The Relationships between Corporate Payout Policy and Earnings Quality

Abstract

This study empirically analyzes the relationships between payout policy and earnings quality by using panel data from Korea Exchange-listed firms. Proxies for earnings quality are estimated as the quality of three accruals based on the Dechow, Sloan and Sweeney (1995) model, the Kasznik (1999) ΔCFO (change in cash flow from operations) model, and the Kothari, Leone and Wasley (2005) ROA (return on assets)-performance-matched-discretionary-accrual model, respectively. The main results of this study can be summarized as follows. Dividends have significant and positive effects on earnings quality, implying that dividends are associated with higher earnings quality, confirming the hypothesis on information content of dividends. Stock repurchases also have significant and positive effects on earnings quality, implying that stock repurchases are associated with higher earnings quality. Although stock repurchases are increasingly being used as dividend-substitutes, they do not provide the same level of assurance about earnings quality as dividends. In conclusion, corporate payout policy affects earnings quality positively. More importantly, dividends are associated with higher earnings quality than stock repurchases. This study implies that earnings quality plays a significant role in payout policy choices, thus, contributing to the literature on the relationship between payout policy and earnings quality.