Corporate governance and payout policy: evidence from India

Published date07 October 2019
Date07 October 2019
Pages1117-1132
DOIhttps://doi.org/10.1108/CG-07-2018-0258
AuthorMonika Rajput,Shital Jhunjhunwala
Subject MatterStrategy
Corporate governance and payout policy:
evidence from India
Monika Rajput and Shital Jhunjhunwala
Abstract
Purpose The purpose of this paper is to study the impact of ownership structure and corporate
governance on dividendpolicy in emerging markets, like India. The studyalso analyses the moderation
effectsof board independence between ownership anddividend payout.
Design/methodology/approach The data set of 1,546 Indian firms over the period of 2006-2017
has been used in this study. Tobit and logistic regression methods has been used. The data used
in this study are collected from the Centre for Monitoring Indian Economy (CMIE) Prowess
database. The sample firms are listed on Bombay Stock Exchange (BSE) and National Stock
Exchange (NSE).
Findings First, the study findsa significant positive influence of corporategovernance on the decision
to pay dividend and is an important determinant of the payout decision. Second, the study finds a
significant negativerelationship of family ownership with dividend payout decisionswhich indicates that
family firms pay lower dividend.Finally, the result from the interaction effect of board independencewith
familyownership has significant positive influenceon dividend policy.
Originality/value This is one of the first attempt to show that there is an interaction between
independent board and ownership structure. It shows that more independent and non-executive
directorsin the board of family controlled firms are likelyto pay more dividends.
Keywords Family firms, Corporate governance, Dividend policy
Paper type Research paper
1. Introduction
Dividend is the distribution of residual profit among the shareholders, the suppliers of
finance. Elucidating dividend policy has been one of the most backbreaker challenges
faced by financial economists. Despite numerous studies, it is still difficult to
understand the factors which influence dividend policy, and how these factors interact
with each other. More than 40 years ago, Black (1976) wrote, “the harder we look at the
dividend picture, the more it seems like a puzzle, with pieces that just don’t fit together”
(p. 5). The situation is pretty much the same today. In a recent study of dividend policy,
“much more empirical and theoretical research on the subject of dividends is required
before a consensus can be reached” (Allen and Michaely, 1995, p. 833). Dividend acts
as a governance mechanism to control manager-shareholder agency problem, as it
decrease the available cash, which could potentially be expropriated otherwise
(Easterbrook, 1984;Faccio et al., 2001). According to agency theory, managers have
an opportunity to use corporate resources in ways that benefit their own interests and
not the funds suppliant (Jensen, 1986). Paying higher dividend to shareholders
subsides the magnitude of agency conflict (Ben-Nasr, 2015;Firth et al., 2016). Rozeff
(1982) introduced agency cost as likely explanation of dividend policy and found
significant relationship between dividend policy and agency costs. The question arises
then how a firm’s director can be persuaded to pay higher dividends when their
personal inclination is to retain cash.
Monika Rajput is a research
scholar at the Delhi School
of Economics, Faculty of
Commerce and Business
Studies, University of Delhi,
New Delhi, India.
Shital Jhunjhunwala is an
associate professor at the
Delhi School of Economics,
Faculty of Commerce and
Business Studies,
University of Delhi, New
Delhi, India.
Received 31 July 2018
Revised 6 March 2019
Accepted 28 April 2019
DOI 10.1108/CG-07-2018-0258 VOL. 19 NO. 5 2019, pp. 1117-1132, ©Emerald Publishing Limited, ISSN 1472-0701 jCORPORATE GOVERNANCE jPAGE 1117
One of the significant studies that captured the governance role of dividend is of La Porta
et al. (2000a,2000b). Dividend can be used to minimize the possible misuse of futile cash,
as it is proportionally distributed amongshareholders, shift firm’s wealth from the controlling
shareholders (La Porta et al., 2000a,2000b).They proposed two models of dividend policy,
namely, “Outcome Model” and “Substitute Model”. The “Outcome Model” predicts that
minority shareholders in common law countries, where investor protection is high, bring
pressure on directors to pay dividends and reduce free cash flows. On the other hand
“Substitute Model” predicts in civil law countries where investor rights are weak, firm’s
managers pay higher dividends as a way to build reputation. Motivated by the significance
of board’s dividend payout decision in emerging economies like India, the impact of
ownership structure and board composition on dividend policy of firms is analyzed in this
study. Using the data set of 1,546 firms over the period of 2006-2017, the Tobit and Probit
regression estimates show strong and robust evidence that board independence and
board size is significantly related to dividend. The results show that if the board members
are independent and non-executive, they take the decision to pay more dividends as
compared to executive directors. In line with this statement the results supports the
outcome hypothesis proposed by La Porta et al. (2000a,2000b). Further, it is found that
there is a moderation role of board independence between the family ownership and
dividend policy.
The governance role of board of directors is the “soul” of corporate governance as
shareholders have vicarious authority on the board to supervise and control the
decisions made by upper management (Fama and Jensen, 1983). According to the
agency theory, firms might minimize agency costs by forming proper monitoring
systems and using board governance to efficiently supervise managers (Byrd and
Hickman, 1992;Fama and Jensen, 1983). Several previous studies have observed the
influence of various characteristics such as board size, outside/non-executive directors
(Sawicki, 2009;Officer, 2011;Al-Najjar and Hussainey, 2009, etc.), director’s age, and
their experience (Cust
odio and Metzger, 2014) on the dividend policy. To protect the
interest of shareholders, regulatory and legislative bodies have increased their
pressure on firms to increase the board independence for good governance.
Subsequently companies have started to respond by increasing the number of outside
directors on board. Several studies have analyzed the impact of board composition on
agency problem (Jiraporn and Ning, 2006;Sawicki, 2009;Al-Najjar and Hussainey,
2009) and found that presence of independent directors on board reduces the agency
problem by influencing dividend payout. Although these studies give the useful insight
into the advancement and importance of independent directors. However, the empirical
investigation mainly focused on developed countries.
The regulatory environment in emerging economies is highly different from developed
economies which generally have weak external regulatory and discipline mechanism (La
Porta et al., 2000a,2000b). The main arguments on agency problem is focused on
developed economies which may not be equally relevant in the context of emerging
economies where principal principal conflict between majority and minority is more
prominent. India has emergedwith the largest block of family businesses where 67 per cent
of all listed companies are family controlled firms (PWC Survey, 2016). Corporate
governance is a major concern in Indian family businesses and is one of the biggest
problems for many investors who want to invest in India. The ownership is the important
aspect of governance which also determine the dividend policy. Kumar (2006) considers
three aspects of ownership group holding viz. family controlled firms, domestic institutional
ownership and foreign institutional ownership. Out of three, only family ownership is
significantly related to dividend policy of the firms. This study suggests that conflicting
inclinations in institutional setting of developing markets may influence the effect of board
composition on dividend policy.
PAGE 1118 jCORPORATE GOVERNANCE jVOL. 19 NO. 5 2019

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