Regulatory Dualism as an Alternative Trust‐Enhancing Mechanism for Dividends and Debt: Evidence from Brazil*

• Published date: 01 March 2021
• Author: María Belén Lozano,Félix J. López‐Iturriaga,Victor Hugo Braz‐Bezerra
• Date: 01 March 2021
• DOI: http://doi.org/10.1111/irfi.12259

Regulatory Dualism as an

Alternative Trust-Enhancing

Mechanism for Dividends and Debt:

Evidence from Brazil*

MARÍA BELÉN LOZANO

†

,FÉLIX J. LÓPEZ-ITURRIAGA

‡,§

AND

VICTOR HUGO BRAZ-BEZERRA

†

†

Financial Economics and Accounting Department, Instituto Multidisciplinar de

Empresa, University of Salamanca, Salamanca, Spain

‡

Financial Economics and Accounting Department, University of Valladolid,

Valladolid, Spain and

§

NRU Higher School of Economics, Moscow, Russia

ABSTRACT

We test whether a market-level corporate governance reform in Brazil

influences the behavior of firms. To do so, we first verify whether the

Novo Mercado (NM)—the segment applying more stringent corporate

governance practices—impacts specificfirms’financial characteristics. We

also investigate if it impacts firms’dividends and leverage, two well-

known mechanisms for mitigating agency problems. Results show the

NM impacts many firms’characteristics and reduces firms’dividends and

leverage. We thus claim that market-level reform may be an effective

trust-enhancing mechanism and may improve minority investor protec-

tion, thus providing evidence that a country’s institutional setting can

evolve over time.

JEL Codes: G31; G35

Accepted: 15 February 2019

I. INTRODUCTION

Previous finance literature emphasizes the importance of dividends and corpo-

rate debt to alleviate conflicts between controlling and minority shareholders

(Jensen and Meckling 1976; Rozeff 1982; Jensen 1986). From this perspective,

distributing more dividends or increasing leverage in companies reduces the

* The authors are grateful to Sudipto Dasgupta, Philip Jaggs, and an anonymous referee for sugges-

tions and comments on previous versions of the paper. All the remaining errors are the authors’sole

responsibility. This work was supported by Spanish Ministry of Science and Technology (grant num-

bers ECO2017-84864-P), Russian Science Foundation under grant 15-18-20039 and by CAPES [grant

number 99999.000996/2015-07]. Any remaining errors are the authors’sole responsibility.

© 2019 International Review of Finance Ltd. 2019

International Review of Finance, 21:1, 2021: pp. 121–144

DOI: 10.1111/irfi.12259

free cash flow that might otherwise be used for purposes detrimental to minor-

ity shareholder interests. In this sense, La Porta et al. (1997, 1998) add that a

country’s legal origin is of major importance vis-à-vis minority shareholder pro-

tection. These authors also find that common law countries evidence a higher

distribution of dividends and attribute these results to the better protection pro-

vided by these countries to minority shareholders (La Porta et al. 2000). Later

studies, however, have found mixed evidence on these issues (Chae et al. 2009;

Bot¸oc and Pirtea 2014; John et al. 2015; Athari et al. 2016), suggesting that the

effects of the institutional setting on firms’financial policies may be affected by

questions other than their static legal origin.

The present study focuses on Brazil, a French civil law country with many

problems related to minority shareholder protection. Previous literature

describes Brazil as a country with traditionally high levels of private control

benefits and both weak legislation and firm-level governance (Black et al. 2012),

high ownership concentration (Gorga 2009), and inherent problems of infor-

mation asymmetry (Moreiras et al. 2012). Nevertheless, in recent years, the Bra-

zilian securities market has undergone many reforms in an effort to make it

more attractive to investors. Most importantly, the main Brazilian stock

exchange (B3), launched a voluntary reform program comprising three seg-

ments with varying corporate governance requirements: Nível 1(Level 1; N1),

Nível 2(Level 2; N2), and the Novo Mercado (New Market; NM).

This voluntary reform is based on functional convergence (or regulatory

dualism), namely, the notion that improvements in minority shareholder pro-

tection in countries displaying weak corporate governance must occur at the

securities market level due to the difficulties associated with reforming laws in

these countries (Coffee 1999). However, the literature presents contrasting

views on the effectiveness of functional convergence. Johnson and Shleifer

(2000), for instance, point out that the lack of strong laws, an efficient judicial

system, or a fair regulator reduce the possibility of enforcing contracts or laws

and, thus, that investor protection remains low.

In this context, the first research question we address is: (i) how does inclu-

sion in the NM impact on firms’financial policies? Previous literature has docu-

mented that in addition to dividends and leverage, corporate governance

mechanisms impact on many firms’policies and characteristics such as their

cash holdings (Dittmar et al. 2003; Dyck and Zingales 2004; Pinkowitz et al.

2006; Kusnadi and Wei 2011; Durán et al. 2016), investment (Gugler 2003;

Honoré et al. 2015; McCahery et al. 2016), performance (Achim et al. 2016),

and firm value (Fan and Yu 2016). Therefore, we contend that if the NM

strengthened minority shareholder protection, then it should affect other

financial characteristics of Brazilian listed firms.

After examining the effect of the NM on firms’general characteristics, the

second issue we address is (ii) do Brazilian listed firms use the NM as a substi-

tute for dividends and debt as trust-generating mechanisms? We conjecture

that, if the NM were effective in improving minority shareholder protection, in

line with the previous literature, then it might also affect firms’dividends and

© 2019 International Review of Finance Ltd. 2019122

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