pays less for them the less of the equity he owns. For instance, a 51% shareholder passes 49% of the bill for private benefits to the other shareholders, but only 1% of the bill if he owns 99%. Accordingly, the conflict potential is more serious the smaller controlling stake. This means controlling shareholders who behave according to the opportunistic model will pay higher dividends the larger their controlling stake. If they instead behave according to the conflict-reducing model, dividends will decrease as the controlling stake increases.
We analyze about 10,000 private Norwegian firms with majority shareholders from 2006 to 2013. We analyze private firms with majority control for three reasons: shareholder conflicts are particularly serious in majority-controlled firms, majority control is much more common in private firms than in public firms, and private firms with majority control have particularly low levels of separation between ownership and management. The first two reasons ensure that at least one shareholder has strong incentives and power to monitor management, while the third reason reduces the need for such monitoring. In fact, a family is the majority shareholder in more than 80% of our sample firms, and provides the CEO in 73%. Accordingly, we can abstract from the “vertical” agency problem between shareholders and managers. In contrast, the “horizontal” agency problem between majority and minority shareholders is very relevant in our sample, since the majority shareholder can single-handedly make the dividend decision. The horizontal agency problem we study has received much less attention in the empirical dividend literature than the vertical agency problem has.
Our evidence shows that most majority shareholders choose the conflict-reducing strategy rather than the opportunistic strategy. For instance, the average dividends to earnings ratio is 50% higher when potential conflicts are high (small majority stake) rather than low (large majority stake). Thus, the larger the potential conflict, the more the actual conflict is reduced through high payout.
We also find that such minority-friendly payout may succeed in building trust, as minority shareholders who have observed high dividends from a high-conflict firm invest more in the firm later on. The additional equity is twice the average dividend minority shareholders received in preceding years. Thus, the firm may be better off paying out the cash as dividends now and asking the minority shareholders for new funding later when the investment opportunity emerges. This evidence suggests the majority shareholder’s best interest is to abstain from opportunism and instead use a minority-friendly approach.
The concern for low conflict and high trust is robust to how we measure both shareholder conflicts and payout. Moreover, dividends are less common and lower in single-owner firms, where shareholder conflicts do not exist. Also, dividends are lower and unrelated to ownership in firms without majority owners, where the horizontal agency problem is less of a concern. Hence, the higher payout and the inverse relationship between ownership concentration and dividends are unique features of multiple-owner firms with controlling owners.
There are several alternative explanations for these results. Firms with lower ownership concentration have more minority shareholders, who may want dividends for liquidity reasons. In contrast, majority shareholders may be less dependent on dividends because they receive salary from the firm—a substitute for dividends as a liquidity source. This substitute would in turn produce an inverse relationship between ownership concentration and dividends. However, we find that even minority shareholders receive salary from the firm in 46% of the cases, that dividends and salary are complements rather than substitutes, and that our main result is robust to controlling for salary paid to shareholders. These results are inconsistent with the notion that shareholder liquidity needs explain our findings.
Because majority-controlled firms with lower ownership concentration need more minority investment, they may be more likely to signal their quality with higher dividends. However, we find that dividend increases are followed by lower rather than higher profitability, suggesting that dividend changes are not used as signals.
The firm’s dividend policy cannot attract tax-based investor clienteles in our sample because the tax system is neutral. Moreover, ownership concentration as measured by the largest equity stake is very stable. It is identical from one year to the next in 80% of the firms, the average coefficient of variation over time being 0.1.
Personal financial constraints may force controlling owners both to hold fewer shares (producing low ownership concentration) and to pay themselves more cash (producing high dividends). We use tax returns data on wealth and income to construct five measures of shareholders’ financial constraints. The inverse relationship between ownership concentration and dividends remains unaltered when we include proxies for this possibly omitted variable.
Overall, our evidence suggests that dividend policy is used as a governance mechanism, and that it tries to mitigate rather than exploit shareholder conflicts. This minority-friendly payout is rewarded with higher minority investment later on. Coming from a country with strong mandatory protection of minority shareholders in the law, these results suggest that voluntary, market-based governance mechanisms are important to reduce conflicts of interest also under tight regulatory constraints.
The full article is available for download here.
