Events at CERGE-EI

Jiří Tresl, Ph.D.

University of Nebraska-Lincoln, USA

Authors: Paul Brockman, Jiri Tresl, and Emre Unlu

Abstract: Using the time-invariant institutional characteristics of 21 countries, we are able to control for endogeneity and establish a directional relationship between the value of smooth dividends and agency costs. We document a positive impact of smooth dividends on firm valuation that is decreasing in stronger shareholder protection rights. We argue that companies use dividend smoothing as a bonding mechanism to mitigate agency costs of equity which investors reward. This bonding framework of dividend smoothing also sheds some light on why smoothing in the US has increased over time. Consistent with our findings, we argue that the necessity to smooth dividends has increased over time due to increasing repurchase-for-dividend substitution, which is previously documented in Grullon and Michaely (2002). On average, $1 paid out through dividends contributes to equity value by about 40% more than $1 paid out in repurchases. Managers have been maximizing equity value by managing the enormous payout burden of the dividend-repurchase substitution through smoothing dividends.  Consistently, we show that firms that pay smoother dividends substitute dividends for repurchases at a 23% faster rate than the firms with less smooth dividends. Overall, these results support the view that dividend smoothing is a bonding mechanism used to undo the agency cost discount on equity valuation.

Keywords: Payout policy, Dividend smoothing, Firm valuation, Agency costs

JEL: G35, G38

Full Text:  “Market Value of Smooth Dividends for Firms with High Agency Costs”