Governance and Payout Precommitment

    Governance and Payout Precommitment Kose John, Anzhela Knyazeva, Diana Knyazeva PII: DOI: Reference:

S0929-1199(15)00057-7 doi: 10.1016/j.jcorpfin.2015.05.004 CORFIN 920

To appear in:

Journal of Corporate Finance

Received date: Revised date: Accepted date:

22 January 2015 11 May 2015 13 May 2015

Please cite this article as: John, Kose, Knyazeva, Anzhela, Knyazeva, Diana, Governance and Payout Precommitment, Journal of Corporate Finance (2015), doi: 10.1016/j.jcorpfin.2015.05.004

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ACCEPTED MANUSCRIPT Governance and Payout Precommitment*

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Kose John† New York University and Temple University

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Anzhela Knyazeva Securities and Exchange Commission

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Diana Knyazeva Securities and Exchange Commission

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This version: March 2015 Abstract

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We examine how firms structure payout and debt commitments to address governance weaknesses. Firms with severe agency conflicts precommit through a combination of dividends and debt or through dividends rather than debt alone. Such firms also shift their shareholder payouts towards regular quarterly dividends – a stronger commitment than special dividends or repurchases. Although dividend commitments are implicit, event study evidence supports their credibility and value-relevance for firms with weak governance. Despite harsher penalties, debt alone cannot replace shareholder payouts as a means of addressing managerial agency conflicts.

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JEL classification: G30, G34, G35, G32 Keywords: precommitment, payout, debt–dividend tradeoff, corporate governance

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We are grateful to the Editor (Jeffry Netter), Senay Agca, Bin Chang, Evren Damar, Antonio Falato, Cesare Fracassi, William Greene, Gerard Hoberg, Victoria Ivashina, Michael Lemmon, John Long, Sattar Mansi, Melissa Melancon, Roni Michaely, Eli Ofek, Micah Officer, Carrie Pan, Michael Raith, Anthony Saunders, G. William Schwert, Cliff Smith, Joseph Stiglitz, Jerry Warner, Toni Whited, Daniel Wolfenzon, David Yermack, and Bernard Yeung and participants at the European Finance Association, American Economic Association, Financial Management Association, Corporate Governance Luncheon and seminars at New York University and University of Rochester for helpful comments and suggestions. All remaining errors and omissions are ours. The earlier version of this paper was circulated under the title ―Payout Policy, Agency Conflicts, and Corporate Governance‖. The authors acknowledge the support of Simon School of Business at the University of Rochester and Stern School of Business at New York University. The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the authors and do not necessarily reflect the views of the Commission or of the authors‘ colleagues on the staff of the Commission. † Corresponding author: Kose John, Stern School of Business, New York University, 44 West 4 th St, New York, NY 10012. Phone: (212)998-0337. E-mail: [email protected]

ACCEPTED MANUSCRIPT 1. Introduction Many firms continue to make regular payouts to shareholders while raising debt to finance their

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investments. This paper provides additional evidence on corporate payout and debt decisions by

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firms with insufficiently strong traditional corporate governance mechanisms. In this paper we examine the relation between weaknesses in traditional corporate governance mechanisms and

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firm decisions regarding the structure of their commitments to distribute cash to external

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claimholders. We characterize the design of payout policy and the tradeoffs between debt and dividend payments in the presence of strong versus weak traditional corporate governance. We

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find that firms with the weakest traditional corporate governance are more likely to use dividend commitments alone or a combination of debt and dividend commitments instead of debt alone,

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which is insufficient to resolve weaknesses in shareholder governance (holding financial slack,

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asset structure, investment opportunities, and other characteristics constant). Conceptually, corporate governance mechanisms can be used to mitigate managerial

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agency problems and ensure that shareholders receive returns on their investment (see, e.g.,

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Shleifer and Vishny, 1997). Precommitment to cash distributions provides firms with an alternative way of addressing agency problems. Our aim in this paper is to understand the relation between these two avenues of lowering agency costs. Specifically, we characterize the design and structure of payout and debt policies as a function of the strength of governance, taking into account the varying degrees of commitment associated with different types of cash distributions (regular cash dividends, repurchases, special dividends, and coupon payments). Intense monitoring through conventional corporate governance mechanisms such as boards, blockholders, and corporate control markets can be costly. The lack of oversight in the absence of such monitoring mechanisms can exacerbate conflicts of interest between managers

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ACCEPTED MANUSCRIPT and shareholders. We argue that the extent of managerial agency conflicts affects the optimal choice of financial policies. The adoption of dividend payments and the use of debt to finance

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investments entail a commitment to future cash distributions. The commitment is implicit in the

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case of dividends and explicit in the case of debt. By restricting the manager‘s discretion, cash distributions can alleviate managerial agency conflicts. Potential agency benefits of dividends

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and debt must be weighed against their costs: debt is associated with financial distress costs and

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shareholder-bondholder conflicts while dividends incur the costs of external financing and personal taxation.

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We empirically establish an ordering of types of cash distributions based on the degree of precommitment involved and relate it to the strength of governance. Compared to cash

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dividends, repurchases offer the firm more financial flexibility (see, e.g., Jagannathan, Stephens,

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and Weisbach, 2000; Hoberg and Prabhala, 2009). The flexible nature of repurchases reduces their cost, but it also limits their effectiveness at addressing managerial agency conflicts. In

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contrast, dividends typically have to be sustained over time. Although dividend commitments are

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not specified in contracts, dividend cuts generate large negative announcement returns (see, e.g., Aharony and Swary, 1980; Denis, Denis, and Sarin, 1994) and impose costs on management (Myers, 2000; Knyazeva and Knyazeva, 2014). As a result, dividends significantly constrain managerial actions. Regular cash dividends – as opposed to special dividends – have the strongest precommitment features. In the absence of a commitment to regular dividends, managers can distribute cash to shareholders in a more discretionary manner—in the form of irregular payouts, such as share repurchases or special dividends—or retain cash in the firm. We find that firms subject to weak monitoring mechanisms are more likely to allocate a larger proportion of their payout to regular cash dividends.

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ACCEPTED MANUSCRIPT Firms with severe agency conflicts combine debt and cash dividends. Both financial policies involve costly cash distributions. Although the higher cost of deviations from debt

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payments makes debt a potentially more effective bonding device, debt does not necessarily

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serve to align managerial and shareholder interests due to the presence of shareholderbondholder agency conflicts. We find that the use of debt alone is insufficient for an effective

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commitment. Weakly governed firms are more likely to choose a mix of dividends and debt over

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debt alone, all else given. Further, firms with significant monitoring problems are more likely to include short-term debt, which induces repeated managerial exposure to the external financing

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market.

Further, we conduct an event study to examine the sensitivity of the market reaction to

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dividend changes to governance.3 We find that departures from dividend precommitment, in the

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form of unexpected dividend cuts, all else equal, are associated with a more adverse market reaction when the firm is covered by antitakeover protections due to state law. Consistent with

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the notion that precommitment through dividends can help alleviate value loss due to managerial

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agency conflicts when external monitoring mechanisms are not readily deployed, deviations from such precommitment are priced by investors as value-destroying. Thus, we conclude that (i) financial policies can serve as a credible alternative to traditional governance mechanisms; (ii) dividend commitments are more effective than repurchases alone; (iii) for most weakly governed firms, a combination of debt and dividends constitutes a more effective mechanism for remedying manager-shareholder agency conflicts than debt alone. 3

Officer (2011) also performs an event study test of market reaction to dividend changes and discusses the dividend-agency hypothesis. Our analysis differs in the following ways: we examine a combination of dividend, repurchase and debt choices; our event study examines changes to existing dividend commitments and not initiations by past nonpayers; we focus on corporate governance rather than the Jensen (1986) and Stulz (1990) Q-based measures of free cash flow problems.

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ACCEPTED MANUSCRIPT Overall, we analyze the effect of governance on the choice of the structure of cash distributions to outside claimholders. We conclude that firms favor a combination of dividend

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and debt commitments to address significant agency costs. Interestingly, debt alone is neither a

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sufficient nor a preferred way of mitigating manager-shareholder incentive conflicts. Despite harsher penalties for deviating from debt commitment, firms use the implicit dividend contract as

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a more effective element of precommitment that cannot be replaced by the use of debt alone.

2. Hypotheses and related work

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This paper focuses on the role of payout and debt policies in the context of corporate governance and managerial agency conflicts. Related work is summarized below, followed by our main

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hypotheses. The first hypothesis characterizes the structure of financial commitments at weakly

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governed firms. The second hypothesis focuses on the role of precommitment to dividends in the context of cash distributions to shareholders as a function of corporate governance. We conclude

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this section with a discussion of managerial self-interest in relation to precommitment decisions.

2.1. Existing work

Existing research on the role of debt suggests that debt can curtail managerial discretion by imposing the threat of bankruptcy, and thus may reduce overinvestment and result in more efficient investment decisions (e.g., Jensen, 1986; Stulz, 1990; Zwiebel, 1996; Amira et al., 2013). At the same time, debt can generate a separate layer of agency costs, stemming from the conflicts of interest between shareholders and debtholders. Similarly, dividends can mitigate agency conflicts by reducing free cash flow. Dividends may also compel the manager to raise external financing and face capital market monitoring

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ACCEPTED MANUSCRIPT more often (Easterbrook, 1984). Empirically, firms with limited investment opportunities use more debt, set higher dividends, and make more repurchases (Smith and Watts, 1992; Dittmar,

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2000; Fama and French, 2002). John, Knyazeva, and Knyazeva (2011) find that high free cash

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flow firms located farther from shareholders pay higher dividends. Other work finds that high free cash flow firms face a larger market reaction to dividend and loan announcements (Officer,

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2011; Lang and Litzenberger, 1989; Harvey, Lins, and Roper, 2004). Announcement return

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evidence on repurchases and special dividends is more ambiguous (Howe, He, and Kao, 1992; Lie, 2000).

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Evidence on the effects of incentive and governance mechanisms on dividend payout is mixed. Some studies reveal a negative relation between managerial ownership and dividends

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(e.g., Rozeff, 1982). Fenn and Liang (2001) find a positive effect of CEO ownership on payout

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for firms with high agency costs. For institutional ownership, Short, Zhang, and Keasey (2002) show a positive relation with dividends, whereas Amihud and Li (2006) document a negative

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relation. Officer (2011) finds a larger market reaction to dividend initiations of weakly governed

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firms. Jo and Pan (2009) document a negative relation between dividends and governance indexes.4 Hu and Kumar (2004) show that dividends are increasing in CEO tenure, cash compensation and board independence and decreasing in CEO ownership and stock options. In cross-country data, firms in strong shareholder rights environments pay higher dividends (La Porta et al., 2000).5

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The use of the G index on the right-hand-side may be associated with endogeneity concerns. Consistent with this, Jo and Pan (2009) conclude that firms select optimal entrenchment levels, ―choosing a combination of antitakeover provisions and dividend policy to maximize shareholder value‖. 5 Alzahrani and Lasfer (2012) show that the link between strong investor protection and high cash dividends is conditional on a low tax cost of dividends. As the tax cost rises, firms in strong investor protection countries switch to repurchases. In weak investor protection countries, cash dividends and repurchases are low and less responsive to taxes.

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ACCEPTED MANUSCRIPT Existing evidence on the use of debt is equally ambiguous. Friend and Lang (1988) observe a negative relation between debt and insider ownership. However, Berger, Ofek, and

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Yermack (1997) show a positive relation between leverage and CEO ownership and monitoring.

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Evidence on antitakeover protections is also mixed. Some studies find low leverage and a high cost of debt in the presence of antitakeover protections (Garvey and Hanka, 1999; Qiu and Yu,

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2009). The effect is insignificant in Wald and Long (2007). Other work finds that antitakeover

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provisions increase the use of debt and decrease the cost of debt, by reducing risk-shifting or

Yeung, 2008; Francis et al., 2010).

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protecting bondholders from the risk of a takeover (John and Litov, 2010; John, Litov, and

Our paper contributes to the literature‘s understanding of firm financial decisions in two

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principal ways. First, we examine interactions between debt and dividend policies and tradeoffs

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inherent in the choice of a debt-dividend mix, rather than focus on leverage ratios or dividend levels. Our findings counter the intuition in the existing literature that debt represents the most

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effective bonding device or that entrenched managers utilize their discretion to avoid

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commitment. We find that dividends and a combination of debt and dividend commitments dominate the use of debt alone for weakly governed firms. Our debt hypothesis does not rely on an entrenched manager‘s reduced risk taking or reluctance to face discipline. Instead, we argue that debt serves as one of the potential precommitment mechanisms. Second, our tests emphasize the structure of commitments and the choice among different types of cash distributions among payers, rather than payout levels or incidence. While other work has examined dividend levels or leverage ratios in relation to agency conflicts, we focus on the interactions in the choice of cash distribution structure as a function of various dimensions of corporate governance - corporate control markets, boards and blockholder monitoring – and

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ACCEPTED MANUSCRIPT uncover important differences in the hierarchy of financial commitments that firms use to

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remedy governance weaknesses.

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2.2. Hypotheses

Governance mechanisms can lower managerial agency costs. However, monitoring is

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costly to establish and sustain, with the relative costs and benefits of monitoring mechanisms

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likely to vary across firms. As an alternative to strong corporate governance, firms can precommit to cash distributions to shareholders or debtholders to address managerial agency

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conflicts. Shareholder payouts and debt payments reduce free cash flow and expose the manager to additional oversight from external financing markets. We expect agency benefits of more

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stringent precommitment to be greatest for firms with weaker monitoring of management,

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controlling for other factors. Since precommitment to distribute internal cash flow increases the future need for external financing and involves other costs, firms with strong corporate

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governance are expected to opt for a more flexible cash distribution structure.

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The main hypotheses on precommitment structure are developed below. The tradeoff between debt and dividend commitments Debt can serve as a bonding device for the management (e.g., Jensen, 1986; Stulz, 1990).6 Although the immediate effect of debt issuance is to provide firms with additional cash from selling debt securities, debt is commonly recognized as a constraint on the management, which limits future managerial discretion considerably more than other methods of raising cash (such as cuts to investment or new equity issues). Debt must be repaid on a contractually specified schedule. Since failure to adhere to the timeline and amounts of payments constitutes 6

There are, of course, other reasons for corporate use of debt. Debt can be issued to take advantage of the tax benefits of debt or to meet a financing deficit created by the firm‘s investment needs or cash flows shortfalls. We will intend to capture other potential motivations for the use of debt in our controls.

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ACCEPTED MANUSCRIPT default and can trigger bankruptcy, the cost of deviations from pre-specified payments is high. Even when the firm is fully able to make payments on schedule, covenants centered on financial

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ratios that may be included in debt contracts further reduce managerial discretion to pursue

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investment projects. Violations of covenants can place the firm in technical default, which can be costly (e.g., Beneish and Press, 1993). The Jensen view indicates that firms facing significant

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agency conflicts that cannot be addressed through monitoring and dividends can precommit

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through debt.

However, an important disadvantage of debt is that it introduces conflicts of interest

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between bondholders and shareholders that can erode shareholder value. Debt as the only form of discipline imposed on the manager need not be the optimal or sufficient method of aligning

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manager and shareholder incentives. For severe managerial agency conflicts, the level of debt

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needed to curb the free cash flow problem can involve high financial distress and shareholderbondholder agency costs that exceed the tax benefits of debt. As a result, we expect that firms

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with significant manager-shareholder conflicts may adopt a combination of debt and cash

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dividends rather than debt commitment alone. While enforcement of a debt commitment is more straightforward as debt contracts specify significant penalties for the firm (and by consequence, the manager‘s career) for nonpayment, the issue of whether self-interested managers can be effectively bound by a dividend commitment warrants additional discussion. Myers (2000) shows that a self-interested manager will optimally agree to an implicit dividend contract in exchange for investors‘ continued funding of the firm.7 The manager optimally continues dividend payments due to the need to secure outside funding for future projects. Investor refusal to supply capital limits the manager‘s

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The presented argument about equity financing is particularly relevant for countries with developed stock markets, such as the US market considered in our sample, and less relevant for developing or bank-based systems.

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ACCEPTED MANUSCRIPT ability to expand the firm, hence, derive private benefits. More generally, a self-interested manager weighs a contemporaneous free cash flow increase from forgoing dividends against

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future shareholder reaction to the (observable) dividend deviation (Knyazeva and Knyazeva,

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2014). Consistent with an adverse shareholder response to deviations from implicit dividend commitments, event studies show a negative market reaction to dividend cuts (e.g., Aharony and

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Swary, 1980; Denis, Denis, and Sarin, 1994). As a result, US managers attempt to avoid

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dividend cuts by managing earnings and cutting investment when faced with cash flow shortfalls (Daniel, Denis, and Naveen, 2008a,b; Servaes and Tufano, 2005). The market penalty for

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dividend cuts is largest for weakly governed firms (Knyazeva and Knyazeva, 2014). Based on theoretical models, event studies and survey evidence, managers are indeed highly reluctant to

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deviate from pre-existing dividend commitments.

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With regards to the initial precommitment decision (assuming it has not been made by the entrepreneur), the dynamic model of capital structure choice in Zwiebel (1996) examines a self-

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interested manager‘s decision to precommit to avert future control challenges. Myers (2000) uses

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the manager‘s need for outside funding to explain the initial adoption as well as continued adherence to an implicit dividend commitment by the manager. Thus, conceptually, the initial precommitment can be compatible with a self-interested manager‘s incentives. “Precommitment through Debt vs. Dividends” Hypothesis Firms with the weakest governance are more likely to choose a combination of debt and dividends. Commitment to debt alone is not sufficient to resolve significant agency conflicts.

Structure of shareholder payout Our second hypothesis considers the structure and design of payout policy based on the varying degrees of precommitment and tradeoffs involving different types of shareholder payout.

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ACCEPTED MANUSCRIPT Although standard free cash flow theory predictions do not distinguish among payout types (e.g., Easterbrook, 1984), we argue that the effectiveness of payout as a precommitment device

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depends on the type of payout. Cash dividends represent a strong commitment, unlike share

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repurchases. Dividend cuts trigger a significant negative market reaction (see, e.g., Aharony and Swary, 1980). The steep penalty for deviations makes cash dividends a credible precommitment

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mechanism. Share repurchases leave more discretion to the manager and are not as effective at

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mitigating agency conflicts. For instance, in the context of open market repurchase programs, managers can vary the level of actual repurchases from period to period depending on the firm‘s

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needs and market conditions (e.g., Stephens and Weisbach, 1998; Chan et al., 2010). Deviations from announced repurchase programs are frequent and are not followed by a negative market

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reaction. Thus, share repurchases are viewed by the market as a more discretionary form of

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payout. At firms that have repurchase programs but no dividends, self-interested managers can retain a high fraction of earnings for investment in value-destroying projects. Weakly monitored

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managers have been shown to dissipate cash inefficiently and overinvest (Harford, Mansi, and

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Maxwell, 2008; Dittmar and Mahrt-Smith, 2007). Firms with less stringent monitoring mechanisms are therefore expected to adopt a precommitment to cash dividends, in the form of a standalone dividend policy or a combination of cash dividends and repurchases. In turn, share repurchases offer the benefit of a smaller loss of financial flexibility, compared to cash dividends (Jagannathan, Stephens, and Weisbach, 2000). A value-maximizing manager can undertake a one-time buyback to distribute a temporary cash windfall and forgo subsequent buybacks, depending on future realizations of cash flow and investment opportunities. Besides the decision to use cash dividends or to rely solely on repurchases, we examine the choice among different types of dividends. Special dividends are infrequent and not easily

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ACCEPTED MANUSCRIPT predictable (DeAngelo, DeAngelo, and Skinner, 2000). Clearly differentiable from regular cash dividends, large special dividends are in many ways similar to share repurchases. In contrast, the

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adoption of regular quarterly cash dividends leaves investors with a strong expectation of

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continued payouts in future periods. We argue that regular quarterly cash dividends are a more effective commitment than other types of shareholder payout.

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“Payout Structure” Hypothesis Weakly governed firms are more likely to substitute regular quarterly cash dividends for repurchases or special dividends alone. The share of cash dividends in payout is higher for weakly governed firms.

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An alternative prediction arises from earlier work (La Porta, Lopez-de-Silanes, Shleifer, and Vishny, 2000; Brown and Caylor, 2006): better governed managers pay higher dividends.

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For instance, La Porta et al. (2000) find lower dividends in countries with poor shareholder rights protections. This paper explores firm-level corporate governance differences among US firms.

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Factors such as the shareholder-friendly legal environment and developed equity markets that

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affect the US sample are expected to deter managerial deviations from payout commitments adopted by the firm. However, we recognize this potential competing effect and the nature of the

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relationship between the strength of governance and the structure of payout is ultimately an empirical question.

3. Data 3.1. Sample Data on payout, debt, and other firm-level characteristics is obtained from Compustat and Center for Research in Security Prices (CRSP). Standard sample filters omit very small firms, so the sample excludes observations with total assets under $20 million to avoid some of the potential noise. Firms incorporated outside the United States are excluded to assure greater

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ACCEPTED MANUSCRIPT comparability of financial and governance measures. Sensitivity tests exclude firms in the regulated utilities and financial sectors, which has little effect on the results. Tests using state-

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level data on antitakeover provisions are performed over the 1980–2013 sample period. The

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main tests using firm-level data on antitakeover provisions and other corporate governance measures are performed over the 1996–2008 sample period due to data availability constraints.8

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Sensitivity tests use the 1996–2013 period and 1996–2006 period. Requiring non-missing

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governance, ownership, and compensation data causes the typical firm in the sample used in firm-level governance analyses to be larger and more mature and we account for these

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3.2. Variables

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differences in multivariate tests.

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Variable definitions are presented in the Appendix. Summary statistics are shown in

[Table 1]

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Dependent variables

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Table 1.

To capture the choice of debt versus dividend commitment, we construct a categorical variable for commitment type that takes on the following values: no commitment, cash dividends alone, debt alone, or a combination of cash dividends and debt. To further evaluate the structure of outflows committed to external claimholders, we examine the share of dividends in distributions to external claimholders associated with some degree of commitment (proxied by the sum of dividends and interest payments) and in total distributions (proxied by the sum of

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Due to our availability of RiskMetrics board structure data, the sample used in firm-level governance tests begins in 1996. Our series of RiskMetrics data on firm-level antitakeover provisions, used to construct the Bebchuk, Cohen, and Ferrell (2005) E index spans years from 1990 to 2008 (with gap years). However, several of the G index provisions are no longer reported in RiskMetrics after 2006.

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ACCEPTED MANUSCRIPT dividends, repurchases, and interest payments). If our hypothesis holds, all else equal, weak governance should be associated with a stronger preference for using dividends (alone or in

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combination with debt commitment) relative to commitment to debt alone among firms adopting

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some form of commitment. In sensitivity tests we also examine the use of short-term debt, which may require the manager to access external financing sources more frequently, conditional on

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having a positive leverage ratio.

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Tests of the shareholder payout structure hypothesis consider the composition of shareholder payout by type. We focus on the choice between different combinations and

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components of cash distributions in the firm‘s design of payout policy. Depending on the intended degree of precommitment, firms that make shareholder payouts can choose to include

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regular cash distributions, such as quarterly cash dividends, to combine regular and irregular

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cash distributions, or to distribute cash entirely through mostly irregular distributions (share repurchases or special dividends. The first two choices entail a high degree of precommitment to

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shareholders whereas the last choice gives the manager a high degree of discretion with respect

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to cash distributions to shareholders. Payout policy type is summarized by a categorical variable that takes on the following values: no payout, repurchases only, or cash dividends (alone or in combination with repurchases). Special dividends include year-end or final, extra or special, and non-recurring dividends. In sensitivity tests, we also isolate regular quarterly cash dividends, which may be more likely to be associated with a firm precommitment. As most dividend-paying firms use regular quarterly cash dividends, the measures produce consistent results. To further analyze payout composition, we examine the share of cash dividends in total shareholder payout. If our predictions are correct, holding all else equal, governance weaknesses should be associated

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ACCEPTED MANUSCRIPT with a preference for dividends over repurchases and with a higher share of dividends in total shareholder payout.

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Data on cash distributions is obtained from Compustat. Sensitivity tests that separate

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dividend distributions by type use CRSP data. Corporate governance

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Our first approach to measuring the strength of corporate governance draws on the

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premise from prior literature that antitakeover provisions are expected to increase managerial power and potential for inefficient behavior by shielding the manager from oversight.9 Similar to

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Gompers, Ishii, and Metrick (2003), we treat antitakeover provisions as being associated with corporate governance weaknesses and follow a consistent approach to the construction of the

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governance index. Due to the likely endogeneity of firm-level provisions, our main measure

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relies on antitakeover provisions in effect in the firm‘s state of incorporation based on the data on business combination, fair price, control share acquisition, poison pill, and director‘s duties laws

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from Karpoff and Wittry (2014). We omit firms they identify as having motivated or lobbied for

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a specific law, for which such provisions may be endogenous.10 Second, at the firm level, we measure corporate governance using several proxies for the intensity of oversight of the manager by external and internal monitors motivated by prior literature. Exposure of the manager to monitoring by the corporate control market is measured 9

Malatesta and Walkling (1988) find a negative effect of antitakeover provisions on firm value. Ryngaert and Netter (1988, 1990) were among the first to examine anti-takeover laws, focusing on the passage of the Ohio antitakeover law, and to find a significant negative effect on affected firms. CEOs in states with antitakeover statutes are more likely to lead a ―quiet life‖ (Bertrand and Mullainathan, 2003). Some evidence on the role of takeover defenses and their effectiveness as a takeover deterrent is mixed. Comment and Schwert (1995) and Heron and Lie (2006) find no effect of poison pills on the probability of future takeovers and a positive effect on takeover premiums. Jarrell, Brickley, and Netter (1988) and Ambrose and Megginson (1992) find a reduction in the takeover threat. Overall, at least some evidence supports the role of antitakeover provisions in increasing managerial power, even if it is not clear that an individual provision can avert an unfriendly takeover. 10 The use of state variation in the corporate governance measure may induce correlation in standard errors, which can be addressed by state effects (used in Table 4, Panel B) or clustering of errors at the state rather than firm level (in unreported tests the main results remain unchanged).

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ACCEPTED MANUSCRIPT using the Bebchuk, Cohen, and Ferrell (2005) E index obtained from IRRC/RiskMetrics. The variable is rescaled to assign higher values to firms with fewer takeover defenses. In addition,

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monitoring by small, independent boards and institutional owners can similarly address

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suboptimal managerial behavior (see, e.g., Cremers and Nair, 2005; Rosenstein and Wyatt, 1990; Yermack, 1996). Thus, our governance index averages annual firm rankings based on board

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independence, board size (smaller boards are assigned higher ranks), and largest institutional

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shareholding, scaled to [0,1]. Data on board characteristics is obtained from IRRC/RiskMetrics. Institutional ownership is based on 13f filings data. Sensitivity tests use the G index of

separate right-hand-side variables.

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Control variables

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antitakeover provisions and individual board, institutional ownership, and CEO characteristics as

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Several determinants of cash distributions potentially correlated with monitoring are included as controls. Our main specification controls for cash flow, investment opportunities,

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and firm size (e.g., Fama and French, 2001, 2002; Krieger, Lee, and Mauck, 2013; Abreu and

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Gulamhussen, 2013; Smith and Watts, 1992). Cash flow is computed as the ratio of EBITDA to total assets. Investment opportunities are captured with market-to-book ratio. Size is defined as the log of market value. Tests in the firm-level governance sample control for managerial ownership and option compensation (ratio of the value of stock option grants to the market value of the firm) obtained from Execucomp. Stock options are expected to have a negative effect on dividends and a positive effect on repurchases (Fenn and Liang, 2001). As was discussed above, the expected sign of the ownership effect is ambiguous. While insider ownership aligns manager and shareholder incentives, high insider ownership can lead to entrenchment. Also, CEOs receiving high dollar dividends on their shares may be reluctant to cut dividends (Daniel, Denis,

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ACCEPTED MANUSCRIPT and Naveen, 2008a). Robustness checks also control for the firm‘s life cycle stage, level of information asymmetry, asset tangibility, liquidity, and tax circumstances.

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Sample and variable definitions are summarized in the Appendix.

3.3. Methodology

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We focus on the type and design of cash distribution commitments chosen by firms with

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weaker monitoring mechanisms in place. Hypothesis tests use multinomial logit to analyze the firm‘s choice of commitment type, such as dividends as the sole form of precommitment, debt as

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the only precommitment, and a combination of debt and dividend commitments. We empirically identify the type of precommitment preferred under different governance regimes. Since the

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share of dividends in cash distributions is a censored variable, ordinary least squares estimates

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would be biased, so we use tobit estimation for this variable, following Dittmar (2000) and Fenn and Liang (2001). Robust standard errors with clustering by firm are used to account for

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potential correlation in errors.

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Like most empirical corporate governance studies, we face potential endogeneity concerns. For instance, omitted variables correlated with future investment opportunities may be related to determinants of corporate governance structure and may also be related to financial decisions.11 Overall, firms may simultaneously select corporate governance structure and financial policies to address agency problems of free cash flow. This will confound the main analysis and potentially bias estimates of firm-level governance effects. We attempt to mitigate this in several ways. We supplement the analysis of firm-level governance with evidence from an index of antitakeover laws, which captures mostly external cross-sectional differences in corporate governance. To the extent that individual firms are unlikely to effectively exert 11

See, e.g., Linck, Netter, and Yang (2008); Cicero, Wintoki, and Yang (2013); Wintoki, Linck, and Netter (2012).

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ACCEPTED MANUSCRIPT significant lobbying influence on state legislators, this alleviates some simultaneity concerns. However, to the extent that antitakeover laws have been affected by lobbying, the legal regime

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would be endogenous for such firms. Thus, we exclude lobbying and motivating firms in all of

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our tests using this measure.12 Second, we repeat firm-level governance tests with lagged governance measures, however, we are cautious in our inference due to persistence in the

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variables of interest. Third, to account for the possibility that some omitted variables remain, we

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conduct an event study of dividend changes. Tests of the market reaction to unexpected dividend changes conditional on the legal regime are less likely to yield spurious evidence since they

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account for pre-existing firm characteristics (including time-varying ones), to the extent that

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those characteristics had been reflected in market prices prior to the announcement.

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4. Results

As we have discussed above, conceptually, both the presence of debt and a commitment

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to dividends can serve to bond a weakly governed manager through regular payments to external

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claimholders. A default on debt payments would impose a significant cost on the manager, which raises the effectiveness of debt as a bonding device (Jensen, 1986). However, while debt can limit managerial discretion with respect to the free cash flow (such as ‗perquisite‘ consumption or inefficient investment decisions), managers constrained by the disciplinary role of debt could also invest in a manner that does not maximize shareholder value. In sum, as has been shown in 12

We rely on our controls to address the remaining concerns about endogeneity due to potential clustering of incorporation decisions of certain types of firms in particular states. Similar to prior literature, we are cognizant of the potential limitations of such an approach and the difficulty in identifying an excludable predictor of the incorporation decision. Firm fixed effects, which have been used for mitigating endogeneity due to unobserved timeinvariant firm-level heterogeneity, are not well suited for our estimation methods and similarly have their limitations. However, the use of the combination of state and industry fixed effects, which likely captures a significant amount of unobserved heterogeneity, does not affect our results (see Table 4, Panel B). Given the trends of dividend disappearance (Fama and French, 2001) and reappearance over time (e.g., Amin et al. 2015), as well as the variation in tax rates applicable to interest, dividends, and capital gains during our sample period, all multivariate tests also include year fixed effects.

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ACCEPTED MANUSCRIPT the prior literature, debt may contribute to its own layer of agency conflicts and potentially result in decreased alignment of shareholder and manager interests (see, e.g., John and Litov, 2010).

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The use of debt can involve restrictive covenants that may impose costs on the firm and prevent

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firms from some investment decisions that would be in the shareholder interest. If the firm only commits to debt payments, the level of commitment necessary to resolve a severe managerial

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agency conflict could be associated with high shareholder-bondholder agency costs. In turn,

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while cash dividends address the manager-shareholder agency conflict more directly, without contributing to a new layer of agency conflicts, they are more susceptible to managerial

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discretion and the possibility of suspension, albeit at a cost to the manager. The question of which of the two types of commitment is relatively more important for firms with manager-

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shareholder agency conflicts due to weak shareholder governance remains an empirical one.

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Table 2 presents evidence on the implications of corporate governance for the tradeoff between

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precommitment to debt versus dividends. [Table 2]

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We find that firms with weaker corporate governance, as measured by antitakeover protections, have both a higher share of dividends in total cash distributions and a higher share of dividends in cash distributions committed to external claim holders (columns I and II). These results are consistent with the more significant role of cash dividends relative to other types of distributions in mitigating manager-shareholder agency conflicts exacerbated by weak corporate governance. Next we evaluate the choice of precommitment structure, focusing on the combination of debt and dividend commitments the firms choose. Firms with weaker corporate governance are more likely to adopt a combination of debt and dividends as opposed to a commitment to debt only (column III). In addition, firms with weaker corporate governance are

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ACCEPTED MANUSCRIPT on the margin (significant at 10%) more likely to be committed to a combination of debt and dividend payments as opposed to being committed to dividends only (column IV). Thus, firms

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with weaker corporate governance, as measured by the presence of more antitakeover provisions,

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appear to prefer a mix of debt and dividends, controlling for other factors. The most pronounced effect is observed in the context of the choice between commitment to debt alone and the use of

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debt and dividends. Conceptually, the results support the hypothesis that firms mitigate manager-

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shareholder agency conflicts through a combination of shareholder payout commitments and the disciplining role of debt. To the extent that firms optimize their precommitment structure, the

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evidence supports the notion that the combination of debt and dividend commitments is more effective than debt itself. Given the tradeoffs involved in the use of dividends and debt, firms

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with significant corporate governance concerns appear to be combining debt and dividends in an

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effort to achieve the best precommitment tradeoff. In contrast to the intuition in prior work, the use of debt alone does not appear to be the preferred approach to resolving agency conflicts

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exacerbated by governance weaknesses.

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Controls enter with expected signs, given past studies of dividends and capital structure. Cash flow has a positive effect on the share of dividends. The effect on the choice to use a combination of dividends and debt is mixed, in light of prior evidence of a negative relation between profitability and debt levels (see, e.g., Fama and French, 2002). Firms with stronger investment opportunities have a lower likelihood of using a combination of debt and dividends. The effect on the share of dividends is mixed. Firm size has a positive effect on the use of a combination of dividends and debt and the share of dividends. In Table 2, we have narrowed our focus to dividends when analyzing a firm‘s tradeoff between shareholder and debtholder precommitment. For that analysis we relied on the

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ACCEPTED MANUSCRIPT assumption that dividends are the most relevant type of payout to shareholders in the context of addressing manager-shareholder conflicts of interest. In Table 3, we relax this assumption and

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empirically examine the structure and the choice between different types of cash distributions to

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shareholders. [Table 3]

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The share of dividends in overall payout to shareholders is higher for weakly governed

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firms (column I). Consistent with this, the probability of using repurchases or a combination of repurchases and special dividends as the only form of payout is lower for firms exposed to

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potentially more significant managerial agency conflicts due to antitakeover protections in place (columns II-III). Dividends appear to be particularly important for addressing managerial agency

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conflicts for such firms. The coefficients are statistically significant as well as economically

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meaningful. Repurchases are less effective as a precommitment device since both the odds of completion of a previously announced repurchase program and the expectation of a future

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repurchase program being undertaken are less certain than in the case of regular cash

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dividends.13 Empirical evidence is consistent with the hypothesis that regular cash dividends play a greater role in the context of precommitment than special dividends or share repurchases. Controls enter with expected signs. Cash flow has a positive effect on the share of dividends and on the choice to use dividends instead of repurchases only. Investment opportunities enter with a negative sign. Firm size has a positive. Overall, conditional on making distributions, larger, more profitable firms appear to have a greater benefit and/or a lower cost of

13

To the extent that repurchases may serve as a financial takeover deterrent (see, e.g., Bagwell, 1991; Heron and Lie, 2006), it is also possible that antitakeover protections reduced the use of repurchases as a supplementary takeover defense. While this finding alone may be somewhat open to interpretation, combined with the evidence on increased use of dividends, for which a takeover defense interpretation does not apply, this explanation is unlikely to be behind our findings.

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ACCEPTED MANUSCRIPT regular dividends, whereas firms with better investment opportunities are more likely to choose repurchases instead.

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Next we perform a number of additional tests to ensure that our main findings are robust

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to alternative explanations, measurement, methodology, and sample definitions. In Panel A of Table 4, we add other explanatory variables to our baseline specification to account for potential

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alternative explanations. Firms with a high proportion of tangible assets likely have lower costs

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of financial distress and thus may be in a better position to take on debt, all else equal (Fama and French, 2002). Indeed, all else equal, firms with more tangible assets are more likely to add debt

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and weigh debt payments more in their precommitment structure. At the same time, a higher share of tangible assets may also serve as an additional proxy for having fewer future growth

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opportunities and more assets in place, which could also be associated with higher dividends

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(Fama and French, 2002; Smith and Watts, 1992). Consistent with this, we find that among firms with debt, tangible assets are associated with a higher likelihood of committing to dividends. A

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higher share of tangible assets increases the likelihood that the firm will precommit to dividends

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rather than use repurchases only. Consistent with DeAngelo, DeAngelo, and Stulz (2006), more mature firms that are farther along in their life cycle, defined as firms with a high ratio of retained earnings to assets, place more emphasis on dividends. Liquidity, measured by share turnover, decreases investor demand for dividends, consistent with Banerjee, Gatchev, and Spindt (2007). We also consider the effects of analyst coverage, a proxy for the level of information available about the firm, which may affect investor demand for dividends, on the structure of precommitment, but the effect is not significant. Tests in Panel B use state fixed effects to account for time-invariant unobserved state-level heterogeneity that may be correlated with the firm‘s choice of the state of incorporation as well as with its precommitment type and

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ACCEPTED MANUSCRIPT thus may be causing endogeneity. Throughout these robustness tests our main corporate governance effect continues to hold.

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[Table 4]

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Panel A of Table 5 introduces alternative definitions of the dependent variable. Weaker corporate governance is associated with a higher probability of a commitment structure that

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includes dividends (alone or in combination with debt), as opposed to debt alone (column III).

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Further, we check whether firms with weak governance are more likely to have short-term debt in their capital structure, which may force the manager to seek debt rollover or new external

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financing more frequently, hence, face more frequent scrutiny from the capital market. The managerial entrenchment view (Berger et al., 1997; Benmelech, 2006) provides an alternative

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prediction: in the absence of stringent monitoring, managers avoid debt to reduce the risk of

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liquidation and avoid dividends to facilitate private benefit extraction. We find that weak governance is associated with a higher probability of inclusion of short-term debt, consistent

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with managers committing to approach the external financing market, and face the associated

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oversight, on a regular basis (column II). For robustness, we also examine the choice of regular quarterly cash dividends versus all other types of ordinary cash dividends and repurchases (column I). The result continues to hold. [Table 5] Tests in Panel B examine the effects of a more parsimonious corporate governance index (comprised of three antitakeover laws - business combination, fair price, and control share acquisition - suggested in Bertrand and Mullainathan (2003)). The effect of interest remains qualitatively similar to the findings shown above, with one exception: while the effect remains significant in the model of choice between a combination of dividends and debt and debt only,

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ACCEPTED MANUSCRIPT the effect becomes insignificant in the model of choice between a combination of dividends and debt and dividends only. Corporate governance, as measured by this variable, has a stronger

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relation to the incremental role of dividends, rather than debt, in the precommitment structure of

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companies that adopt a commitment.

Our main sample contains firms from all industries and uses industry effects to account

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for differences across sectors. In Panel C, we exclude financial firms and utilities from the

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sample. All of the results remain qualitatively similar to Panel B. Several sensitivity tests are not tabulated to save space (available upon request). Our

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main findings continue to hold when we repeat the main tests in ten-year subsamples, control for three-digit industry fixed effects, state of location fixed effects, firm risk, cash holdings, or

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cluster standard errors at the state rather than firm level.

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Despite the extensive set of robustness checks, it is difficult to completely rule out endogeneity. Therefore, we also present event study evidence of the market reaction to changes

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in dividend policy as a function of corporate governance. To the extent that stock prices reflect

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existing firm characteristics, as well as any variation not captured by our controls that may be related to both investment opportunities and governance (and in this instance, state of incorporation), the market reaction to the dividend surprise announcement should allow us to isolate the incremental effect on firm value associated with the change in dividend policy. The relation between corporate governance and the market reaction to a dividend surprise demonstrates how the market perceives dividend policy depending on the extent of agency conflicts stemming from its governance regime. Looking at how shareholders as a group (assumed to be rational on aggregate) react to unexpected dividend changes can thus provide an additional test of our hypothesis that a dividend precommitment can limit value destruction by

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ACCEPTED MANUSCRIPT managers affected by significant agency conflicts. Table 6 reports tests of the market reaction to announcements of decreases and increases in regular quarterly dividends.

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[Table 6]

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Consistent with our main argument, all else equal, deviations from the dividend precommitment that manifest themselves as cuts to quarterly cash dividends (the most regular

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dividend component that is best suited for the purposes of testing precommitment changes)

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trigger a more adverse market reaction when corporate governance is weaker (as measured by more antitakeover protections) and agency conflicts are more severe. In line with John et al.

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(2011), we do not find a similar effect of corporate governance on the reaction to dividend increases. Overall, it appears that the market is most likely to react differently depending on the

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strength of corporate governance to dividend decisions that involve an unexpected deviation by

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the manager from a previously established implicit commitment to dividends. The preceding analysis has focused on corporate governance measures based on state

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antitakeover provisions. While state-level variation in governance yields a larger sample size and

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is relatively more exogenous, firm-level governance data offers more insight into various dimensions of monitoring and governance. Tests using the subsample with nonmissing firm-level corporate governance data are reported in Table 7. [Table 7] Firms with weaker corporate governance are more likely to precommit to a combination of debt and dividends rather than debt alone and have a higher share of dividends in payout and payments committed to external claim holders. Among firms that make payouts, weak corporate governance is associated with a preference for using regular quarterly dividends rather than repurchases or special dividends only. The effects are statistically and economically significant. Overall, firms appear to trade off alternative mechanisms of constraining the manager explicit

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ACCEPTED MANUSCRIPT monitoring and precommitment through debt and dividends. Thus, evidence from firm-level governance is broadly consistent with the earlier findings. However, in the sample with non-

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relatively greater role than firm-level antitakeover provisions.

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missing firm-level governance data, board and institutional blockholder monitoring played a

Table 8 reports additional sensitivity tests. Panel A presents the results of the tests in a

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subsample that excludes financials and utilities (similar to Panel C of Table 5). Panel B shows

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the results of regressions incorporating additional controls. In addition to the controls used in Panel A of Table 4, the analysis of the role of debt in a firm‘s precommitment structure in this

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table also accounts for variation in the firm‘s tax circumstances, which may affect debt use for reasons unrelated to agency conflicts (e.g., Modigliani and Miller, 1963; Barclay, Heitzman, and

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Smith, 2013). We include investment tax credits and deferred taxes, which are intended to proxy

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non-debt tax shields, as an additional control (e.g., DeAngelo and Masulis, 1980). The results continue to hold. Panel C reports the results based on alternative definitions of the dependent

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variable (similar to Panel A of Table 5). The results continue to hold after these robustness

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checks. In unreported tests, we repeat the analysis with lagged governance metrics, and the results continue to hold.

[Table 8]

We use alternative corporate governance measures in Table 9. In Panel A, we extend the firm-level corporate governance sample to 2013 by replacing the Bebchuk et al. (2005) E index14 with the declassified board indicator and the index of state antitakeover provisions. The index of board and institutional monitoring remains significant. The state antitakeover provisions index enters significantly as well, but the declassified board coefficient is statistically insignificant. In

14

We do not have data to reconstruct the G index after 2006 and the E index after 2008 due to our data availability (following changes in RiskMetrics coverage of data on takeover defenses).

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ACCEPTED MANUSCRIPT Panel B, we use the Gompers et al. (2003) G index of antitakeover provisions as an alternative to the Bebchuk et al. (2005) E index (both measures are rescaled, so that higher levels correspond

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to stronger governance). Our series for the G index ends in 2006, so the sample is smaller, but

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the results are highly consistent with the estimates presented above. In Panel C, we disaggregate the corporate governance index and include three separate variables: board independence, board

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size, and the largest institutional stake in the firm. In addition, CEO pay slice (defined following

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Bebchuk, Cremers, and Peyer, 2011) is used to proxy CEO power, and an indicator for CEO age is used as a measure of a CEO‘s proximity to retirement (e.g., Knyazeva, Knyazeva, and

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Masulis, 2013). The structure of precommitment is primarily affected by small boards,

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institutional blockholder monitoring, and CEO characteristics. [Table 9]

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Our paper has emphasized the agency view in evaluating the structure of dividend and debt commitments. John and Williams (1985) present a costly signaling model of dividends.

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Although cross-sectional payout policy tests do not directly relate to signaling, to account for the

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possibility that weakly governed managers face higher information asymmetries and use dividend signaling to resolve them, we have included proxies for the extent of information asymmetry.

5. Conclusion This paper has found that firms precommit through payout and debt policies in the presence of weak corporate governance. Our evidence reveals the effects of antitakeover provisions at the state level and firm-level governance measures on the structure of firms‘ financial commitments. Differently from existing work on agency and dividends, our results

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ACCEPTED MANUSCRIPT distinguish among the various types of cash distributions depending on the degree of precommitment and uncover important patterns in the design of financial commitments.

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Our first set of results revolves around the use of debt as an alternative precommitment

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device in the presence of weak governance. Both dividends and debt engage outside claimholders in the oversight of the manager. Importantly, in contrast to the assumption in the

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existing literature, a combination of debt and dividends is more effective in firms with

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monitoring issues than debt alone. Although steep penalties for deviations from debt contracts strengthen managerial discipline, debt can induce suboptimal investment due to shareholder-

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bondholder agency conflicts. We find that weakly governed firms are more likely to use a combination of debt and dividends than debt alone. The presence of a commitment to dividends

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(rather than debt) plays a more instrumental role in resolving managerial agency conflicts

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exacerbated by governance weaknesses.

Second, we differentiate between different types of shareholder payouts along the

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dimension of their effectiveness as a precommitment device. In contrast to the common intuition

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that repurchases are another method of distributing excess cash and therefore a substitute for dividends, we argue that regular cash dividends are more effective than share repurchases at limiting managerial agency conflicts of free cash flow that result in suboptimal investment. Consistent with this reasoning, firms with weak governance on the margin opt for regular quarterly cash dividends instead of repurchases or special dividends. In turn, at firms with strong governance managers retain the flexibility to keep cash in the firm or make discretionary payouts, such as share repurchases and special dividends. Our evidence has important implications for future research. Precommitment features embedded in payout and debt policies can mitigate agency conflicts. Our findings suggest that

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ACCEPTED MANUSCRIPT firms need not choose the strictest governance standard to address agency conflicts since other mechanisms can be used to limit managerial discretion. The presented evidence calls for a

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broader view of monitoring that surpasses traditional definitions of corporate governance. The

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results obtained in the US sample are conditional on strong shareholder protections and developed capital markets. An international study of tradeoffs between debt, dividends,

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CE

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repurchases, and firm-level governance may reveal important cross-country differences.

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Ryngaert, M., Netter, J., 1990. Shareholder wealth effects of the 1986 Ohio antitakeover law revisited: its real effects. Journal of Law, Economics, and Organization 6, 253–262. Servaes, H., Tufano, P., 2005. Survey of corporate financial policies and practices: corporate dividend policy. Working paper. Shleifer, A., Vishny, R., 1997. A survey of corporate governance. Journal of Finance 52, 737– 783. Short, H., Zhang, H., Keasey, K., 2002. The link between dividend policy and institutional ownership. Journal of Corporate Finance 8, 105–122. Smith, C., Watts, R., 1992. The investment opportunity set and corporate financing, dividend, and compensation policies. Journal of Financial Economics 32, 263–292. Stephens, C., Weisbach, M., 1998. Actual share reacquisitions in open-market repurchase programs. Journal of Finance 53, 313–333. Stulz, R., 1990. Managerial discretion and optimal financing policies. Journal of Financial Economics 26, 3–27.

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ACCEPTED MANUSCRIPT Wald, J., Long, M., 2007. The effect of state laws on capital structure. Journal of Financial Economics 83, 297–319. Wintoki, B., Linck, J., Netter, J., 2012. Endogeneity and the dynamics of internal corporate governance. Journal of Financial Economics 105, 581–606.

RI P

T

Yermack, D., 1996. High market valuation of companies with a small board of directors. Journal of Financial Economics 40, 185–211.

AC

CE

PT

ED

MA

NU

SC

Zwiebel, J., 1996. Dynamic capital structure under managerial entrenchment. American Economic Review 86, 1197–1215.

34

ACCEPTED MANUSCRIPT Appendix Sample and variable definitions

RI P

T

The full sample is based on annual Compustat data for 1980–2013, excluding firms incorporated outside the US and firms with total assets under $20 million. The sample with firm-level governance data is based on annual Compustat data for 1996–2008(2013), excluding firms with missing governance (IRRC/RiskMetrics), institutional ownership (Thomson Financial 13f filings), and compensation (Execucomp) data.15

NU

SC

The event study sample is based on CRSP/Compustat data for 1980–2013. Div is the change in quarterly dividend per share (CRSP distribution code 1232), scaled by the previous quarterly dividend. The remaining variables are based on quarterly Compustat data and follow the definitions below. The sample excludes firms incorporated outside the US and firms with total assets under $20 million. Changes that amount to less than five percent of the previous quarter‘s dividend and observations that coincide with announcements of other dividend types or earnings are excluded to minimize noise.

MA

Some sensitivity tests use different sample definitions, as specified. Div/Total is the ratio of cash dividends to the sum of cash dividends, share repurchases, and interest. Source: Compustat.

ED

Div/Commit is the ratio of cash dividends to the sum of cash dividends and interest. Source: Compustat.

PT

Div/Payout is the ratio of cash dividends to the sum of cash dividends and share repurchases. Source: Compustat.

CE

Commitment Type is the categorical variable that assumes ‗Div & Debt‘ (cash dividends and debt present), ‗Debt Only‘ (debt but no dividends), ‗Div Only‘ (dividends but no debt), or ‗None‘ (no debt or dividends). Source: Compustat.

AC

Commitment Type (II) is the categorical variable that assumes ‗Div‘ (cash dividends present), ‗Debt Only‘ (debt but no dividends), or ‗No Commitment‘ (no debt or dividends). Source: Compustat. Payout Type is the categorical variable that assumes ‗Div‘ (cash dividends present), ‗Rep Only‘ (share repurchases but no dividends), or ‗No Payout‘. Payout Type (II) is the categorical variable that assumes ‗Reg Qtrly Div‘ (CRSP ordinary taxable quarterly cash dividends, with distribution code 1232), ‗Rep/Special Div Only‘ (CRSP ordinary taxable cash dividends with distribution codes 1262, 1272, 1292 or share repurchases but no regular dividends), or ‗None/misc.‘ (no dividends or dividends other than quarterly or special, and no share repurchases). Defined only for firms with a CRSP record. Source: Compustat and CRSP.

15

IRRC/RiskMetrics board structure data is available annually starting in 1996. IRRC/RiskMetrics data on firmlevel antitakeover provisions is available to us for 1990–2008, with gap years. However, several of the G index provisions are not reported after 2006. Gap years during the sample period were filled in using the closest year or the average of the two closest years with data on antitakeover provisions. Sensitivity tests that exclude firm-level antitakeover provisions use 1996–2013 and sensitivity tests that include the G index use 1996–2006.

35

ACCEPTED MANUSCRIPT

T

Payout Type (III) is the categorical variable that assumes ‗Reg Qtrly Div‘ (CRSP ordinary taxable quarterly cash dividends, with distribution code 1232), ‗Rep/Other Div Only‘ (CRSP ordinary cash dividends, excluding dividends with distribution code 1232, or share repurchases, are present, but no regular quarterly cash dividends), or ‗No Payout‘ (no dividends or share repurchases). Defined only for firms with a CRSP record. Source: Compustat and CRSP.

RI P

Debt Type is the categorical variable that assumes ‗Short-Term Debt‘, ‗Long-Term Debt Only‘, or ‗No Debt‘. Source: Compustat.

SC

Cash Flow is the ratio of earnings before interest, taxes, and depreciation to total assets, times hundred. Source: Compustat.16 Invest Opp is the ratio of firm market value to the book value of total assets. Source: Compustat.

NU

Firm Size is the log of firm market value. Source: Compustat.

Tangible Assets is the ratio of property, plants, and equipment to total assets. Source: Compustat. Retained Earnings is the ratio of retained earnings to total assets. Source: Compustat.

MA

Share Turnover is the ratio of common shares traded to common shares outstanding. Source: Compustat.

ED

InvTaxCrt&DefTax is the ratio of investment tax credits and deferred taxes to total assets, times hundred. Source: Compustat. CEO Own is the ratio of the number of shares held by the CEO (excluding stock options) to the number of common shares outstanding, times hundred. Source: Execucomp.

PT

CEO Options is the ratio of S&P‘s Black-Scholes value of CEO stock option grants to firm market value, times hundred. Source: Execucomp.

AC

CE

Antitakeover Laws Index adds one for each antitakeover law (business combination, fair price, control share acquisition, poison pill, and director‘s duties) in effect in the state of the firm‘s incorporation (starting with the year after passage). Antitakeover Laws Index (II) adds one for each of the following antitakeover laws: business combination, fair price, and control share acquisition. Lobbying and motivating firms are excluded. Source: Karpoff and Wittry (2014). Gov Index (Brd&Inst) is the average of annual firm rankings based on the largest institutional holding (Thomson Financial 13f filings; higher values earn higher rankings); proportion of independent directors on the board (IRRC/RiskMetrics; higher values earn higher rankings); and number of directors on the board (IRRC/RiskMetrics; lower values earn higher rankings). The rankings are rescaled to [0,1]. Higher values reflect stronger governance. Gov Index (E) is (6 – E)/6, where E is the Bebchuk, Cohen, and Ferrell (2005) index that assigns 1 for each of the following provisions: classified board, limits to amend bylaws, limits to amend charter, supermajority requirement to approve merger, poison pill, golden parachute. Higher values reflect stronger governance. Source: IRRC/RiskMetrics. Gov Index (G) is (24 – G)/24, where G is the Gompers-Ishii-Metrick (2003) index based on the sum of twenty-four antitakeover provisions in firm charters and state laws. Higher values reflect stronger governance. Source: IRRC/RiskMetrics; Gompers, Ishii, and Metrick (2003). 16

In event study tests, operating income before depreciation is used instead due to differences in data items between annual and quarterly Compustat data.

36

ACCEPTED MANUSCRIPT Indep Dir is the proportion of independent directors on the board. Source: IRRC/RiskMetrics. Board Size is the log of the number of directors on the board. Source: IRRC/RiskMetrics.

T

Largest Instit is the ownership stake of the firm‘s largest institutional shareholder. Source: Thomson Financial 13f filings.

RI P

No Classified Board is an indicator variable equal to 1 if the firm does not have a classified board, and 0 otherwise. Source: IRRC/RiskMetrics. CEO Pay Slice is the fraction of the aggregate compensation of the top-five executive team captured by the CEO, constructed following Bebchuk, Cremers, and Peyer (2011). Source: Execucomp.

AC

CE

PT

ED

MA

NU

SC

CEO Age ≥ 65 is an indicator variable equal to 1 if the CEO is of age 65 or older, and 0 otherwise. Source: Execucomp.

37

ACCEPTED MANUSCRIPT Table 1 Summary statistics of the main variables Observations

Mean

Median

Div/Total

123940

0.22

0.00

0.31

Div/Commit

120031

0.28

0.00

0.36

Div/Payout

81834

0.58

0.75

0.43

Cash Flow

142401

8.01

Invest Opp

142401

1.74

Firm Size

142401

6.22

Antitakeover Laws Index

142401

Share Turnover

115241

Retained Earnings

115241

Analyst Coverage

RI P

T

Full sample

Std. Dev.

15.97

1.24

1.69

6.04

1.86

2.31

2.00

1.39

1.35

0.83

1.46

-0.20

0.07

1.82

115241

0.08

0.00

0.38

Tangible Assets

115241

0.23

0.15

0.24

Antitakeover Laws Index (II)

142401

1.27

1.00

0.90

15325

0.23

0.14

0.27

14677

0.36

0.30

0.35

12788

0.46

0.38

0.41

16218

13.21

12.96

10.30

16218

1.95

1.50

1.44

16218

8.17

8.05

1.53

16074

2.15

1.66

1.62

16074

0.20

0.24

0.66

16074

0.19

0.00

0.63

16074

0.27

0.20

0.23

16218

0.57

0.50

0.23

Gov Index (Brd&Inst)

16218

0.47

0.48

0.18

CEO Own

16218

2.19

0.32

5.34

CEO Options

16218

0.05

0.01

0.11

Gov Index (G)

11126

0.61

0.63

0.11

Indep Dir

16218

0.41

0.56

0.38

Board Size [number]

16218

9.47

9.00

2.74

Board Size

16218

2.21

2.20

0.28

Largest Instit

16218

0.09

0.09

0.05

CEO Pay Slice

16076

0.38

0.38

0.12

CEO Age ≥ 65

15583

0.09

0.00

0.29

NU

MA

Firm-level governance sample Div/Total

ED

Div/Commit Div/Payout Cash Flow

PT

Invest Opp Firm Size Retained Earnings Analyst Coverage Gov Index (E)

AC

Tangible Assets

CE

Share Turnover

SC

9.68

38

ACCEPTED MANUSCRIPT Table 2 The tradeoff between dividend and debt commitments

[10.58] [20.16] Invest Opp

-0.011

[21.69] ***

[-3.29] Firm Size

0.061

0.20

***

0.038

[1.72] ***

[20.63] -0.320

[28.39]

***

[-4.57] ***

[-15.26] 0.367

-0.015 -0.452

***

[-18.56] ***

0.529

***

[19.78]

120031

142401

142401

0.21

0.21

0.21

AC

CE

PT

ED

Pseudo-R

0.080

[21.22]

123940

2

-0.003

[-0.89] ***

[21.30] Observations

0.012

NU

0.009

[11.81]

***

MA

Cash Flow

[11.04] ***

SC

RI P

T

This table examines the relation between antitakeover provisions and the debt-dividend tradeoff. The sample and variables are defined in the Appendix. Tobit with censoring at 0 and at 1 is used in columns I-II. Multinomial logit is used in other columns. Fama-French industry effects and year effects are included. Robust z-statistics with clustering by firm are in the brackets. Significance at 1%, 5%, and 10% level is denoted with ***, **, and *, respectively. I II III IV Commitment Type: Commitment Type: Div/Total Div/Commit Div & Debt vs. Div & Debt vs. Variable Debt Only Div Only *** *** *** Antitakeover Laws Index 0.047 0.064 0.196 0.068 *

39

ACCEPTED MANUSCRIPT Table 3 Structure of payout to shareholders

SC

RI P

T

This table examines the relation between antitakeover protection and the structure of payout to shareholders. The sample and variables are defined in the Appendix. Tobit with censoring at 0 and 1 is used in column I. Multinomial logit is used in other columns. Fama-French industry effects and year effects are included. Robust z-statistics with clustering by firm are in the brackets. Significance at 1%, 5%, and 10% level is denoted with ***, **, and *, respectively. I II III Payout Type (II) Payout Type: Div/Payout Reg Qtrly Div vs. Div vs. Rep Only Variable Rep/Special Div Only Antitakeover Laws Index 0.058 *** 0.208 *** 0.208 *** [7.79] 0.002 [2.61] Invest Opp

-0.019

0.021

NU

Cash Flow

[10.24]

***

[11.24]

***

MA

[-2.91] Firm Size

0.053

Observations

[20.65] ***

[-8.52] 0.297

-0.379

***

[-12.88] ***

0.496

[20.81]

[28.47]

81834

142401

134917

0.19

0.22

0.10

***

***

AC

CE

PT

Pseudo-R

***

-0.157

0.052

[10.21]

ED

2

[9.15] ***

40

ACCEPTED MANUSCRIPT

Table 4 Sensitivity tests: additional controls

AC

CE

PT

ED

MA NU S

CR

IP

T

This table introduces additional controls. The sample and variables are defined in the Appendix. Panel A presents the results with additional controls. Panel B presents the results with state of incorporation fixed effects. Tobit with censoring at 0 and 1 is used in columns I, II, and V of Panels A and B. Multinomial logit is used in other columns. Fama-French industry effects and year effects are included. Robust z-statistics with clustering by firm are in the brackets. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. Panel A: Additional controls I II III IV V VI VII Payout Type (II): Commitment Type: Commitment Type: Payout Type: Reg Qtrly Div Div/Total Div/Commit Div & Debt Div & Debt Div/Payout Div vs. Rep vs. Rep/Special Variable vs. Debt Only vs. Div Only Only Div Only Antitakeover Laws Index 0.046 *** 0.064 *** 0.159 *** 0.089 ** 0.061 *** 0.179 *** 0.141 *** [9.96] [10.34] [9.47] [2.34] [7.74] [8.56] [5.78] Cash Flow 0.005 *** 0.008 *** 0.019 *** -0.011 ** -0.001 * 0.005 ** 0.018 *** [6.73] [7.32] [9.02] [-2.48] [-1.68] [2.39] [5.23] Invest Opp 0.007 ** 0.018 *** -0.171 *** -0.367 *** 0.003 -0.030 * -0.292 *** [2.18] [4.11] [-8.44] [-15.89] [0.43] [-1.77] [-8.43] *** *** *** *** *** *** Firm Size 0.076 0.102 0.439 0.581 0.071 0.356 0.562 *** [22.23] [21.54] [30.55] [19.19] [12.28] [21.76] [26.79] *** *** *** *** *** Share Turnover -0.097 -0.123 -0.368 -0.059 -0.124 -0.366 -0.360 *** [-22.79] [-21.55] [-21.42] [-1.44] [-16.10] [-20.96] [-15.31] *** *** *** *** ** *** Retained Earnings 0.103 0.147 0.623 -1.067 0.036 0.650 3.010 *** [3.85] [3.88] [6.71] [-4.09] [2.18] [7.00] [21.27] Analyst Coverage 0.001 0.013 -0.020 -0.005 -0.031 -0.096 -0.033 [0.11] [0.78] [-0.34] [-0.04] [-1.31] [-1.49] [-0.45] Tangible Assets -0.027 -0.115 *** 0.419 *** 2.826 *** 0.426 *** 0.776 *** 0.836 *** [-0.90] [-3.01] [3.29] [8.37] [7.00] [5.46] [4.39] Observations 98874 95092 115241 115241 62832 115241 109029 Pseudo-R2 0.23 0.25 0.23 0.23 0.10 0.21 0.28

41

ACCEPTED MANUSCRIPT

II

III

IV

Variable

Div/Total

Div/Commit

Commitment Type: Div & Debt vs. Debt Only

Commitment Type: Div & Debt vs. Div Only

Antitakeover Laws Index

0.010

[19.29] -0.008 0.064 [22.31] Observations 2

Pseudo-R

0.037

[20.91] ***

[-2.60] Firm Size

0.011 -0.001

-0.306 0.379

[22.31]

[29.01]

123940

120031

0.21

0.22

IP

-0.446 0.528

[19.39]

***

0.001 -0.017 0.058 [11.19]

0.074

**

0.020

[2.31] ***

[10.45] ***

[-2.59] ***

Payout Type: Div vs. Rep Only

[2.16] *

[1.81] ***

[-18.40]

***

0.030 [2.70]

[-5.02]

***

[-14.74] ***

0.083

-0.016

***

[2.81]

***

[19.87]

[-0.16] ***

***

0.145

Div/Payout

-0.146 0.311

0.050

***

[20.07] ***

[-8.01] ***

VII Payout Type (II): Reg Qtrly Div vs. Rep/Special Div Only 0.077 **

-0.366

***

[-12.43] ***

[21.41]

0.513

***

[29.06]

142401

142401

81834

142401

134917

0.22

0.22

0.10

0.20

0.23

PT

Invest Opp

[4.11] ***

ED

0.008

[3.04] ***

***

VI

CE

Cash Flow

0.102

MA NU S

[1.98]

***

0.020

CR

**

V

T

I

AC

Panel B: State fixed effects

42

ACCEPTED MANUSCRIPT

Table 5 Sensitivity tests: additional measures and definitions

[2.58] Cash Flow

0.050

***

Invest Opp

-0.368

***

***

PT

[-12.51]

ED

[20.13]

Firm Size

0.510

2

Pseudo-R

[5.17] -0.009

[11.54] ***

[-6.85] -0.050

[5.00]

***

[22.31] ***

[-3.45] 0.061

0.038 -0.200

***

[-11.32] ***

0.320

***

[25.75]

134917

142398

142401

0.23

0.13

0.21

AC

Observations

CE

[29.15]

MA NU S

CR

IP

T

This table introduces additional dependent variables, additional measures of the variable of interest, and alternate sample definitions. The sample and variables are defined in the Appendix. Panel A uses alternative dependent variables. Panel B uses an alternative index of antitakeover provisions. Panel C excludes financial firms (SIC codes 6000-6999) and utilities (SIC codes 4900-4999). Tobit with censoring at 0 and 1 is used in columns I, II, and V of Panels B and C. Multinomial logit is used in other columns. Fama-French industry effects and year effects are included. Robust z-statistics with clustering by firm are in the brackets. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. Panel A: Alternative dependent variables I II III Payout Type (III): Debt Type: Commitment Type (II): Reg Qtrly Div Short-Term Debt vs. Div vs. Debt Only vs. Rep/Other Div Only Long-Term Debt Only *** *** Antitakeover Laws Index 0.085 0.094 0.189 ***

43

ACCEPTED MANUSCRIPT

II

III

IV

Div/Total

Div/Commit

Commitment Type: Div & Debt vs. Debt Only

Commitment Type: Div & Debt vs. Div Only

[10.67] 0.009

[11.10] ***

[20.16] Invest Opp

-0.011 0.061 [21.45]

Observations 2

Pseudo-R

[11.13] ***

0.012

0.038

[21.71] ***

[-3.29] Firm Size

0.271

[20.60]

-0.004

-0.321

[-0.90] ***

[-15.25] ***

0.080 120031

0.20

0.21

IP

-0.015 -0.454

0.21

***

[7.88] ***

[-4.56]

***

0.002 -0.019 0.053 [10.28]

0.300

***

0.021 -0.158 0.297

0.297

***

0.052

***

[20.62] ***

[-8.53] ***

Payout Type (II): Reg Qtrly Div vs. Rep/Special Div Only

[8.76] ***

[11.18] ***

[-2.93] ***

Payout Type: Div vs. Rep Only

[9.90] **

[2.56] ***

[-18.52] [19.76]

142401

0.086

[1.09]

***

0.528

[28.48]

123940

0.061

***

0.367

[21.39]

***

Div/Payout

VII

-0.381

***

[-12.88] ***

[20.88]

0.497

***

[28.49]

142401

81834

142401

134917

0.21

0.10

0.19

0.22

CE

Cash Flow

***

0.094

CR

***

ED

0.070

VI

AC

Antitakeover Laws Index (II)

MA NU S

Variable

V

T

I

PT

Panel B: Alternative governance definitions

44

ACCEPTED MANUSCRIPT

II

III

IV

Div/Total

Div/Commit

Commitment Type: Div & Debt vs. Debt Only

Commitment Type: Div & Debt vs. Div Only 0.044

***

[8.49]

[8.59] ***

[18.81] Invest Opp

-0.008 0.073

Observations 2

Pseudo-R

0.013

0.033

-0.002 0.094

[22.63]

[23.60]

100544

97290

0.16

0.15

IP

[0.93]

***

[16.61] -0.327

[-0.43] ***

***

[8.99] ***

[20.61] **

[-2.45] Firm Size

0.202

0.516

-0.020 -0.480 0.627

***

0.003 -0.017 0.074

0.208

***

0.020 -0.143 0.365

0.056

***

[20.56] ***

[-7.23] ***

Payout Type (II): Reg Qtrly Div vs. Rep/Special Div Only 0.242 *** [7.88]

***

[10.04] **

[-2.18] ***

Payout Type: Div vs. Rep Only

[8.23] ***

[3.17] ***

[-19.18]

***

0.068 [6.28]

***

[-5.46]

***

[-15.12] ***

-0.411

***

[-12.40] ***

0.550

[31.51]

[19.01]

[11.01]

[21.00]

[25.10]

106730

106730

61769

106730

101962

0.21

0.21

0.10

0.18

0.21

ED

0.009

***

Div/Payout

VII

***

CE

Cash Flow

0.060

PT

0.049

VI

AC

Antitakeover Laws Index

CR

Variable

V

T

I

MA NU S

Panel C: Alternative sample definitions

45

ACCEPTED MANUSCRIPT Table 6 Market reaction to dividend announcements

I

Antitakeover Laws Index

-0.209

II *

-0.191

[-1.91]

Div

0.018

III **

[-2.06] ***

[3.73]

0.019

-0.242

IV

*

[-1.80] ***

[4.37]

0.023

0.209 0.108

[-1.02]

[-1.91]

4129

4129

4129

4129

0.02

0.02

0.03

0.03

0.02

[0,+1]

[-2,+2]

[-1,+1]

[0,+1]

[-2,+2]

I

II

III

IV

V

VI

-0.049

-0.045

-0.034

-0.055

-0.051

-0.043

MA

[-1.15]

PT

[-1,+1]

4129

ED

4129

Variable

CE

[-1.28] 0.004

0.004 [4.35]

[-0.67] ***

0.005 [3.77]

AC

[3.56]

[-1.31]

***

[-1.46] ***

0.003

[-1.50] ***

0.005

[3.98]

[3.40]

-0.003

0.007

8.E-05

-0.063

[0.40] ***

-0.056

*

*

[-0.86] ***

[3.20] [-0.14]

Invest Opp

0.004

***

[3.74] ***

[1.87]

CAR - increases

Adjusted R2

0.110

***

[3.95] ***

[3.72] **

0.023

-0.292

0.02

Observations

0.140

*

[-1.72] ***

[2.62]

Adjusted R

Firm Size

0.019

-0.230

-0.107

2

Cash Flow

[-1.96] [4.46]

***

[3.43] 0.120

-0.181

VI **

[2.54]

Observations

Div

0.154

V

-0.141

Invest Opp

Antitakeover Laws Index

0.019

***

[3.82]

NU

Firm Size

*

[-1.83]

***

[3.87]

Cash Flow

-0.198

SC

Variable

RI P

T

This table reports regressions of dividend announcement returns. The dependent variable is cumulative abnormal return (CAR) around the dividend announcement in percentage terms, where the market model is used to predict normal return. The sample and variables are defined in the Appendix. Ordinary least squares regressions of CAR are performed. Fama-French industry effects and year effects are included. Robust t-statistics with clustering by firm are in the brackets. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. [-1,+1] [0,+1] [-2,+2] [-1,+1] [0,+1] [-2,+2] CAR - decreases

***

[0.00] ***

-0.084

[-4.01]

[-4.16]

[-4.17]

-0.019

-0.055

-0.041

[-0.36]

[-1.28]

[-0.60]

16513

16513

16513

16513

16513

16513

0.01

0.01

0.01

0.01

0.01

0.01

***

46

ACCEPTED MANUSCRIPT

Table 7 Firm-level governance

[-8.65] -0.012

-0.022 [-0.43] ***

Invest Opp

[7.08]

0.001

0.020

[0.18] Firm Size

0.017 0.003

Observations 2

Pseudo-R

-0.725

0.030 0.004

*

[1.66] ***

-0.876

***

[-4.74]

***

[3.16] *

[1.70] CEO Options

-0.281

***

0.409

-0.015

0.875 -0.037

[-0.54]

[-2.74] ***

[-4.81]

-0.053

-0.353

-0.373

[-1.43]

[-1.42]

0.003

0.022

***

[-5.98] ***

***

[8.63]

-0.006

[-6.37]

-0.010

[-1.26] -0.585

[-5.52] [-0.91]

[-7.28] ***

[9.67]

-2.779

-1.461

***

[-2.61]

***

[5.62]

*

[1.79] **

[2.56] CEO Own

0.031

PT

[3.67]

0.010

[-2.08] ***

CE

0.003

-0.461

[-0.05]

**

ED

[-0.34] Cash Flow

[-6.66]

AC

Gov Index (E)

[-8.63]

MA NU S

CR

IP

T

This table presents the results of firm-level governance tests. Sample and variable definitions are summarized in the Appendix. Tobit with censoring at zero and at one is used in columns I, II, and V. Multinomial Logit is used in the remaining columns. Fama-French industry effects and year effects are included. Robust zstatistics with clustering by firm are in the brackets. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. I II III IV V VI VII Commitment Payout Type (II): Commitment Type: Type: Payout Type: Reg Qtrly Div Variable Div/Total Div/Commit Div & Debt Div/Payout Div & Debt Div vs. Rep Only vs. Rep/Special vs. Debt Only vs. Div Only Div Only *** *** *** *** *** Gov Index (Brd&Inst) -0.423 -0.635 -2.117 -0.030 -0.451 -2.234 -1.741 ***

***

[0.46]

-0.004

-0.128

[-0.31]

[-2.68]

[3.23] ***

-0.247

0.330

[0.97]

[7.19]

[7.78]

0.003

0.009

4.E-04

0.302

-1.266

[0.80] ***

-3.402

***

[-4.41] ***

0.010

[1.35]

***

0.378

***

[0.04] ***

-3.860

[-9.06]

[-7.47]

[-6.40]

[0.33]

[-9.62]

[-7.98]

[-7.92]

15325

14677

16218

16218

12788

16218

16218

0.25

0.20

0.27

0.27

0.15

0.22

0.24

***

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Table 8 Firm-level governance (sensitivity tests)

-0.011

-9.E-05 [0.00] ***

[4.85] Invest Opp

[8.05]

-0.003

0.016

[-0.35] Firm Size

0.024 0.004

[3.43] *

[1.94] CEO Options Observations 2

Pseudo-R

-0.676

0.038

***

0.005

*

[1.67] ***

-0.796

[6.14]

[-1.15]

0.038

***

***

[-5.33] 0.461 [9.18]

-0.015 -0.658 0.969 -0.046 [-3.33]

***

[-5.87]

-0.089

-0.470

[-1.26] -0.009

***

***

[-4.14] *

[-1.72] ***

[-4.84] ***

[8.91]

-0.011 -2.878

[-5.25] **

[-7.89] ***

[-0.95] ***

-1.339

[-2.34]

-0.333

[1.31] ***

[3.08] CEO Own

0.013

[-0.09]

**

[-2.46] ***

CE

0.005

-0.642

PT

[-0.27] Cash Flow

[-5.95]

AC

Gov Index (E)

[-6.90]

ED

[-7.15]

MA NU S

CR

IP

T

This table presents the results of sensitivity tests with firm-level governance variables. Sample and variable definitions are summarized in the Appendix. Panel A presents the results of estimation after excluding financial firms (SIC codes 6000-6999) and utilities (SIC codes 4900-4999). Panel B introduces additional control variables. Panel C uses alternative dependent variables. Tobit with censoring at zero and at one is used in columns I, II, and V of Panels A–C. Multinomial Logit is used in the remaining columns. Fama-French industry effects and year effects are included. Robust z-statistics with clustering by firm are in the brackets. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. Panel A: Additional I II III IV V VI VII sample criteria Commitment Payout Type (II): Commitment Type: Type: Payout Type: Reg Qtrly Div Variable Div/Total Div/Commit Div & Debt Div/Payout Div & Debt vs. Div vs. Rep Only vs. Rep/Special vs. Debt Only Div Only Div Only Gov Index (Brd&Inst) -0.396 *** -0.566 *** -2.149 *** -0.060 -0.515 *** -2.232 *** -1.617 ***

0.012 -0.147

[-0.83]

[-2.89]

0.032 -0.241

[1.37]

[6.38]

[7.04]

0.004

0.007

0.003

0.136

-1.281

[0.58] -3.405

***

[-4.20] ***

0.323

***

***

[4.40] ***

0.017

[1.26]

**

[-2.29] *

[1.76]

-0.012

-0.647

0.373

***

[0.29] ***

-3.677

[-8.28]

[-6.68]

[-6.65]

[0.15]

[-9.17]

[-7.95]

[-7.69]

12744

12134

13143

13143

10332

13143

13143

0.20

0.15

0.27

0.27

0.13

0.20

0.20

***

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Invest Opp Firm Size Share Turnover Retained Earnings Analyst Coverage Tangible Assets InvTaxCrt&DefTax CEO Own CEO Options Observations Pseudo-R2

Div/Commit

Commitment Type: Div & Debt vs. Debt Only

Commitment Type: Div & Debt vs. Div Only

***

**

**

***

***

***

-0.305 [-4.74] 0.019 [0.43] 0.002 [1.13] 0.036 [3.35] 0.043 [5.17] -0.093 [-10.98] 0.649 [12.34] -0.018 [-1.01] -0.118 [-1.70] -0.001 [-0.44] 4.E-04 [0.16] -0.450 [-4.15] 12617 0.26

***

***

***

***

***

-1.459 [-4.04] -0.554 [-2.16] 0.004 [0.63] -0.231 [-3.26] 0.520 [10.59] -0.420 [-10.26] 1.801 [7.13] 0.016 [0.90] -0.135 [-1.54] 0.063 [0.16] -0.017 [-1.53] -1.890 [-4.37] 13578 0.33

***

*

***

***

**

IP

CR

-0.220 [-4.72] 0.019 [0.56] -0.002 [-2.31] 0.016 [2.15] 0.024 [3.92 -0.070 [-11.54] 0.383 [10.93] -0.011 [-0.92] -0.016 [-0.29] 0.002 [0.93] 0.001 [0.63] -0.445 [-5.97] 13192 0.32

***

***

***

***

***

V

T

Div/Total

0.248 [0.35] -1.689 [-3.04] 0.008 [0.53] -0.561 [-5.50] 0.829 [7.11] -0.188 [-2.40] -2.768 [-5.14] 0.049 [0.27] 2.232 [2.61] -4.E-04 [-0.01] -0.022 [-1.73] -0.066 [-0.08] 13578 0.33

MA NU S

Cash Flow

IV

ED

Gov Index (E)

III

PT

Gov Index (Brd&Inst)

II

CE

Variable

I

AC

Panel B: Additional controls

***

***

***

**

***

***

*

VI

Div/Payout -0.317 [-3.92] -0.047 [-0.84] -0.014 [-8.01] 0.014 [1.09] 0.013 [1.34] -0.096 [-9.21] 0.165 [3.70] -0.020 [-0.93] 0.357 [3.76]

0.001 [0.41] -1.030 [-8.05] 12658 0.17

***

***

***

***

***

***

Payout Type: Div vs. Rep Only -1.627 [-4.47] -0.337 [-1.36] -0.022 [-3.19] -0.071 [-1.39] 0.384 [8.17] -0.382 [-10.18] 1.937 [7.74] -0.133 [-1.45] 0.756 [1.90]

-0.004 [-0.38] -2.401 [-5.79] 16074 0.27

***

***

***

***

***

*

***

VII Payout Type (II): Reg Qtrly Div vs. Rep/Special Div Only -1.094 *** [-2.85] -0.447 * [-1.65] -0.005 [-0.61] -0.241 *** [-3.65] 0.466 *** [9.11] -0.381 *** [-9.05] 2.470 *** [8.79] -0.078 [-0.79] 0.701 * [1.66]

-0.010 [-0.94] -2.838 [-5.97] 16074 0.29

***

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Gov Index (Brd&Inst)

II Debt Type: Short-Term Debt vs. Long-Term Debt Only -0.988 ***

T

I Payout Type (III): Reg Qtrly Div vs. Rep/Other Div Only -1.681 ***

IP

Panel C: Alternative dependent variables

-0.386 [-1.48]

Cash Flow

0.022

***

[3.30] Invest Opp

-0.249

***

[-4.44] 0.381 [7.88] CEO Own

-1.5E-04

CEO Options

PT

[-0.01] -3.823

Pseudo-R

***

-2.118 [-6.84]

-0.056

-0.304

[-0.20]

[-1.40]

-0.003

0.029

[-0.59] -0.209 [-4.24] 0.301

***

-0.136

***

[-2.79] ***

[6.45] 0.023

***

[5.50] ***

0.314

***

[7.72] **

0.006

[2.02]

[0.55]

0.391

-2.916

[1.22]

[-6.97]

16218

16218

16218

0.24

0.23

0.24

AC

2

CE

[-7.85]

Observations

ED

Firm Size

***

MA NU S

Gov Index (E)

Commitment Type (II): Div vs. Debt Only

[-2.83]

CR

[-4.67]

III

***

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Table 9 Firm-level governance (additional sensitivity tests)

AC

CE

PT

ED

MA NU S

CR

IP

T

This table presents the results of additional sensitivity tests with firm-level governance variables. Sample and variable definitions are summarized in the Appendix. Panel A uses alternative governance measures and the 1996–2013 sample period. Panel B uses the G index as an alternative governance measure and the 1996-2006 sample period. Panel C uses the main sample but replaces the governance index with individual governance variables. Tobit estimation with censoring at zero and at one is performed in columns I, II, and V of Panels A–C. Multinomial Logit estimation is performed in the remaining columns. FamaFrench industry effects and year effects are included. Robust z-statistics with clustering by firm are in the brackets. ***, **, and * denote significance at the 1%, 5%, and 10% levels, respectively. Panel A: Alternative governance I II III IV V VI VII measures Payout Type (II): Commitment Type: Commitment Type: Payout Type: Div/Commi Reg Qtrly Div Div/Total Div & Debt Div & Debt Div/Payout Div vs. Rep t vs. Rep/Special vs. Debt Only vs. Div Only Only Variable Div Only Gov Index (Brd&Inst) -0.426 *** -0.606 *** -1.681 *** 0.216 -0.450 *** -1.918 *** -1.458 *** [-8.53] [-8.46] [-6.04] [0.41] [-5.59] [-6.47] [-4.75] *** *** *** *** *** Antitakeover Laws Index 0.027 0.041 0.151 0.033 0.041 0.168 0.135 *** [3.94] [4.27] [3.63] [0.42] [3.58] [3.59] [2.86] No Classified Board -0.007 -0.010 -0.071 -0.166 0.004 -0.049 -0.066 [-0.42] [-0.45] [-0.77] [-0.89] [0.14] [-0.50] [-0.65] Cash Flow 0.005 *** 0.012 *** 0.036 *** -0.019 ** -0.007 *** 0.010 * 0.027 *** [5.70] [8.76] [7.26] [-2.05] [-4.50] [1.84] [4.65] *** *** *** Invest Opp -0.002 0.011 -0.291 -0.573 -0.007 -0.133 -0.238 *** [-0.31] [1.16] [-6.01] [-9.41] [-0.51] [-3.34] [-5.18] *** *** *** *** * *** Firm Size 0.024 0.046 0.438 0.907 0.018 0.347 0.402 *** [3.61] [4.92] [11.87] [11.40] [1.74] [8.88] [9.78] * * *** CEO Own 0.003 0.004 -0.004 -0.035 0.003 0.010 -0.005 [1.71] [1.81] [-0.51] [-3.11] [1.34] [1.14] [-0.50] CEO Options -0.767 *** -0.864 *** -2.486 *** 0.669 -1.351 *** -3.156 *** -3.479 *** [-9.36] [-7.34] [-6.22] [0.79] [-10.39] [-8.23] [-7.84] Observations 23115 22061 24332 24332 19028 24332 24332 2 Pseudo-R 0.22 0.20 0.26 0.26 0.14 0.20 0.22

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***

-0.323 0.005 -0.002 0.013 0.003 -0.709 [-8.32]

Observations 2

Pseudo-R

10330 0.26

0.012

0.040

0.019 [1.93]

*

0.005 [1.96]

***

*

0.380

-0.831

***

[8.05]

T

-0.011 -0.591 0.831 -0.048

[-0.46]

[-3.59] ***

-0.549 -0.011

***

[-5.49] ***

***

***

VII

Payout Type: Div vs. Rep Only -2.180

***

[-5.62] ***

[-3.73]

[6.93]

-0.005 -2.951

-2.441

***

[-4.69] *

[-6.52] ***

VI

Div/Payout -0.430

[-0.73]

***

[-4.81]

*

-0.397

[-1.89]

***

[5.64] -0.332

V

[-0.51]

***

[-5.48] ***

[1.17] *

[1.72] CEO Options

-3.021

0.013

[1.90] CEO Own

-0.518

***

[-6.28] ***

[6.71]

[-0.23] Firm Size

-2.175

[-4.37] ***

[4.24] Invest Opp

***

[-8.08] ***

[-3.81] Cash Flow

-0.609

ED

Gov Index (G)

Commitment Type: Div & Debt vs. Div Only

MA NU S

[-8.28]

Div/Commit

Commitment Type: Div & Debt vs. Debt Only

PT

-0.433

IV

CE

Variable Gov Index (Brd&Inst)

III

IP

Div/Total

II

CR

I

-3.493

Payout Type (II): Reg Qtrly Div vs. Rep/Special Div Only -1.690 *** [-4.08]

***

-3.085

[-5.40]

[-4.75]

0.003

0.026

[0.45]

0.000

-0.128

[0.01]

[-2.29]

-0.279

0.288

[0.76]

[5.49]

[6.50]

0.003

0.015

0.005

0.435

-1.271

[1.24] ***

-3.455

***

***

[-4.04] ***

0.009

[0.97]

***

[3.07] **

0.364

***

[0.40] ***

-3.936

[-6.87]

[-6.52]

[0.43]

[-9.02]

[-7.71]

[-7.45]

9916

11126

11126

8453

11126

11126

0.20

0.30

0.30

0.15

0.25

0.26

AC

Panel B: Alternative governance measures (G index)

***

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CEO Age ≥ 65 Gov Index (E) Cash Flow Invest Opp Firm Size CEO Own CEO Options Observations Pseudo-R2

Commitment Type: Div & Debt vs. Div Only

***

**

***

*

***

0.007 [0.14] 0.365 [6.51] -0.746 [-3.10] 0.182 [2.40] 0.046 [1.41] 0.021 [0.40] 0.010 [6.72] 0.029 [2.52] 0.016 [1.56] 0.006 [2.23] -0.945 [-7.28] 14099 0.21

**

***

***

***

**

-0.089 [-0.42] 1.371 [5.88] -2.266 [-3.23] 1.134 [3.34] 0.282 [1.97] -0.288 [-1.28] 0.031 [5.53] -0.241 [-4.13] 0.347 [7.58] 3.3E-04 [0.03] -3.200 [-6.70] 15583 0.27

***

**

**

***

V

IP

CR

-0.022 [-0.66] 0.244 [6.55] -0.429 [-2.30] 0.163 [3.20] 0.040 [1.81] 0.016 [0.43] 0.003 [3.35] 0.007 [0.99] 0.007 [1.03] 0.004 [2.26] -0.797 [-8.90] 14717 0.25

1.032 [1.03] 1.365 [1.37] -0.813 [-0.81] 0.915 [0.92] 0.104 [0.10] -1.245 [-1.25] -0.015 [-0.01] -0.546 [-0.55] 0.744 [0.74] -0.031 [-0.03] -0.002 [0.00] 15583 0.27

MA NU S

CEO Pay Slice

Div/Commit

Commitment Type: Div & Debt vs. Debt Only

ED

Largest Instit

IV

AC

Board Size

III

***

***

***

**

PT

Div/Total Variable Indep Dir

II

VI

VII

T

I

CE

Panel C: Alternative governance measures (components and additional measures)

***

***

***

***

***

***

**

***

***

**

Div/Payout -0.105 [-1.91] 0.279 [4.59] -0.373 [-1.44] 0.290 [3.16] 0.120 [3.18] -0.020 [-0.34] -0.010 [-5.78] 0.004 [0.27] -0.001 [-0.08] 0.004 [1.36] -1.387 [-9.61] 12298 0.16

*

***

***

***

***

***

Payout Type: Div vs. Rep Only -0.084 [-0.39] 1.373 [5.33] -2.513 [-3.01] 0.962 [2.58] 0.420 [2.56] -0.154 [-0.62] 0.003 [0.51] -0.098 [-2.07] 0.274 [5.49] 0.014 [1.18] -3.762 [-7.97] 15583 0.22

***

***

***

**

**

***

***

Payout Type (II): Reg Qtrly Div vs. Rep/Special Div Only -0.270 [-1.24] 1.429 *** [5.39] -2.127 ** [-2.19] 1.649 *** [4.22] 0.277 * [1.67] -0.158 [-0.60] 0.021 *** [2.99] -0.203 *** [-3.69] 0.293 *** [5.65] 0.008 [0.64] -4.748 *** [-8.66] 15583 0.25

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Highlights

CE

PT

ED

MA

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SC

RI P

T

We examine payout and debt commitments in the context of corporate governance. Weakly governed firms precommit through dividends and debt or dividends alone. They are less likely to precommit through debt alone. Weakly governed firms shift the structure of their payout towards regular quarterly dividends.

AC

   

54