THE ASSOCIATION BETWEEN DIVIDEND POLICY AND EARNINGS MANAGEMENT

Abstract

ABSTRACT Manuscript Type: Empirical Research Question/Issue: This study explores the relationship between dividend policy and earnings management by using the cash dividend payout ratio as a test variable while controlling for factors associated with earnings management. Research Findings/Insights: We find that conservative dividend policies are associated with higher discretionary accruals. We further suggest that firms are less likely to manage their earnings when financial leverage is high, there are outside blockholders on the board, and there is a larger fraction of the total payout issued in the form of share repurchases. Finally, the study also suggests that sectoral affiliation of the firm has a significant relationship with an amount of discretionary accruals. Theoretical/Academic Implications: We use panel data and Hausman-Taylor panel IV procedure and report that conservative dividend policies are associated with higher discretionary accruals. In fact, by controlling unobserved heterogeneity and endogeneity of dividend payout ratio we are able to claim that relationship is causal in nature, a pivotal finding on its own given the discourse in existing studies. Practitioner/Policy Implications: Dividend policy is generally deemed a critical tool for conveying information about firms’ future prospects to the capital markets - particularly with regard to valuation, reducing agency costs, and attracting new investors. Firms may thus be motivated to pay dividends even when internally generated capital is insufficient to meet company needs. Such firms may then be motivated to manage earnings so that their dividend policy does not appear inconsistent with their operating performance. Keywords dividend policy, earnings management, Hausman-Taylor IV, instrumental variable