Are Investment Opportunities Associated with Dividend Reduction?: Evidence from Korea

Abstract

Purpose This paper examines associations among firm dividend reductions, investment opportunities(IOS), and share repurchases(SRP). Also, I examine the association between these factors and future operating performance. Design/Methodology/Approach This paper uses un-balanced panel data of 21,453 firm-year observations of non-financial Korean listed firms from 2003 to 2018. Findings Empirical evidence suggests that firms with higher IOS are more likely to reduce dividends to retain internally generated capital to prevent sub-optimal investments, while SRPs have a substitution effect on dividends in the dividend reducing context, and the effect is more pronounced with a less flexible SRP method. Also, dividend reductions associated with higher IOS are likely followed by enhanced operating performance. Additional tests suggest that the signaling effect of SRP varies according to the IOS among dividend-reducing entities over the long-run horizon. Research Implications Dividend reductions have been considered a ‘last resort’ for corporate managers, and thus manager reluctance to reduce dividends is taken for granted. However, there are firms reducing dividends despite good operating performance. This study provides a clue of such a phenomenon in practice.