Corporate Governance and Dividend Policy

in Emerging Markets

Todd Mitton*

Marriott School
Brigham Young University

May 2004

Abstract

In a sample of 365 firms from 19 countries, I show that firms with stronger corporate
governance have higher dividend payouts, consistent with agency models of dividends. In
addition, the negative relationship between dividend payouts and growth opportunities is
stronger among firms with better governance. I also show that firms with stronger
governance are more profitable, but that greater profitability explains only part of the higher
dividend payouts. The positive relationship between corporate governance and dividend
payouts is limited primarily to countries with strong investor protection, suggesting that
firm-level corporate governance and country-level investor protection are complements
rather than substitutes.

JEL Classification: G35, G34

Keywords: Dividend policy, corporate governance, emerging markets

*
I appreciate the helpful comments of Jim Brau, Simon Johnson, Mike Lemmon, Grant McQueen, Sendhil
Mullainathan, Mike Pinegar, David Scharfstein, and Jeremy Stein on earlier versions of the paper. All errors
are mine. Todd Mitton, BYU Marriott School, 684 TNRB, Provo, UT 84602, Phone: (801) 422-1763, E-mail:
todd.mitton@byu.edu.
 Corporate Governance and Dividend Policy
in Emerging Markets

1. Introduction

In the United States, the debate surrounding dividend policy has traditionally

centered on the question of why firms pay dividends, given that the tax disadvantage of

dividends appears to be large. But in countries where investor protection is weak, a more

fundamental question regarding dividend policy might be more relevant: How can

shareholders hope to extract dividends from firms, given that the legal environment of the

country and the governance mechanisms of individual firms offer investors relatively few

protections? Agency theory suggests that outside shareholders have a preference for

dividends over retained earnings because insiders might squander cash retained within the

firm (see, e.g., Easterbrook, 1984, Jensen 1986, Myers 2000). This preference for dividends

may be even stronger in emerging markets with weak investor protection if shareholders

perceive a greater risk of expropriation by insiders in such countries.1 La Porta, Lopez-de-

Silanes, Shleifer, and Vishny (LLSV, 2000) show that dividend payouts are higher, on

average, in countries with stronger legal protection of minority shareholders. This finding

lends support to what LLSV (2000) call the “outcome” agency model of dividends, which

hypothesizes that dividends result from minority shareholders using their power to extract

dividends from the firm.

If protection of minority shareholders does have a positive impact on dividend

payouts, then shareholder protection should help explain not just country-level differences in

dividend payouts, but also firm-level differences in dividend payouts within countries.

1
In a recent paper, Brav, Graham, Harvey, and Michaely (2003) find limited evidence for the agency theory of
dividends in the U.S., at least from the perspective of corporate executives.

2
Indeed, while country-level investor protection is an important factor in preventing

expropriation, firm-level corporate governance could carry equal or greater importance.

And corporate governance practices can vary widely even among firms in the same country

operating under the same legal regime. This paper uses firm-specific corporate governance

ratings developed by Credit Lyonnais Securities Asia (CLSA) for 365 firms from 19

emerging markets to study the impact of firm-level corporate governance on dividend

payouts. It is important to note, as do LLSV (2000), that the outcome model does not hinge

on investors holding specific rights to dividends. Rather, what is important is that the

country’s laws – or the company’s governance practices – allow minority shareholders more

rights in general, which rights may then be used to influence dividend policy. For example,

observers have noted that Russian firms are more commonly electing independent directors

to their boards, despite a legal system that does little to define or enforce board

independence (Nicholson, 2003). Mark Mobius, elected as an independent director to the

board of Russia’s LUKoil in 2002, later acted on behalf of shareholders to propose a

minimum-dividend policy that LUKoil’s board approved in 2003 (Investor Protection

Association, 2003).

Using the CLSA data, I first show that firms with higher corporate governance

ratings have higher dividend payouts. The effect appears to be economically meaningful as

well as statistically significant; regression results imply that a one-standard-deviation

increase in a firm’s corporate governance rating is associated with an average four-

percentage-point increase in dividend payouts (the average payout ratio is about 30%.) A

move from the worst governance (in this dataset, Indonesia’s Indocement) to the best

governance (in this dataset, Hong Kong’s HSBC) would imply, on average, a higher

dividend payout ratio of some 22 percentage points. This result is consistent with the

3
hypothesis of the outcome agency model that investors that are afforded stronger rights use

those rights to extract dividends from the firm. This result is also complementary to the

findings of Faccio, Lang, and Young (2001). Interpreting dividends as a means for limiting

expropriation, they study East Asian and Western European firms and find that dividend

payouts are significantly impacted by the vulnerability of a firm’s minority shareholders to

expropriation by controlling shareholders.2

Even when shareholders are well protected, however, they may not prefer higher

dividend payouts if they believe the firm has good investment opportunities available for

excess cash. Indeed, LLSV (2000) find that in countries with strong investor protection,

there is a stronger negative relationship between growth opportunities and dividend payouts.

That is, it appears that when shareholders perceive that their rights are well protected, they

are more willing to let firms with good growth opportunities retain cash, being confident that

they will share in the payoff from good projects later on. In contrast, if shareholders know

that investor protection is poor, they may be more haphazard in their desire for dividends,

trying to extract whatever value they can – regardless of the firm’s growth opportunities –

before being expropriated. Complementary to the country-level finding of LLSV (2000), I

find at the firm level that firms with stronger corporate governance also show a stronger

negative relationship between dividends and growth opportunities. In other words, the

pattern of dividend payouts seems to make more sense among firms with good corporate

governance.

I next examine how dividend policy is impacted by the interplay of country-level

investor protection and firm-level corporate governance. I find first of all that across all

2
In a related finding, Gugler and Yurtoglu (2003) show, using data from Germany, that negative reactions to
dividend reductions are stronger among firms where minority shareholders are more susceptible to
expropriation.

4
countries, both country-level investor protection and firm-level corporate governance have

explanatory power for dividend payouts. Of the two, the country-level measures have

perhaps greater explanatory power. Next, I find that firm-level corporate governance is

positively associated with dividend payouts primarily in countries that offer strong investor

protection (as measured by legal origin or antidirector rights). This suggests that firm-level

corporate governance and country-level investor protection work as complements rather

than substitutes. Firm-level improvements in corporate governance may be most effective

when the legal regime of the country also offers a higher level of protection for

shareholders.

The findings of the paper are robust to many different specifications (although I find

some specifications where they are not). The results hold when controlling for financial

variables that have been shown previously to be correlated with dividend payouts, namely

growth, size, and profitability (see Fama and French, 2001). I show separately that firms

with stronger governance have higher profitability, but improved profitability explains only

part of the connection between governance and dividends. The results also hold when

controlling for industry and country fixed effects. In addition, I show that the results hold

with or without financial firms, with or without mandatory-dividend countries, and when

controlling for the tax advantage of dividends. Nevertheless, as will be discussed further in

Section 4, because I lack a suitable instrument for firm-level corporate governance, these

results are subject to typical problems of endogeneity, and therefore any interpretations

regarding causality should be made cautiously.

I also use additional data to get a sense as to whether the result holds among a

broader sample of firms. Lacking governance ratings for a broader sample, I use variables

that have been used in previous work as indicators of good governance. These variables

5
(whether or not a firm is diversified, has a Big Five international auditor, or is cross-listed in

the U.S.) are available for a much larger sample (over 14,000 firms). Although these

indicators are clearly not as refined as the CLSA ratings, they are generally supportive of the

results using the CLSA ratings, suggesting that the findings may be applicable to a broader

sample.

The results presented here add to the current literature in a few ways. These firm-

level findings add confidence to previous country-level findings regarding investor

protection and dividends. Because country-level measures of investor protection can be

correlated with other important variables, some uncertainty remains about which country-

level variables impact dividend policy. Showing that differences in shareholder protection

at the firm level also impact dividend policy helps confirm that investor protection is a

significant factor affecting dividend policy. In addition, the results add to a growing

literature that uses firm-level measures of governance to study the impact of corporate

governance on corporations around the world. Such papers (too numerous to list briefly)

include those that measure firm-level governance with ratings, with various measures of

ownership structure, and with other indicators of governance.3 Finally, the firm-level

findings suggest that individual firms are not entirely trapped by the legal regimes of their

home country. By improving corporate governance at the firm level, firms can demonstrate

a commitment to protecting investors that translates into real economic outcomes.

The next section describes the data used in the study. Section 3 presents the

empirical results. Section 4 discusses robustness and alternative interpretations. Section 5

examines the results with a broader sample using governance indicators. Section 6

concludes.

3
See Denis and McConnell (2003) for a discussion of many of these papers.

6
2. Data and Methodology

To measure the strength of corporate governance at the firm level I use corporate

governance ratings developed by Credit Lyonnais Securities Asia (CLSA, 2001). CLSA

analysts assess the performance of emerging market firms on 57 issues in seven areas of

corporate governance. 4 These ratings have been used in several other studies 5 to examine

the impact of corporate governance on firm performance. In rating the firms, analysts are

required to give only binary (yes/no) responses to each of the issues, in an effort to reduce

subjectivity. Firms are then given a composite rating based on their scores in the areas of

management discipline, transparency, independence, accountability, responsibility, fairness,

and social responsibility. The first six areas have a 15% weighting in the composite score,

and social responsibility has a 10% weighting. The rating is on a scale of 1 to 100, with a

higher score indicating stronger corporate governance. I adopt CLSA’s composite score as

my primary measure of firm-level corporate governance.

A few issues regarding use of the CLSA scores should be addressed. First, it’s clear

that there is a selection bias in the set of firms covered. CLSA chooses firms to cover based

on whether the firms are of interest to international investors. Thus the results presented

should be thought of as applying particularly to larger, more visible, firms. Second, it’s not

clear that “social responsibility” should be included as part of the rating as it doesn’t relate

directly to minority shareholder protection. Also, the “management discipline” rating is a

concern because it includes one issue (out of nine) that is at least partially related to

4
See Durnev and Kim (2002) for a complete listing of all 57 issues addressed in the survey.
5
Examples include Durnev and Kim (2002), Khanna, Kogan, and Palepu (2002), Klapper and Love (2002),
Chen, Chen, and Wei (2003), and Friedman, Johnson, and Mitton (2003).

7
dividend payouts. 6 To avoid discarding useful information and to avoid tampering with

CLSA’s rating, I stick with the CLSA composite score as a base case. The results presented

are robust to exclusion of either the social responsibility or management discipline rating

(see Section 4).

I match the firms in the CLSA study with financial data from the Worldscope

database. I use the October 2002 version of Worldscope, in which the latest data reported

for most firms is from 2001, which corresponds with the 2001 date of the CLSA report. The

primary measure of dividends I use from Worldscope is the dividend payout ratio, which is

defined as dividends per share/earnings per share*100. As secondary measures of dividends

I also calculate dividends/cash flow and dividends/sales (as in LLSV, 2000). Because

dividend payouts naturally change over the life cycle of a firm, I try to account for life cycle

properties of firms by controlling for firm size and firm growth rates. To measure size I take

from Worldscope the log of total assets of the firm, measured in billions of $U.S. To

measure growth I take from Worldscope the one-year growth rate in total assets, measured

in $U.S. In addition to size and growth, it has been shown that profitability is positively

correlated with dividend payouts (Fama and French, 2001), so I use profitability as an

additional control variable. (In section 4 I discuss the impact of profitability in more detail.)

Profitability is measured as return on assets and also comes from Worldscope. To avoid

undue influence of outliers, growth and profitability are both winsorized at the 5th and 95th

percentile.

The Worldscope database does not have a match for every firm rated by CLSA. Of

the 495 firms from 25 countries included in the CLSA ratings, I am able to match 447 (90%)

of the firms with Worldscope. Of that number, I exclude 45 firms from 4 countries

6
The exact wording of the question is as follows: “Over the past 5 years, is it true that the company has not

8
identified by LLSV (2000) as mandatory dividend countries – Brazil, Chile, Colombia, and

Greece. (The results are robust to including these countries; see Section 4.) Finally, from

this number I exclude 37 firms that are missing necessary financial data in Worldscope. The

most common missing item is the growth rate, as it requires two years of available data

rather than one. After these adjustments, 365 firms from 19 countries constitute the base

sample.

Table 1 presents descriptive statistics of the data by country. The median corporate

governance rating of all firms in the sample is 55.4. The highest rating in the sample is 93.5

(Hong Kong’s HSBC Holdings), and the lowest rating in the sample is 13.9 (Indonesia’s

Indocement). The average dividend payout ratio for all firms in the sample is 30.1%. In

comparison, the average dividend payout ratio for listed U.S. firms from 1993-98 was 39.3%

(Fama and French, 2001). In addition to the financial data described above, Table 1 also

shows measures of country-level investor protection. The two measures presented are

antidirector rights and legal origin. As explained in LLSV (1997, 1998), antidirector rights

is a composite measure, on a scale of 1 to 5, where a higher number indicates that the

country offers more legal protections for equity investors. Legal origin is also important in

that common law countries have been shown to offer greater shareholder protection than

civil law countries (LLSV, 1997, 1998). I compile the country-level data from LLSV (2000)

and Claessens, Djankov, and Nenova (2000).

In the results that follow I estimate the effect of corporate governance on dividend

payouts using ordinary least squares regression. I present specifications with and without

industry fixed effects and country fixed effects, but the specification that I ultimately focus

on includes both industry and country fixed effects. Because tests detect heteroskedasticity

built up cash levels, through retained earnings or cash calls, that has brought down ROE?”

9
of errors in some specifications, I report heteroskedasticity-adjusted standard errors (White,

1980) throughout the analysis.

3. Results

I first examine whether firms with stronger governance have higher dividend

payouts. Regressions results are reported in Table 2. In Table 2 the dependent variable is

the dividend payout ratio and the independent variable of interest is the corporate

governance rating. Column 1 of Table 2 shows the coefficient on corporate governance with

no control variables. The coefficient is 0.302, meaning that a one-point increase in the

corporate governance rating is associated with an increased dividend payout ratio of 0.3

percentage points. The coefficient on corporate governance is significant at the 1% level of

confidence.

In subsequent columns of Table 2 I add control variables in turn, adding first growth,

then profitability, size, industry dummies, and country dummies. The magnitude of the

coefficient on corporate governance decreases somewhat as controls are added, but always

remains significant at the 5% level or higher. The largest decrease in the magnitude of the

coefficient comes with the addition of profitability as a control. (The relative impact of

profitability and governance will be discussed further in Section 4.) In the final column,

with all controls included, the coefficient on corporate governance is 0.271 and is significant

at the 5% level. As mentioned earlier, the coefficient suggests that a one-standard deviation

increase in corporate governance is associated with a higher dividend payout of 4 percentage

points. In summary, Table 2 demonstrates that stronger corporate governance is associated

with higher dividend payouts, possibly reflecting the increased ability of shareholders to

limit expropriation by insiders.

10
 As will be typical in the tables that follow, in the final column of Table 2, the control

variables also have some explanatory power for dividend payouts, as would be expected.

The coefficient on growth is negative and significant, probably reflecting that firms with

higher growth retain cash for investme nt. The coefficient on profitability is positive and

highly significant, probably reflecting that profitable firms have more cash available for

dividends, all else equal. Finally, the coefficient on size is positive and marginally

significant in some specifications, indicating that larger firms have higher dividend payouts.

In Table 3, I turn to the secondary question of how dividends are affected by the

interaction of corporate governance and growth. As put forth by LLSV (2000), when

investors are well protected we should see a stronger negative relationship between

dividends and growth. LLSV (2000) demonstrate this with country-level variables, and in

Table 3 we examine the same with variables that vary at the firm level.

Our independent variable of interest in Table 3 is corporate governance interacted

with growth. As in LLSV (2000), I implicitly view past growth rates as a proxy for future

growth opportunities. Column 1 of Table 3 presents the coefficient on this interaction term

along with the main effects on corporate governance and growth and with no other control

variables. The coefficient on corporate governance interacted with growth is -0.012 and is

significant at the 5% level of confidence. The negative coefficient is as expected and

indicates that among firms with stronger corporate governance, the negative relationship

between growth and dividends is stronger.

In subsequent columns I progressively add control variables as before. In the

intermediate columns the coefficient on the interaction between governance and growth

declines and even loses significance in Columns 3 and 4. However, once all controls are

included in Column 5, the coefficient is again significant at the 5% level with a magnitude

11
of -0.009. In addition, the separate coefficients on corporate governance and growth remain

significant and of the expected sign when the interaction term is included. In short, Table 3

shows that the pattern of dividend payouts makes more sense among firms with stronger

corporate governance.

Table 4 investigates the interaction of investor protection and corporate governance.

First, I investigate whether country-level variables or firm-level variables are more dominant

in their impact on dividend policy. Table 4 addresses this question by simply including

investor protection and corporate governance as right-hand-side variables simultaneously.

Of course this calls for a modified specification, as country fixed effects are now excluded

(but industry fixed effects are retained throughout).

Column 1 of Table 4 presents the coefficient on antidirector rights without corporate

governance. The coefficient on antidirector rights is 3.442 and is significant at the 1% level.

The magnitude of the coefficient implies that firms in countries with a higher score of one

point (the scale is from 1 to 5) have higher dividend payout ratios, on average, of more than

3 percentage points. This result is essentially a confirmation of the results in LLSV (2000).

In Column 2 corporate governance is also included in the regression. Here the coefficient

on antidirector rights falls to 2.396, but it remains significant, although now only at the 5%

level. Meanwhile, the coefficient on corporate governance is 0.282, also significant at the

5% level. In this case it doesn’t appear that either effect dominates the other; both country-

level investor protection and industry-level corporate governance have strong explanatory

power for dividend payouts. Columns 3 and 4 repeat the regressions of Columns 1 and 2 but

with profitability included as a control. Here similar relationships are seen, but the

coefficients on antidirector rights and corporate governance are smaller and of a lower

significance level.

12
 Columns 5 through 8 repeat the analysis of Columns 1 through 4, but with legal

origin as the country-level variable. The results are similar, except that now legal origin

appears to have stronger explanatory power than corporate governance, to the extent that

corporate governance loses significance in Column 8. On balance then, the evidence

suggests that both country-level investor protection and firm-level corporate governance

have significant explanatory power for dividends, but that the explanatory power of country-

level investor protection may be somewhat greater.

In Table 5 I turn to the next issue of the interaction of country-level investor

protection and firm-level corporate governance. The question I want to address here is

whether country-level investor protection and firm-level corporate governance act as

complements or substitutes. A priori, it is not obvious which to expect. On the one hand,

investor protection and corporate governance may be substitutes, meaning that when

investor protection is weak, firms can have a greater impact on strengthening the rights of

their shareholders when they improve corporate governance. On the other hand, investor

protection and corporate governance may be complements, meaning that the efforts of

individual firms to improve corporate governance may have little effectiveness if the

country doesn’t provide a legal environment that respects shareholder rights.

I address this question in Table 5 in two ways, by partitioning the sample, and with

interaction terms. First, I split the sample between countries with strong investor protection

and weak investor protection. As discussed previously, I use two measures of investor

protection, legal origin (with common law countries offering better protection) and

antidirector rights (with a higher score indicating better protection). In Columns 1 and 2 I

split the sample between common law countries and civil law countries. Throughout Table

5 I include all control variables. Column 1 shows that among firms in common law

13
countries the coefficient on corporate governance is much greater than it is among all firms.

The coefficient is 0.515 (compared to 0.271 in Table 2), and is significant at the 1% level.

Meanwhile, Column 2 shows that among firms in common law countries, the relationship

between governance and dividends is actually negative (but not significantly different from

zero). Columns 4 and 5 tell a similar story with antidirector rights. Among firms in

countries with above-median antidirector rights the coefficient on corporate governance is

0.451, but among firms with below-median antidirector rights the coefficient on corporate

governance is 0.011. These results strongly suggest that, regarding dividend policy,

country-level investor protection and firm-level corporate governance are complements

rather than substitutes.

The second approach in Table 5 is to create interactions of investor protection and

corporate governance. In Column 3 corporate governance is interacted with a dummy

variable equal to one for common law countries. The coefficient on the interaction term is

positive and significant at the 5% level. Column 6 confirms this results with corporate

governance interacted with antidirector rights. Again the coefficient on the interaction term

is positive, although not significant at standard levels. The coefficients on the interaction

terms confirm what is demonstrated with the partitioned sample, that investor protection and

corporate governance are complements in their impact on dividend policy. This result

stands in contrast to the results of Klapper and Love (2002) and Durnev and Kim (2002),

who find that firm-level corporate governance and country-level investor protection are

substitutes in terms of their impact on firm value.

14
4. Alternative Interpretations and Robustness

If we interpret the results presented in the previous section in the context of the

outcome agency model of dividends, then the interpretation is as has been discussed

previously. That is, when shareholders are afforded stronger rights by companies that have

stronger corporate governance, shareholders use that power to extract dividends. But other

interpretations of the results are possible. The first alternative to consider is that firms with

stronger governance have improved operating performance which then allows these firms to

pay higher dividends (irrespective of the power or wishes of shareholders). In particular, if

stronger governance leads to greater profitability, then it may be greater profitability that

leads to higher dividend payouts, not the exertion of influence by shareholders. Since a

positive correlation between governance and profitability has not yet been established, I first

address this issue in Table 6.

In Table 6 the dependent variable is profitability. Column 1 shows that corporate

governance does indeed have a positive effect on profitability, with a coefficient of 0.058

which is significant at the 5% level. Controls for growth and size are also highly significant,

and industry dummies are included throughout. The significance of corporate governance

remains if we add either country fixed effects or indicators of country-level investor

protection. (Neither antidirector rights nor legal origin has significant explanatory power for

profitability.) In sum, Table 6 establishes a positive association between firm-level

corporate governance and profitability. (Again, no causality can be inferred, it could be, for

example, that when firms become more profitable they have the luxury of improving

governance.)

Returning then to the question of whether improved profitability explains the

relationship between governance and dividends, previous tables already demonstrate that

15
this explanation may have some relevance, because the coefficient on corporate governance

declines when profitability is included as a control variable. However, previous tables also

demonstrate that profitability is not the entire explanation, because corporate governance

retains significance even when profitability is included as a control. In sum, both the

indirect effect of profitability and the direct effect of governance have explanatory power for

dividend payouts. In subsequent robustness checks I present results with and without

profitability as a control variable.

An additional alternative interpretation of the results is that causality is reversed or

that both governance and dividends are jointly influenced by an omitted variable. Ideally, I

would like to use standard econometric techniques to deal with potential endogeneity. This

would involve identifying an instrument, that is, a variable that is correlated with the key

independent variable (in this case, the corporate governance rating), but that is otherwise

uncorrelated with the dependent variable (in this case, dividend payout ratios).

Unfortunately, I am unable to identify an appropriate instrument for this situation. This type

of problem is a recurring issue in studies of corporate governance. In one atypical case,

Black, Jang, and Kim (2002) are able to use an instrumental variables approach to establish

causation running from corporate governance to firm value, but their instrument is specific

to institutional details of Korea and is not suited to this cross-country analysis. The bottom

line for this study is that lacking a suitable instrument for corporate governance it is not

possible to rule out alternative explanations based on endogeneity.

In Table 7 I turn to some additional regressions to assess the robustness of the main

result along different dimensions. In each case I present results with and without

profitability as a control variable. In the first two robustness checks I alter the corporate

governance rating to exclude the discipline measure and the social responsibility measure

16
respectively. The reasons for potentially wanting to omit these variables are discussed in

Section 2. Columns 1 through 4 demonstrate that the results are robust to excluding these

measures, as the coefficient on corporate governance retains significance at the 10% level or

higher whether or not profitability is included as a control variable.

In the next two robustness checks I use alternative definitions of dividend payouts,

dividends/cash flow and dividends/sales. While these are not standard definitions of

dividend payouts, they are used in LLSV (2000) as alternative definitions. These results are

presented in Columns 5 through 8 of Table 7. Here the robustness of the results does not

fare as well. With dividends/cash flow as the dependent variable, the coefficient on

corporate governance is significant in one specification, but with dividends/sales as the

dependent variable, the coefficient on corporate governance is not significant, although it

retains the expected sign.

In the next two robustness checks presented I change the sample in two important

ways. Columns 9 and 10 repeat the basic results but with countries designated as mandatory

dividend countries now included in the regressions. The coefficient on corporate

governance is significant in both of these specifications. Columns 11 and 12 repeat the

analysis with but with financial firms (SICs in the 6000s) excluded. Without financial firms

the results are even stronger than in the full sample. Finally, in Columns 13 and 14 I present

one more robustness check, where I control for a country’s tax advantage of dividends. This

measure is taken from LLSV (2000). The results are robust to inclusion of this variable,

which in itself has little explanatory power for dividend payouts.

17
5. Tests Using a Broader Sample of Firms

As a final test of the robustness of the results, Table 8 presents results using

governance indicators in place of the CLSA ratings. These indicators are rougher measures

of governance than the CLSA ratings, but they have the advantage that they can be

examined for a larger set of firms. The intent from examining this data is to get an

indication as to whether the results presented previously apply to a broader set of firms. An

alternative, and sharper, way of expanding the sample would be to use as the governance

measure (or measure of susceptibility to agency problems) the divergence between cash-

flow rights and control rights, as has been done in a number of papers including Lins (2003),

Lemmon and Lins (2003), Harvey, Lins, and Roper (2004), and Faccio, Lang, and Young

(2001). Lacking this detailed data, I rely on financial data from Worldscope, but now using

indicators that allow the sample to include over 14,000 firms from 50 countries. I examine

three indicators of governance that are available for the large sample. The first is a dummy

variable that equals one if the firm operates in only one industry, with industries defined at

the two-digit SIC level. A focused firm is used as an indicator of good governance both in

the CLSA study and in previous research (see, e.g., Mitton, 2002 and Friedma n, Johnson,

and Mitton, 2003). The second indicator is a dummy variable that equals one if the auditor

of the firm is one of the Big Five international accounting firms. 7 Having a Big Five auditor

has been used previously as an indicator of higher disclosure quality (Titman and Trueman,

1986, Reed et al, 2000, Mitton, 2002), which is an important element of corporate

governance (see LLSV, 1998). The third indicator is a dummy variable that equals one if

the firm’s stock is cross-listed on a U.S. exchange, either directly or with a Level II or III

depository receipt. Because such a cross-listing subjects the firm to a higher level of

7
The data come from 2001, prior to the breakup of Arthur Andersen.

18
disclosure requirements and investor scrutiny, it may bond the firm to maintain a higher

standard of governance (see Coffee, 1999, Stulz, 1999, and Reese and Weisbach, 2002 for

examples of this view).

Table 8 presents results of regressions of dividend payout ratios on these indicators.

Column 1 shows that focused firms have higher dividend payout ratios than diversified

firms, even after controlling for growth, size, profitability, industry, and country. The

difference does not appear large (focused firms have higher payout ratios of just under one

percentage point) but it is statistically significant at the 5% level. Column 1 also shows that

the negative relationship between growth and dividends is stronger among focused firms,

suggesting that focused firms allocate capital more efficiently. This coefficient is significant

at the 1% level. Column 2 repeats the analysis for the Big Five auditor indicator. Firms

with Big Five auditors have higher payout ratios (by around two percentage points) and this

difference is significant at the 1% level. The negative relationship between growth and

dividends is also stronger among firms with Big Five auditors, although this difference is not

significant. Column 3 shows the same results for the cross-listed indicator. Here the results

are not as expected, as cross-listed firms have lower dividend payouts. But the negative

relationship between growth and dividends is still stronger among cross-listed firms (though

again not significant). Column 4 shows that the same results hold with all three indicators

included simultaneously. In summary, though the evidence is mixed for cross-listed firms,

on balance these results seem to support, in a broader sample, that stronger governance is

associated with higher dividend payouts and a stronger negative relationship between

growth and dividends.

19
6. Conclusion

The ultimate goal of corporate governance is to ensure that suppliers of finance to

corporations receive a return on their investment (Shleifer and Vishny, 1997). While

suppliers of equity can receive a return through dividends or capital gains, agency theory

suggests that shareholders may prefer dividends, particularly when they fear expropriation

by insiders. The outcome agency model tells us that when shareholders have greater rights,

they can use their power to influence dividend policy. Shareholders can receive greater

rights either through a country’s legal protection or through a firm’s governance practices

that may not be mandated by government. This paper shows that firm-level corporate

governance, in addition to country-level investor protection, is associated with higher

dividend payouts, suggesting that both mechanisms help reduce agency problems. In

addition, stronger corporate governance is shown to be associated with a stronger negative

relationship between growth and dividends, demonstrating that the pattern of dividend

payouts makes more sense among firms with stronger corporate governance. The results

suggest that when shareholders are well protected, either by governments or by corporations

themselves, capital can be allocated more efficiently.

20
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22
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23
 Table 1
Descriptive statistics by country

Total Asset Total

Growth Assets Profitability Dividends/ Dividends/ Antidirecto Legal
Country Obs Corporate Governance Rating Dividend Payout Ratio % ($US) % ($Bil) (ROA) Cash Flow % Sales % r Rights Origin
Mean Median St. Dev. Mean Median St. Dev. Mean Mean Mean Mean Mean
ARGENTINA 1 66.70 66.70 0.00 0.00 -7.34 6.633 0.71 0.00 0.00 4 civil
CHINA 12 45.99 48.70 7.66 40.38 45.62 25.00 8.35 6.861 5.74 23.00 10.50 1 civil
HONG KONG 39 62.46 67.30 13.20 42.52 43.14 27.40 -0.16 27.389 5.73 39.34 11.00 5 common
HUNGARY 1 60.40 60.40 0.00 0.00 51.74 4.005 7.50 0.00 0.00 3 civil
INDIA 68 56.47 54.35 10.06 30.25 24.58 22.54 33.47 2.493 8.25 19.76 2.83 5 common
INDONESIA 17 38.39 36.40 11.43 25.25 27.65 22.60 8.84 1.615 8.29 28.64 4.23 2 civil
KOREA (SOUTH) 22 47.71 46.50 6.91 15.76 12.43 16.65 8.44 17.790 2.85 7.15 1.09 2 civil
MALAYSIA 40 56.19 59.40 14.47 33.49 30.52 25.39 9.61 4.370 6.20 21.00 5.10 3 common
MEXICO 7 64.50 67.10 8.61 16.68 10.77 18.29 10.71 17.654 5.33 8.98 2.48 1 civil
PAKISTAN 9 33.90 30.70 14.45 52.06 63.49 28.65 -0.49 0.869 7.14 37.66 6.71 5 common
PERU 1 75.50 75.50 21.60 21.60 24.06 0.540 11.50 37.56 9.13 3 civil
PHILIPPINES 20 43.87 38.65 12.67 17.39 5.29 20.01 -1.83 2.334 1.85 12.21 2.19 3 civil
POLAND 2 36.20 36.20 3.11 6.74 6.74 9.53 9.29 6.120 2.09 1.86 0.15 3 civil
RUSSIA 1 15.40 15.40 14.58 14.58 32.28 15.673 18.31 12.00 2.94 civil
SINGAPORE 30 65.78 64.65 9.24 30.97 28.18 23.38 6.61 8.436 4.36 30.97 5.16 4 common
SOUTH AFRICA 29 67.55 67.40 8.55 30.87 30.97 28.59 0.55 5.661 5.71 14.92 7.52 5 common
TAIWAN 40 54.06 52.90 9.20 27.67 32.44 25.68 10.25 6.689 5.04 9.73 2.62 3 civil
THAILAND 17 55.15 54.80 12.22 29.98 28.78 34.11 4.99 4.510 4.23 16.55 3.98 2 civil
TURKEY 9 42.13 38.40 8.33 20.60 0.00 37.76 3.48 4.694 4.75 7.19 1.04 2 civil
Total 365 55.10 55.40 13.87 30.07 28.50 25.95 10.89 9.916 5.75 20.42 4.76 3.11
The table reports descriptive statistics of variables used in subsequent tables. Corporate governance ratings come from CLSA (2001). Financial data come from Worldscope. Country-level
variables are compiled from LLSV (2000) and Claessens, Djankov, and Nenova (2000).
 Table 2
Firms with stronger governance have higher dividend payouts

(1) (2) (3) (4) (5) (6)

Dependent variable is dividend payout ratio
Corporate governance 0.302 *** 0.323 *** 0.261 *** 0.245 ** 0.271 *** 0.271 **
(0.105) (0.105) (0.098) (0.097) (0.104) (0.133)

Growth -0.135 ** -0.237 *** -0.252 *** -0.170 *** -0.129 *

(0.062) (0.062) (0.062) (0.065) (0.068)

Profitability 1.397 *** 1.572 *** 1.537 *** 1.527 ***

(0.211) (0.219) (0.251) (0.269)

Size 1.558 * 1.147 1.327

(0.853) (1.098) (1.313)

Industry dummies No No No No Yes Yes

Country dummies No No No No No Yes

N 365 365 365 365 365 365

R-squared 0.026 0.036 0.144 0.153 0.292 0.352
The table reports regression coefficients of dividend payout ratios on corporate governance ratings and control variables.
Corporate governance ratings come from CLSA (2001). Financial data come from Worldscope. Growth is the one-year
growth rate in total assets, profitability is return on assets, and size is the log of total assets. Heteroskedasticity-robust
standard errors are reported below coefficients in parentheses. Asterisks denote levels of significance (***=1%, **=5%,
 Table 3
Stronger governance is associated with a stronger negative relationship between dividends and growth

(1) (2) (3) (4) (5)

Dependent variable is dividend payout ratio
Corporate governance 0.293 *** 0.243 ** 0.230 ** 0.258 ** 0.260 **
(0.102) (0.098) (0.098) (0.104) (0.130)

Growth -0.121 * -0.225 *** -0.240 *** -0.162 ** -0.120 *

(0.063) (0.063) (0.063) (0.066) (0.068)

Corporate governance X Growth -0.012 ** -0.008 * -0.007 -0.006 -0.009 **

(0.005) (0.005) (0.005) (0.005) (0.004)

Profitability 1.358 *** 1.526 *** 1.500 *** 1.491 ***

(0.215) (0.226) (0.258) (0.269)

Size 1.457 * 1.085 1.443

(0.863) (1.104) (1.325)

Industry dummies No No No Yes Yes

Country dummies No No No No Yes

N 365 365 365 365 365

R-squared 0.049 0.150 0.158 0.295 0.358
The table reports regression coefficients of dividend payout ratios on the interaction of corporate governance with
growth and control variables. Corporate governance ratings come from CLSA (2001). Financial data come from
Worldscope. Growth is the one-year growth rate in total assets, profitability is return on assets, and size is the log of
total assets. Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks
denote levels of significance (***=1%, **=5%, *=10%).
 Table 4
Country-level measures of investor protection and firm-level measures of corporate governance both have explanatory power for dividend payouts

Antidirector rights Legal origin

(1) (2) (3) (4) (5) (6) (7) (8)
Dependent variable is dividend payout ratio
Antidirector rights 3.442 *** 2.396 ** 2.853 *** 2.186 *
(1.160) (1.219) (1.050) (1.123)

Common law 10.672 *** 7.551 ** 9.204 *** 7.126 **

(3.266) (3.422) (2.944) (3.075)

Corporate governance 0.282 ** 0.186 * 0.257 ** 0.175

(0.118) (0.111) (0.115) (0.107)

Growth -0.028 -0.058 -0.140 ** -0.156 ** -0.039 -0.063 -0.152 ** -0.164 ***
(0.067) (0.067) (0.063) (0.065) (0.066) (0.066) (0.062) (0.063)

Size 0.663 0.405 1.734 1.521 0.884 0.591 1.847 1.616

(1.182) (1.157) (1.138) (1.131) (1.162) (1.135) (1.127) (1.117)

Profitability 1.624 *** 1.558 *** 1.576 *** 1.525 ***

(0.250) (0.255) (0.243) (0.248)

Country dummies No No No No No No No No

Industry dummies Yes Yes Yes Yes Yes Yes Yes Yes

N 364 364 364 364 365 365 365 365

R-squared 0.199 0.215 0.295 0.302 0.205 0.219 0.297 0.303
The table reports regression coefficients of dividend payout ratios on country-level measures of investor protection, corporate governance ratings, and control variables. Corporate governance
ratings come from CLSA (2001). Financial data come from Worldscope. Growth is the one-year growth rate in total assets, profitability is return on assets, and size is the log of total assets.
Country-level variables are compiled from LLSV (2000) and Claessens, Djankov, and Nenova (2000). Heteroskedasticity-robust standard errors are reported below coefficients in parentheses.
Asterisks denote levels of significance (***=1%, **=5%, *=10%).
 Table 5
Are country-level investor protection and firm-level corporate governance complements or substitutes?

Legal origin Antidirector rights

Common law Civil law
countries countries All countries Above median Below median All countries
(1) (2) (3) (4) (5) (6)
Dependent variable is dividend payout ratio
Corporate governance 0.515 *** -0.226 0.223 * 0.451 ** 0.011 0.260 **
(0.153) (0.222) (0.129) (0.227) (0.178) (0.130)

Corporate governance X 0.583 **

Common law (0.256)

Corporate governance X 0.164

Antidirector rights (0.107)

Growth -0.043 -0.271 -0.128 * -0.035 -0.213 -0.122 *

(0.079) (0.166) (0.069) (0.090) (0.130) (0.069)

Profitability 1.093 *** 2.328 *** 1.536 *** 0.868 ** 2.277 *** 1.512 ***
(0.365) (0.413) (0.270) (0.427) (0.387) (0.267)

Size 0.975 3.823 * 1.395 1.938 0.203 1.402

(1.659) (2.304) (1.316) (1.942) (2.137) (1.321)

Country dummies Yes Yes Yes Yes Yes Yes

Industry dummies Yes Yes Yes Yes Yes Yes

N 232 133 365 176 188 364

R-squared 0.391 0.549 0.363 0.368 0.453 0.357
The table reports regression coefficients of dividend payout ratios on corporate governance ratings, the interaction of governance with country-level measures of
investor protection, and control variables. Corporate governance ratings come from CLSA (2001). Financial data come from Worldscope. Growth is the one-
year growth rate in total assets, profitability is return on assets, and size is the log of total assets. Country-level variables are compiled from LLSV (2000) and
Claessens, Djankov, and Nenova (2000). Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks denote levels of
significance (***=1%, **=5%, *=10%).
 Table 6
Firms with stronger governance have greater profitability

(1) (2) (3) (4)

Dependent variable is profitability ratio
Corporate governance 0.058 ** 0.074 *** 0.061 ** 0.054 **
(0.023) (0.027) (0.024) (0.026)

Antidirector rights 0.135

(0.282)

Common law 0.278

(0.757)

Growth 0.066 *** 0.057 *** 0.063 *** 0.066 ***

(0.020) (0.021) (0.020) (0.020)

Size -0.691 *** -0.703 *** -0.716 *** -0.672 ***

(0.220) (0.273) (0.223) (0.228)

Country dummies No Yes No No

Industry dummies Yes Yes Yes Yes

N 365 365 364 365

R-squared 0.387 0.422 0.391 0.388
The table reports regression coefficients of profitability (return on assets) on corporate governance ratings
and control variables. Corporate governance ratings come from CLSA (2001). Financial data come from
Worldscope. Growth is the one-year growth rate in total assets and size is the log of total assets. Country-
level variables are compiled from LLSV (2000) and Claessens, Djankov, and Nenova (2000).
Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks denote
levels of significance (***=1%, **=5%, *=10%).
 Table 7
Robustness checks

Exclude discipline measure Exclude social responsibility Dividends/Cash flow as Dividends/Sales as dependent Include mandatory dividend Control for country's tax
from rating measure from rating dependent variable variable countries Exclude financial firms advantage of dividends
(1) (2) (3) (4) (5) (6) (7) (8) (9) (10) (11) (12) (13) (14)
Dependent variable is dividend payout ratio (except where noted)
Corporate governance 0.336 ** 0.247 * 0.345 *** 0.239 * 0.278 ** 0.172 0.056 0.024 0.337 ** 0.224 * 0.471 *** 0.328 ** 0.456 *** 0.339 ***
(0.131) (0.132) (0.123) (0.124) (0.135) (0.133) (0.035) (0.036) (0.134) (0.134) (0.155) (0.155) (0.114) (0.109)

Growth -0.036 -0.127 * -0.039 -0.127 * -0.028 -0.105 * 0.009 -0.016 -0.037 -0.135 ** -0.028 -0.135 * -0.069 -0.158 **
(0.071) (0.068) (0.071) (0.068) (0.057) (0.054) (0.020) (0.018) (0.069) (0.066) (0.079) (0.076) (0.072) (0.069)

Size 0.274 1.364 0.234 1.315 -0.012 0.930 -0.133 0.175 -0.541 0.813 1.025 1.954 0.487 1.499
(1.398) (1.321) (1.387) (1.316) (1.178) (1.153) (0.632) (0.584) (1.415) (1.284) (1.489) (1.402) (1.224) (1.181)

Profitability 1.550 *** 1.533 *** 1.350 *** 0.438 *** 1.642 *** 1.539 *** 1.457 ***
(0.268) (0.269) (0.256) (0.077) (0.262) (0.272) (0.257)

Dividend tax advantage -7.126 -3.190

(12.186) (11.766)

Country dummies Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes No No

Industry dummies Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes Yes

N 365 365 365 365 359 359 365 365 402 402 278 278 339 339
R-squared 0.268 0.351 0.271 0.351 0.373 0.436 0.337 0.409 0.259 0.349 0.313 0.408 0.226 0.303
The table reports regression coefficients of measures of dividends on corporate governance ratings and control variables. Corporate governance ratings come from CLSA (2001). Financial data come from Worldscope. Growth is the one-year
growth rate in total assets, profitability is return on assets, and size is the log of total assets. Mandatory dividend countries added to the sample include Brazil, Chile, Colombia, and Greece. Financial firms are defined as those with primary SIC in
the range 6000-6999. Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks denote levels of significance (***=1%, **=5%, *=10%).
 Table 8
Governance indicators in an expanded sample

(1) (2) (3) (4)

Dependent variable is dividend payout ratio
Focused 0.912 ** 0.933 **
(0.443) (0.442)

Big Five Auditor 2.113 *** 2.144 ***

(0.542) (0.542)

Cross-listed -5.451 *** -5.523 ***

(1.047) (1.048)

Focused X Growth -0.042 *** -0.042 **

(0.016) (0.016)

Big Five Auditor X Growth -0.023 -0.022

(0.016) (0.016)

Cross-listed X Growth -0.056 -0.050

(0.041) (0.041)

Growth -0.056 *** -0.057 *** -0.058 *** -0.056 ***

(0.009) (0.009) (0.009) (0.009)

Size 2.511 *** 2.343 *** 2.587 *** 2.501 ***

(0.112) (0.116) (0.114) (0.120)

Profitability 1.487 *** 1.484 *** 1.489 *** 1.483 ***

(0.034) (0.034) (0.034) (0.034)

N 14766 14766 14766 14766

R-squared 0.270 0.271 0.271 0.272
The table reports regression coefficients of dividend payout ratios on corporate governance indicators, interactions
of the indicators with growth, and control variables. Focused means the firm operates in just one two-digit SIC
industry. Big Five Auditor means the name of the firm's auditor is one of the Big Five international firms. Cross-
listed means the firm's stock is listed in the U.S. (directly or as a Level II or III ADR). Financial data come from
Worldscope. Growth is the one-year growth rate in total assets, profitability is return on assets, and size is the log
of total assets. Heteroskedasticity-robust standard errors are reported below coefficients in parentheses. Asterisks
denote levels of significance (***=1%, **=5%, *=10%). Also estimated but not reported are full sets of industry
and country dummy variables.