Dividend Smoothing: An Agency Explanation and New Evidence

Abstract

In spite of considerable research into firm dividend behavior, dividend smoothing has eluded a definitive explanation. This paper provides an agency interpretation of dividend smoothing and offers evidence that variation in corporate governance and managerial incentive conflicts explains differences in intertemporal properties of dividends. We argue that smooth dividends are an alternative to traditional corporate governance mechanisms. Empirically, we document a greater degree of dividend smoothing, fewer dividend cuts, and a trend towards regular incremental dividend increases at firms with weak traditional monitoring mechanisms. The effect of governance on dividend changes is largest for firms with high free cash flow. We document consistent patterns for total shareholder payout and overall commitment to external claimholders. However, dividends and repurchases are not perfect substitutes and adjustments to repurchases are secondary to the weakly governed managers’ need to sustain dividends.