Do terrorist attacks matter to dividend policy?

• Published date: 01 May 2022
• Author: Trung K. Do
• Date: 01 May 2022
• DOI: http://doi.org/10.1111/corg.12405

ORIGINAL ARTICLE

Do terrorist attacks matter to dividend policy?

Trung K. Do

Department of Economics, Danang

Architecture University, Danang, Vietnam

Correspondence

Trung K. Do, Department of Economics,

Danang Architecture University, 566 Nui

Thanh Str., Hai Chau Dist., Danang 50218,

Vietnam.

Email: trungdk@g.ncu.edu.tw

Abstract

Research Question/Issue: Motivated by the importance of dividend policy in corpo-

rate finance as well as the rising frequency and severity of terrorism in society, this

study aims to investigate whether and how dividend policy is influenced by terrorist

attacks.

Research Findings/Insights: Using a comprehensive sample of terrorist attacks

occurring in the United States between 1994 and 2015, we find that relative to firms

located in safety areas (nonimpact firms), firms headquartered in terrorism-affected

areas (impact firms) are more likely to pay dividends and pay higher amount of cash

dividends. We further find that the effect of terrorist attacks on dividends is driven

by agency costs of free cash flow.

Theoretical/Academic Implications: We contribute to the literature by shedding light

on how terrorism affects firms' dividend preferences. We highlight that uncertainty

caused by terrorism heightens the need for dividend payouts in the presence of free

cash flow. Our paper also adds to the existing literature by showing that better

corporate governance quality as defined by a more independent board featuring

CEO–chairman separation and greater presence of independent directors coupled

with larger institutional ownership has a crucial role in mitigating the impact of terror-

ism on corporate payout policy.

Practitioner/Policy Implications: Public firms should regard dividend policy as a

governance tool that reduces agency costs during times of uncertainty. The results of

this study strengthen the idea that institutional investors can play a key role in

corporate governance. As such, for investors, as far as agency costs are concerned,

investments in firms that have a higher proportion of institutional holdings are

sensible.

KEYWORDS

corporate governance, agency theory, dividend payouts, terrorist attacks

1|INTRODUCTION

Threats of terrorism have continuously spread in recent years.

According to the Global Terrorism Index by the University of

Maryland, College Park, two out of every three indexed countries in

2017, or 106 nations, experienced at least one terrorist attack. With

respect to economics and finance, terrorism has received much atten-

tion from researchers recently. The impact of the 9/11 terrorist

attacks on stock markets has indicated that terrorism risk is a new

type of catastrophic risk that investors and firms may be facing. In this

study, we focus on the impact of terrorism on dividend policy—one of

the major financial decisions for companies. Since the publication of

the dividend irrelevance hypothesis by Miller and Modigliani (1961),

extensive works have suggested different explanations of the divi-

dend policy puzzle, such as “bird-in-the-hand”(Gordon, 1963; Lintner,

1962), tax-preference (Litzenberger & Ramaswamy, 1979), signaling

Received: 9 June 2020 Revised: 11 September 2021 Accepted: 14 September 2021

DOI: 10.1111/corg.12405

354 © 2021 John Wiley & Sons Ltd Corp Govern Int Rev. 2022;30:354–372.wileyonlinelibrary.com/journal/corg

(Bhattacharya, 1979; Lang & Litzenberger, 1989), agency-cost

(Easterbrook, 1984; Jensen, 1986), and catering (Baker & Wurgler,

2004) theories. Motivated by the importance of dividend policy in

corporate finance as well as the rising frequency and severity of

terrorism in society, this paper aims to investigate how dividend policy

is influenced by terrorist attacks.

It has long been recognized that the risk associated with terrorism

can substantially affect the financial markets and business activities

(Abadie & Gardeazabal, 2008; Eldor & Melnick, 2004; Karolyi &

Martell, 2010; Papakyriakou et al., 2019). Arin et al. (2008) show that

terror has a significant impact on both stock markets and the stock

market volatility. Chesney et al. (2011) find that terrorist attacks lead

to a negative effect on stock markets in 25 countries over the period

1994–2005. Furthermore, terrorism has been described to have

adverse consequences on cost of debts (Procasky & Ujah, 2016), audit

fees (Guan et al., 2016), pricing of initial public offerings (Chen

et al., 2020), mergers and acquisitions (Nguyen et al., 2020), and

corporate innovation (Fich et al., 2020).

Regarding psychological sequelae, prior studies indicate that

terrorist attacks can influence individual psychological traits and

that this effect is greater when a person is in close proximity to

such events (Ahern, 2018; Fischhoff et al., 2005). For example,

Brodeur (2018) demonstrates that terrorist attacks reduce the

number of jobs and total earnings in targeted areas and increase

levels of consumer pessimism in terms of business conditions.

Antoniou et al. (2017) and Chen et al. (2020), respectively, show

that managers who are local to attack events adopt more conserva-

tively corporate policies and issue more negatively biased earnings

forecasts. Also, Cuculiza et al. (2021) show that affected analysts

issue forecasts that are relatively more pessimistic than the consen-

sus forecast. Dai et al. (2020) indicate that CEOs, who face

increased psychological stress caused by terrorist attacks, demand

larger compensation packages in order to compensate them for

their perceived loss of well-being. In line with these studies, it is

plausible to posit that terrorist attacks affect firm behavior con-

cerning dividend payments.

Terrorist attacks may be negatively associated with dividend

policy. Obviously, beyond the loss of human life and the destruction

of property, there are enormous costs associated with terrorist

attacks, such as reduced buyer demand due to fear and uncertainty,

interrupted supply chains (delayed shipments), increased corporate

expenses, and reduced supply of foreign capital (Czinkota

et al., 2010; Eckstein & Tsiddon, 2004; Procasky & Ujah, 2016).

Greater market risks and higher operation costs caused by terrorist

attacks will lead to higher volatility of cash flow. The more volatile

future cash flow means higher risk related to the future earnings.

According to information signaling theory (Bhattacharya, 1979), man-

agers will lower the dividend in case the firm cannot distribute the

announced amount when the future cash flow is uncertain. Thus, in

response to terrorist attacks, firms might retain a greater portion of

their earnings, reduce payout, and save the cash for future invest-

ment. Consistent with this view, Bliss et al. (2015) find that firms

react to the 2008–2009 financial crisis by significantly decreasing

payouts to maintain cash levels and fund investment. Furthermore,

given that dividends are sticky and that decreasing dividends may

suffer a severe decline in firm value (Chay & Suh, 2009), unless firms

are confident of their ability to maintain high levels of dividends,

they tend to avoid paying high dividends in the presence of terrorist

attacks, which is more likely to be related to a high degree of cash

flow uncertainty.

In contrast to the above argument, terrorist attacks may posi-

tively affect corporate payout policy for the following reasons.

First, according to the agency theory, paying dividends is used to

take away the free cash from the control of managers and ensure

that they will have to approach the capital market in order to meet

funding needs for new projects. Dividends bind managers to a

long-term commitment and expose them to monitoring by the mar-

ket (Easterbrook, 1984; Jensen, 1986). An increase in dividends will

lead to a decrease in free cash flow, thereby lowering agency

costs. The larger the variance of cash flow, the greater the poten-

tial agency costs and the more reliance on dividend distribution.

The dividend payout to guard against non-value maximizing invest-

ments should be greatest for the firms with the highest cash flow

uncertainty (Bradley et al., 1998). Given that agency costs are

more pronounced during times of uncertainty because of the larger

cash flow variance (Attig et al., 2021; Boubakri et al., 2010;

Duchin & Schmidt, 2013), the monitoring role of dividends is

expected to be more important when firms suffer from terrorism.

Therefore, firms are more likely to use dividends as a device to

reduce agency costs of free cash flow during periods characterized

by terrorism. We refer to this argument as the agency conflict

hypothesis.

Second, by posing severe personal safety threats, terrorism can

induce strong negative feelings such as fear, anxiety, and depression

and subsequently alter individuals' risk taking. Caplin and Leahy

(2001) develop a model that incorporates anticipatory emotions into

a risk-averse agent's preference for risky assets. The model predicts

that investors experiencing anxiety will hold fewer risky assets and

increase their allocation of safer assets that provide more secure

returns. Developing this idea further, Wang and Young (2019) show

that in response to psychological distress induced by terrorist

attacks, households significantly reduce their trading activity and

equity ownership, are less likely to enter the market, and increase

the value of their savings accounts.

1

Hence, terrorist attacks, which

are characterized by increased feelings of fear, anxiety, and stress,

may increase investors' preference for the “bird in the hand”of cash

dividends over the “two in the bush”of future capital gains

(Gordon, 1963; Lintner, 1962). To the extent that household stock

ownership tends to be local (Becker et al., 2011) and that firms pay

dividends to cater to investor demand for dividends (Baker &

Wurgler, 2004), impacted firms following a terrorist attack are more

likely to face demand for dividends by local shareholders. In short,

investors' demand may play an important role in motivating firms to

increase their dividend payouts following the negative shock

resulting from terrorism. We term this argument the local investor

demand hypothesis.

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