Mandatory Dividend Policy, Growth, Liquidity and Corporate Governance: Evidence from Chile

Abstract

Chilean publicly listed companies are required by law to pay out a minimum 30% of distributable earnings after taxes as dividends on common stock. The study extends Lintner’s [Lintner, J (1956). Distribution of incomes of corporations among dividend retained earnings and taxes. American Economic Review, 46, 97–113.] model of dividend smoothing and Banerjee [Banerjee, S, VA Gatchev and PA Spindt (2007). Stock market liquidity and firm dividend policy. Journal of Financial and Quantitative Analysis, 42(2), 369–398.] logistic model of the likelihood of a firm paying a dividend to investigate the signaling, liquidity, corporate governance, and information risk-based theories of dividends. The results show that Chilean firms’ excess dividends are smoothed in relation to the prior period level of excess dividends, and lagged earnings do not drive excess dividends even though the mandatory minimum dividend is defined in terms of lagged earnings. This insight establishes that dividend decisions regarding the size of the excess dividend and the likelihood of paying an excess dividend are distinct from the mandatory dividend payment. Additionally, the size of excess dividends and their likelihood are higher at firms with higher growth opportunities, a result consistent with the use of excess dividends as a signaling device. Results also demonstrate that greater transparency is associated with a greater likelihood of paying an excess dividend, but transparency does not drive policy regarding the size of the excess dividend. Moreover, the corporate governance mechanism creditor monitoring influences the size of excess dividends but not the likelihood of paying excess dividends. These results have implications for securities regulators evaluating the pros and cons of a mandatory dividend policy to protect minority shareholders in emerging markets.