Payout Policy and the Interaction of Firm- and Country-level

Governance∗

Richard Herron†

January 15, 2017

Abstract

For a panel of 1900 firms across 21 countries over 2004 to 2008 the impact of firm- and

country-level governance on payout policy is consistent with the La Porta, Lopez-de-Silanes,

Shleifer, and Vishny (2000) outcome model. In weak legal regimes dividend and repurchase

payout ratios increase in firm-level governance. In strong legal regimes dividend payout ratios

decrease in firm-level governance and repurchase payout ratios increase, which suggests a sub-

stitution from dividends to repurchases. These results are robust to an instrumental variable

(IV) approach, alternative payout ratio definitions, and alternative firm- and country-level gov-

ernance measures. An alternative firm-level governance measure verifies these results in a larger

panel of 9461 firms over 2002 to 2011.

JEL classifications: G35, G34, G15

Keywords: Payout Policy, Corporate Governance, International Financial Markets

∗Thank you for helpful comments and discussions to Jay Dahya and Jerome Taillard, as well as seminar participantsat Baruch College. Earlier versions of this paper circulated as What matters more in governance? Firm or country?.†Finance Division, Babson College. 326 Tomasso Hall, Babson Park, MA 02457-0310, United States. Office

number 781-239-3835. Fax number 781-239-5004. rherron1@babson.edu.

1 Introduction

A large corporate governance literature examines the role of firm- and country-level governance

around the world, but does not fully connect firm- and country-level governance to the mechanism

through which investors ultimately receive returns: both cash dividends and share repurchases. I

fill this void by examining payout policy and the interaction of firm- and country-level governance

for 1900 firms across 21 countries over 2004 to 2008. A longer panel would be preferable, but

these are the five years for which Aggarwal, Erel, Ferreira, and Matos (2011) provide Gov41, a

well-understood firm-level governance measure.1 I find that around the world both cash dividends

and share repurchases fit the outcome model in which shareholders use additional rights to achieve

return of capital. In weak legal regimes shareholders use additional rights to extract both cash

dividends and share repurchases. However, in strong legal regimes shareholders use additional

rights to substitute from cash dividends to share repurchases. This substitution is better for both

firms and shareholders, but requires a stronger overall governance environment to ensure return of

capital and avoid expropriation.

The relation between payout policy and firm- and country-level governance is interesting for at

least two reasons. First, La Porta, Lopez-de-Silanes, Shleifer, and Vishny (1997, 1998, 2000) and

Djankov, La Porta, Lopez-de-Silanes, and Shleifer (2008) investigate country-level governance and

conclude that some countries offer investors stronger legal protection than other countries. Stronger

legal protection results in greater financial development, less expropriation of shareholder wealth,

and greater return of capital to investors via cash dividends. Given that firms and investors may

find it difficult to change their residency, it is important to understand the relation between payout

policy and firm-level governance in the context of country-level governance.

Second, given firms’ and investors’ residency constraints, firm-level governance improvements

may be the most feasible way for firms to commit to return capital and for minority sharehold-

ers to avoid expropriation. The efficacy of firm-level governance improvements, conditional on

country-level governance, is not yet fully understood. The extant literature suggests that firm-level

governance has little value when country-level governance is low. For example, Doidge, Karolyi, and

1. This panel is sufficient for Aggarwal et al. (2011) to find a relation between firm-level governance and interna-tional institutional investors and Aggarwal, Erel, Stulz, and Williamson (2010) to find a relation between firm-levelgovernance and valuations.

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Stulz (2007) show that firm-level characteristics matter little relative to country-level characteristics

in weak legal regimes and that firm-level characteristics matter only once country-level shareholder

protection exceeds some threshold. Aggarwal et al. (2010) show that firm- and country-level gov-

ernance are complements, and that higher country-level governance makes it optimal to invest in

firm-level governance. Aggarwal et al. (2011) show that foreign institutional investors in general,

and U.S. institutional investors in particular, demand improvements in firm-level governance.

Mitton (2004) provides a one-year, cross-sectional analysis of dividend payout policy and firm-

level governance for 365 firms. He finds a positive relation between dividend payout ratios and

firm-level governance, but only in strong legal regimes. I extend Mitton (2004) along several

dimensions. First, I examine both cash dividends and share repurchases. Von Eije and Megginson

(2008) show that share repurchases surge in the European Union (EU) over 1989 to 2004 and in my

sample more than half of firm-years repurchase shares. My comprehensive payout policy analysis

shows that the relation between firm- and country-level governance is a continuum and that payout

policy responses to firm-level governance depend heavily on the country-level legal environment.

Second, I analyze a panel rather than a one-year cross section. This panel provides enough

variation in firm-level governance that I can use an instrumental variable (IV) approach to resolve

the endogeneity between choices of payout policy and firm-level governance. In robustness tests

with alternative firm-level governance measures this panel expands almost ten fold to cover ten

years. Third, I also examine the payout initiation decision so that I cover every aspect of payout

policy. This includes payout initiation, payout level, and choice between cash dividends and share

repurchases. In all, the literature calls for a better understanding of the observable outcomes of

firm-level governance conditional on country-level governance.

My panel regressions show that dividend payout ratios increase in country-level legal investor

protection, consistent with La Porta et al. (2000). Also, there is a positive relation between dividend

payout ratios and firm-level governance and economic effect of firm-level governance is similar to

that of the country-level governance, consistent with Mitton (2004). These relations are not strictly

mechanical, as the correlation between firm- and country-level governance is 0.38. However, with

both firm- and country-level governance measures in the panel regression, country-level governance

dominates and the relation between dividend payout ratios and firm-level governance is neither

economically meaningful nor statistically significant. This introductory finding supports the belief

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that the importance of country-level governance dwarfs that of firm-level governance in corporate

payout decisions.

That country-level governance dominates firm-level governance does not imply that firm-level

governance does not affect payout decisions. Further analysis reveals complementarity between firm-

and country-level governance with respect to dividend and repurchase levels, as well as dividend

and repurchase initiations. I identify this complementarity by splitting the sample on country-

level governance and examining the relation between payout and firm-level governance. In weak

legal regimes both dividend and repurchase payout ratios increase in firm-level governance. These

positive relations suggest that in weak legal regimes increasing firm-level governance increases

shareholder rights and facilitates return of capital. These results are robust to an IV approach to

address the simultaneous choice of payout ratios and firm-level governance. As well, these results

are robust to different payout ratio definitions, Tobit regressions to address left-censored payout

ratios, and alternative firm- and country-level governance measures. The result that in weak legal

regimes improved firm-level governance relates to economically meaningful increases in dividend

and repurchase payout ratios is consistent with the La Porta et al. (2000) outcome model.

In strong legal regimes dividends decrease in firm-level governance, but repurchases increase in

firm-level governance. These results are consistent with a more nuanced outcome model in which

further increases in firm-level governance facilitate a substitution from dividends to repurchases.

If shareholders are confident that the firm will return capital when appropriate, the both firms

and shareholders should prefer share repurchases over cash dividends. This is because share repur-

chases are more flexible for firms and tax-advantaged for shareholders.2 Given the advantages of

repurchases over dividends, repurchases are a better outcome for shareholders with strong rights

and protections. Black (1976) ponders why dividends even exist in light of the advantages of share

repurchases.

Overall, in strong legal regimes improvements to firm-level governance result in lower cash

dividends, but higher share repurchases. This is consistent with a substitution from dividends to

repurchases. In weak legal regimes improvements to firm-level governance result in higher dividends

and repurchases. Both are consistent with the La Porta et al. (2000) outcome model and an

2. This tax advantage may come in two forms. First, share repurchases allow shareholders to choose the timing oftaxable events. Second, in some countries the tax code advantages capital gains over dividends.

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improved return of capital to shareholders. Although the specifics differ between weak and strong

legal environments, in both regimes increases in firm-level governance lead to shareholders’ preferred

payout policy.

I next investigate payout initiation decisions and find that they are also consistent with an

outcome model that considers both dividends and repurchases. In weak legal regimes the rela-

tion between firm-level governance and both dividend and repurchase initiations are negative, but

economically small. This suggests that improved firm-level governance enables firms to postpone

the return of capital in the presence of profitable growth opportunities. In strong legal regimes,

the relation between dividend initiation decisions and firm-level governance is also negative, but

the relation between repurchase initiation and firm-level governance is positive. This lends further

support for an outcome model with substitution from rigid dividends to flexible repurchases. These

results are again robust to an IV approach, alternative specifications, alternative definitions of weak

and strong legal environments, and alternative definitions of firm-level governance.

My robustness tests include an alternative firm-level governance measure: the service of either a

U.S.- or U.K.-based director on the board of directors of a non-U.S. or non-U.K. firm. Gov41 is well

understood and provides continuous variation in firm-level governance, but it is one perspective

on firm-level governance and limits the sample to the largest firms in 21 countries. The U.S. and

U.K. director indicator variable also offer an out of sample test because they are available for more

firm-years, both in the cross section and the time series. The alternative firm-level governance

measure results are not strictly mechanical because in sample the correlation between U.S.- and

U.K.-director indicator variables and Gov41 is low, in both levels and changes.

In weak legal regimes the director indicator variables relate to higher share repurchase and

total payout ratios. In strong legal regimes the director indicator variables related to lower divi-

dend payout ratios and higher share repurchase ratios, again consistent with the substitution from

dividends to repurchases. The results are the same with respect to payout initiation decisions.

Directors delay dividend initiation in both high and regimes, which is consistent with initiation

being a less reversible decision than adjustments to payout ratios, but significantly increase the

probability of repurchases in strong legal regimes. The alternative firm-level governance results are

qualitatively similar to my main results. As with Gov41, the choice of a U.S. director and choice

of payout ratios is endogenous and these results are robust to an IV approach.

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I proceed as follows. Section 2 reviews the related literature and Section 3 describes my data.

Section 4 provides the key results with respect to dividend and repurchase ratios, as well as dividend

and repurchase initiations. Section 5 provides robustness checks, including an alternative firm-level

governance measure that allows a larger panel in Section 5.4. Section 6 concludes.

2 Literature Review

I connect three literatures that address the impact of country-level governance on corporate de-

cisions, the relation between firm- and country-level governance, and the determinants of payout

policy around the world. My contribution is identifying the impact of firm-level governance on

payout policy in the context of country-level governance.

The first literature focuses on country-level governance and its impact on corporate decisions.

La Porta et al. (1998) begin this literature and La Porta et al. (2000) examine the relation between

country-level governance, investment opportunities, and dividend payout ratios. They propose two

competing hypotheses on dividend payout policy. Under their outcome hypothesis, dividends are

the outcome of good governance so that dividend payout is higher in strong governance regimes

because this is where shareholders’ rights are strong enough to force management to return capital.

The outcome model predicts that dividend payout decreases in investment opportunities in strong

governance regimes because shareholders forgo return of capital to facilitate investment, confident

that they will be able to force dividend payout when investment opportunities decrease. Under their

substitute hypothesis, dividends are an adaptation that compensates for weak governance so that

dividend payout is higher in poor governance regimes. The substitute model predicts an ambiguous

relation between growth opportunities and dividend payout because of the tension between the need

to return capital to investors to initially raise capital and the need retain capital to invest in growth

opportunities.

La Porta et al. (2000) find support for the outcome model and observe higher dividend payout

ratios in strong governance regimes. As well, they find that dividend payout ratios decrease in

investment opportunities in strong governance regimes, but are unrelated to investment opportu-

nities in weak governance regimes. It could be that firm-level governance explains some portion of

the unexplained variation in payout ratios in weak and strong governance regimes. As well, the

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impact of firm-level governance could vary significantly across weak and strong governance regimes.

Pinkowitz, Stulz, and Williamson (2006) use Fama and French (1998) valuation regressions to

determine the marginal value of cash and dividends in countries around the world. They hypoth-

esize that because minority shareholders fear expropriation from majority shareholders, minority

shareholders in weak legal regimes value cash less and dividends more. They find support for

both hypotheses. I contribute to this literature by examining how shareholders in different legal

regimes use additional rights to influence payout policy, including both cash dividends and share

repurchases.

The second literature examines firm-level governance in an international setting, but typically

as an outcome, rather than as a cause. Aggarwal et al. (2010) look at the amount of firm-level

governance around the world and find complementarity between firm- and country-level governance.

They posit that firms with lower firm-level governance choose lower firm-level governance because

the costs of higher firm-level governance exceed the benefits, given their country-level governance.

Aggarwal et al. (2011) connect international institutional investment flows and firm-level governance

changes in 23 countries over 2003 to 2008. They conclude that changes in institutional ownership

positively affect changes in firm-level governance, but not vice versa. They connect firm-level

governance changes to observable outcomes, such as CEO turnovers and firm valuation gains. Their

firm-level governance measure is Gov41, which I also use and discuss in more detail in Section 3.

Aggarwal et al. (2011) highlight the demand for firm-level governance, which suggests that there

may be additional benefits to firm-level governance, including some of the variation in dividend

payout policy that La Porta et al. (2000) are unable to explain.

Doidge et al. (2007) use the source data for Gov41, as well as Credit Lyonnais Securities Asia

(CLSA) data, and show that country characteristics matters more than firm characteristics in

determining firm-level ratings in weak legal regimes. In strong legal regimes firm characteristics

explain a larger fraction of the variation in firm-level ratings. They propose that the net benefit

of firm-level investor protection is lower when country-level corporate governance is weaker. This

is because firm-level governance is more costly when the country-level legal framework is weak and

less beneficial when the country’s capital markets are less developed. As a result, firms invest less

in corporate governance. I contribute here by determining if payout policy changes as firm-level

governance changes, and if this response varies with country-level governance.

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The third literature focuses on dividend and repurchase determinants in the U.S. and around

the world. Fama and French (2001) investigate the attributes of firms that pay dividends to answer

the fundamental question of who pays dividends. Their objective is to better understand the large

decline in dividend payers in the U.S. from 67 % in the late 1970s to 21 % in the late 1990s. They

conclude that large, profitable firms are more likely to pay dividends and that firms with better

investment opportunities are less likely to pay dividends. This framework identifies two sources of

the decline in dividends. First, there was a decline in the fraction of firms that are likely to pay

dividends. Second, there was a decline in the propensity of any given firm to pay dividends. They

conclude that these two mechanisms are equally responsible for the disappearing dividends trend.

DeAngelo, DeAngelo, and Stulz (2006) build upon Fama and French (2001) and propose the

life-cycle theory of dividends. The life-cycle theory is that young firms have large investment op-

portunities but little capital, so retention dominates distribution. As firms mature their investment

opportunities decrease and their cumulative profits increase, so they distribute excess capital as

dividends. DeAngelo et al. (2006) proxy firm life-cycle with the earned-to-contributed-equity ratio,

which is the ratio of retained earnings to total equity. Firms with relatively low retained earnings

will be reliant on external capital to fund investment opportunities and will be less likely to pay

dividends. Firms with relatively high retained earnings will be largely self-financing and more likely

to pay dividends. DeAngelo et al. (2006) find strong empirical support for their life-cycle theory

of dividends and conclude that it exaggerates the Fama and French (2001) disappearing dividends

trend.

Skinner (2008) complements this literature by documenting a substitution from dividends to

share repurchases in U.S. firms. He finds that U.S. firms that only pay dividends are increasingly

rare and that repurchases are increasingly used in place of dividends, even among firms that pay

dividends. The increasing popularity of share repurchases allows firms to delay dividend initiation

and explains a large fraction of the declining propensity to pay dividends that Fama and French

(2001) and DeAngelo et al. (2006) document. Skinner (2008) proposes that share repurchases

are substitutes for dividends and have become the predominant payout mechanism, with even the

major dividend payers returning large amounts of capital via repurchases.

These three domestic studies provide the framework for two international studies. Denis and

Osobov (2008) extend Fama and French (2001) and DeAngelo et al. (2006) to six major economies

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(U.S., U.K., Canada, France, German, and Japan) and find that firms from these countries also

exhibit a declining propensity to pay dividends. Von Eije and Megginson (2008) use a larger sample

of 15 countries (European Union members over 1989 to 2005) to examine the evolving nature of

repurchases relative to dividends and find that international share repurchases follow the U.S. trend

with a ten-year lag. These papers are the first large-scale cross-country applications of propensity

to pay models, but do not address the impact of firm-level governance on payout choice around

the world. I extend this literature with a wider of panel of 21 countries and examine the impact of

firm-level governance on both payout level and initiation for both dividends and repurchases.

Mitton (2004) examines the relation between dividend payout level and firm-level governance

and finds a positive relation only in strong legal environments. I expand Mitton (2004) in several

ways. First, I examine the choice between cash dividends and share repurchases. Second, I use

a large panel of data with both time-series and cross-sectional variation. This facilitates an IV

approach to resolve the endogeneity between the choice of firm-level governance and payout policy.

Third, I examine every aspect of payout policy, including payout level and initiation. In short,

there’s a need to examine firm-level governance in the context of the country-level governance to

determine how firm-level governance impacts payout policy around the world.

3 Data

My main data are Worldscope annual data and I follow Denis and Osobov (2008) and Von Eije and

Megginson (2008) to generate firm fundamentals. Country-level governance data are from Djankov

et al. (2008) and firm-level governance data are from Aggarwal et al. (2011). The Aggarwal et

al. (2011) firm-level governance measure Gov41 limits my main analysis to large firms in the largest

economies over 2004 to 2008. Robustness checks in Section 5.4 relax this limitation with Bureau Van

Dyck (BVD) data on boards of directors and use U.S.- and U.K.-based directors as an alternative

firm-level governance measure.

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3.1 Firm-level Governance Data

The Aggarwal et al. (2011) firm-level governance measure is the least complete data, so I begin the

data discussion with Gov41.3 Aggarwal et al. (2011) provide Gov41, which they aggregate from

Risk Metrics data.4 Gov41 is the sum of indicator variables for 41 governance attributes multiplied

by 100 then divided by 41, so that Gov41 falls between 0 and 100. These 41 governance attributes

fall into four areas: board, audit, anti-takeover provisions, and compensation and ownership.5 See

Aggarwal et al. (2010) and Aggarwal et al. (2011) for a complete discussion of Gov41.

Aggarwal et al. (2011) document that Gov41 differs between country, with country averages

as high as 50% in the U.S. and Canada, but as low as 10% in Italy and Spain. Given that La

Porta et al. (2000) report a positive relation between country-level governance and dividend payout

ratios, this could weaken any finding of a relation between Gov41 and payout policy. My analysis

controls for country-level governance and follows the literature with firm random effects (REs) and

year fixed effects (FEs) to absorb unobserved heterogeneity.6

3.2 Firm-level Fundamental Data

Worldscope data from 2003 to 2008 provide firm fundamental variables for sample firms from 2004

to 2008.7 The main dependent variable is dividend payout ratio (D/Y), where dividends (D) is

Worldscope’s “Common Dividends Cash” and net income available to common shareholders (Y)

3. The Gov41 data are available here: http://faculty.msb.edu/aggarwal/Gov.xls

4. RiskMetrics covers U.S. firms that are members of any of the following indices: Standard & Poors’ (S&P) 500;S&P Small Cap 600; and Russell 3000. RiskMetrics also covers non-U.S. firms that are members of the followingmajor stock indexes: MSCI Europe, Australasia, and Far East Index (MSCI EAFE), which covers 1,000 stocks in21 developed countries outside North America; FTSE All Share Index, which consists of FTSE 100, FTSE 250, andFTSE SmallCap indices; FTSE AllWorldDeveloped index, which consists of the largest firms in developed markets;and S&P/TSX index of the Toronto Stock Exchange.

5. Board measures characteristics of the board of directors such as board independence, composition of committees,size, transparency, and how the board conducts its work. Audit measures independence of the audit committee andthe role of auditors. Anti-takeover provisions measure dual-class structure, role of shareholders, poison pills, andblank check preferred. Compensation and ownership measures executive and director compensation on issues relatedto options, stock ownership and loans, and how compensation is set and monitored. RiskMetrics sets each of these 41indicator variables to one if the firm exceeds some minimum level and zero otherwise. Gov41 is the average of theseindicators variables each firm-year, scaled to fall between 0 and 100. Unlike the revised anti-director and anti-self-dealing indices (Djankov et al. 2008), Gov41 has both cross-sectional and time-series variation. Some attributes maymatter more than others, but linear combinations of binary governance attributes have a foundation in the literature(e.g., Gompers, Ishii, and Metrick 2003; Bebchuk, Cohen, and Ferrell 2009). In any case, noise in these measuresmake it more difficult to find statistical relations. To the extent that de facto governance measures are noisy, a morede jure measure of appointment of U.S. director provides validation in Section 5.4.

6. Von Eije and Megginson (2008) use firm REs and La Porta et al. (2000) use country REs. My results arequalitatively similar with industry and year FEs.

7. The previous year’s data are necessary to generate total asset and sales growth rates.

9

is Worldscope’s “Net Income Before Extraordinary Items”. Untabulated robustness checks include

several other payout ratio denominators: operating cash flows (CF) is “Funds From Operations”

minus “Discontinued Operations”, if available, and sales (S) is “Net Sales or Revenues”. Skinner

(2008) shows that share repurchases comprise an increasingly large share of payout in the U.S. and

Von Eije and Megginson (2008) show the same trend around the world with a ten-year lag. Following

Von Eije and Megginson (2008), share repurchases (R) are “Common/Preferred Purchased, Retired,

Converted, Redeemed”. A firm is a dividend payer for a given year if cash dividends are positive

and a share repurchaser if share repurchases are positive.

In addition to Gov41, the independent variables include the Fama and French (2001) and DeAn-

gelo et al. (2006) payout predictors, which Denis and Osobov (2008) and Von Eije and Megginson

(2008) show relate to dividend and repurchase decisions around the world. Fama and French (2001)

propose that the main determinants of the decision to pay dividends are profitability, growth op-

portunities, and size, and DeAngelo et al. (2006) add the ratio of earned to contributed capital.

Following Denis and Osobov (2008), the profitability proxies is return on assets (E/A), which is

“Earnings Before Interest” divided by “Total Assets”, where “Earnings Before Interest” is “Net

Income After Preferred Dividends” plus “Interest Expense on Debt”, if available. The growth

opportunities proxies are the market-to-book-assets ratio (V/A is “Total Assets” minus “Com-

mon Equity” plus “Market Capitalization” divided by “Total Assets”) and total asset growth rate

(dA/A is change in “Total Assets” divided by this period’s “Total Assets”). The size proxy is the

size percentile within each country-year based on “Total Assets”. This approach avoids currency

conversion and is likely the best size metric within each country-year. The earned-to-contributed

capital ratio (RE/BE) is the ratio of “Retained Earnings” to “Book Equity”.

Gov41 limits my analysis to the largest firms in each market, so there are only modest additional

data requirements. Over 2004 to 2008 there are 197,896 firm-years in Worldscope without regard

to country. Limiting my main analysis to countries with Gov41 data further limits the analysis

to 140,669 firm-years. Dropping firm without Gov41 is the most significant data limitation and

reduces the sample to 26,452 firm-years. Requiring the main set of variables (D/Y, R/Y, V/A,

E/A, dA/A, Size, and RE/BE) reduces the sample 25,383 firm-years. I also drop the U.S. and

countries without at least five observations every year from 2004 to 2008.8 This provides the main

8. Gov41 is available for many U.S. firms, but dropping the U.S. avoids the “horse and rabbit stew” problem. In

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sample of 7566 firm-years. I Winsorize all ratios at 5 % in each tail. Table 1 provides the number

of observations by country and year.

Table 2 provides descriptive statistics for key payout and predictor variables by legal origin,

country, and firm-level governance quantile, where quantiles are above and below median Gov41

each country-year. Values in Table 2 are the time-series means of country-year-Gov41 quantile

medians. Panel A reports these values for common law countries and Panel B reports these values

for civil law countries.9 The median dividend payout ratio is positive in all country-Gov41 quantiles.

The median repurchase payout ratio is (near) zero for about one half of the country-Gov41 quantiles,

but untabulated results so that there are repurchasers in every country. There aren’t clear relations

between firm fundamentals and Gov41 by country, although consistent with Mitton (2004) high

Gov41 firms often have higher profitability.

3.3 Comparing Country-level and Firm-level Governance

As a first step to understanding the relation between dividend payout ratios and firm- and country-

level governance, Table 3 provides dividend payout ratio models with the dividend predictors (Denis

and Osobov 2008; Von Eije and Megginson 2008) and combinations of firm- and country-level gov-

ernance measures. Throughout I omit profitability (E/A) from payout ratio regressions because

earnings measures in the dependent variable denominator and an independent variable numerator

mechanically create a negative coefficient. Results with and without profitability are qualitatively

similar. The country-level governance measures include legal origin and the anti-self-dealing index

(Djankov et al. 2008). The firm-level governance measure is Gov41 (Aggarwal et al. 2011). Con-

sistent with Von Eije and Megginson (2008) all models include firm REs, year FEs, and cluster

standard errors by firm. In untabulated results my results are qualitatively similar if I replace

firm REs with two-digit SIC code industry FEs and cluster standard errors by industry. To avoid

negative dividend payout ratios I drop observations with non-positive net income (Y). Throughout,

I Winsorize all ratios at 5% in each tail.

Columns 1 and 2 include a common law indicator variable and the Djankov et al. (2008) anti-self-

dealing index, respectively, to control for country-level governance. These results are consistent with

untabulated results the U.S. results are similar to other common law country results.9. I follow La Porta et al. (2000) and don’t differentiate between different civil law origins. Civil law is the

remainder of countries without English legal origins.

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La Porta et al. (2000) and show that dividend payout ratios increase in country-level governance

and decrease in growth opportunities. The coefficient on the common law indicator is twice as large

as the coefficient on the anti-self-dealing index, but this is expected given that the anti-self-dealing

index mean and standard deviation are one half those of the common law indicator. Dividend payout

ratios decrease in growth opportunities. I proxy growth opportunities with total asset growth rates

to avoid reverse causality between the market-to-book-assets ratio (V/A) and dividend payout

ratio. My results are qualitatively similar if I proxy growth opportunities with either the market-

to-book-assets ratio or sales growth rate (dS/S). Column 3 replaces the country-level governance

measures with Gov41 and reports similar results. The Gov41 coefficient is two orders of magnitude

smaller than the country-level measure coefficients, but the economic significance is nominally the

same. The Gov41 mean and standard deviation are two orders of magnitude larger than those for

the country-level governance measures. The inferences from the other predictors remain the same.

When the dividend payout ratio regressions includes both firm- and country-level governance

measures, I find that country-level governance dominates firm-level governance. Columns 4 and

5 include both firm- and country-level governance measures and the coefficients on common law

and anti-self-dealing are unchanged, but those on Gov41 are not significantly different from zero.

These results suggest that both firm- and country-level governance matter, but that country-level

dominates.

Given the importance of firm-level governance in other studies, as well as its dependence on

country-level governance, it could be that there is more nuance in the relation between payout

policy and firm- and country-level governance. This is my focus as I examine payout policy and

the interaction of firm- and country-level governance.

3.4 Firm-level Governance Instrumental Variable

An implicit assumption so far is that firm-level governance is randomly assigned. However, given

Doidge et al. (2007), Aggarwal et al. (2010), and Aggarwal et al. (2011) this assumption is unlikely

to be correct and it is likely that firm-level governance is chosen each year alongside payout policy.

This simultaneous choice makes Gov41 endogenous, but an IV for Gov41 can address this problem.10

The Gov41 IV must be correlated with payout policy (relevance), but only through Gov41

10. Going forward I present only regressions with the Gov41 IV.

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(exclusion restriction). Aggarwal et al. (2011) show Gov41 varies in both the cross section and

time series, which makes the average Gov41 for all other firms in the same country-year a possible

IV. I refer to this average of all other firms in the same country-year as the leave-out average of

Gov41. For the leave-out average to be a valid instrument it must induce variation in firm-level

governance Gov41 and affect payout decisions only through this relation with Gov41. Aggarwal

et al. (2010) use a similar IV with valuation as the dependent variable. Aggarwal et al. (2011)

show that Gov41 improves in waves within each of these countries over the sample period, so it

could be that some portion of a given firm’s Gov41 improvements are due to a country-level trend

to improve firm-level governance.

This same IV motivation appears elsewhere in the literature. In the setting of U.S. governance,

John and Kadyrzhanova (2008) and John and Litov (2010) show that good governance leads to

good governance in peer firms. In a broader setting, Leary and Roberts (2014) show that peer firms

determine capital structure and financial policies, and that these peer effects are more important

than many other fundamental determinants. John and Kadyrzhanova (2008) define peer firms as

within the same state and Leary and Roberts (2014) define peer firms as within same three-digit SIC

code. John and Litov (2010) instrument firm-level governance [Gompers et al. (2003) G Index] with

the leave-out average at the industry-year level. Given my international setting the appropriate

peers are within country and year.11 Throughout, the leave-out average of Gov41 passes weak

instrument tests with first-stage F-tests greater than 10, as well as the more demanding Stock

and Yogo (2002) minimal F-test scores well beyond conventional significance levels. The exclusion

restriction that the leave-out average of Gov41 does not affect payout ratios, except through its

impact on firm-level governance must be maintained.

4 Results

La Porta et al. (2000) relate country-level governance and dividend payout ratios, but the dividend

decision has three aspects. First the firm must decide to initiate payout, second the level of payout,

11. My main results are qualitatively similar if I use the leave-out average at the country-industry-year level, whereindustry is either Fama and French (1997) 12-industry or one-digit SIC code. However, my robustness tests use aU.S.- or U.K.-based director as an alternative firm-level governance measure. These indicator variables have morediscrete cross-sectional variation, and require country-year leave-out averages to identify the regression. For simplicityI use the same IV approach throughout and use leave-out averages at the country-year level. Both country-year andcountry-industry-year leave-out averages exceed all weak IV thresholds.

13

and third the division of earnings between payout and retention. Section 4.1 assesses the relation

between firm-level governance and payout level and Section 4.2 assesses the relation between firm-

level governance and payout initiation decisions.

4.1 Payout Level

Table 4 presents my main analysis of the relation between payout ratios and firm-level governance

conditional on country-level governance, where firm-level governance is Gov41 instrumented with

the country-year leave-out average of Gov41. I present only panel linear models because they allow a

more conventional IV approach, but my results are qualitatively similar with panel Tobit models.12

Columns 1 and 3 mirror column 3 in Table 3 and control for country-level governance by splitting

the sample on legal origin. For weak legal regimes in column 1 there is a positive relation between

Gov41 and dividend payout ratios, consistent with the outcome model. However, for strong legal

regimes in column 3, there is a negative relation between Gov41 and dividend payout ratios. This

is more consistent with the substitute model, but further analysis shows that this is consistent

with a more nuanced version of the outcome model that substitutes from rigid dividends to flexible

share repurchases as governance improves. The economic magnitude of both of these changes is

significant. For the civil law sample the standard deviation of Gov41 is 6.8, so a one standard

deviation rise in firm-level governance results in a 3.7 % point rise in dividend payout ratios. This

is sizable given the average civil law dividend payout ratio of 31 %. The magnitudes are similar in

common law countries where the standard deviation of Gov41 is 11 and leads to a 10 % point fall

in dividend payout ratios, which is sizable given the average dividend payout ratio of 38 %.

Columns 2 and 4 repeat this analysis with share repurchase payout ratios (R/Y). For both civil

and common law countries there is a significantly positive relation between firm-level governance

and payout via repurchases. Considering both columns 3 and 4 there appears to be substitution

from dividends to repurchases for common law countries. In strong legal regimes improved firm-

level governance allows firms and shareholders to substitute from dividends to the preferred payout

method of repurchases. Payout ratios decreases in growth opportunities in both legal regimes,

12. My main results in Sections 4.1 and 4.2 use linear panel regressions, but panel Tobit and logit models are moreappropriate given the left-censored and binary dependent variables, respectively. However, the Gov41 IV complicatesthese models. Section 5.2 addresses this concern with the control function approach. Untabulated results for thesemodels are qualitatively similar.

14

although consistent with the outcome model dividend payout ratios are more sensitive to growth

opportunities in common law countries.

Columns 5 and 6 pool the sample and repeat the analysis in columns 1 to 4 with common

law indicator variables and interactions. The same results appear. Civil law firms payout more

dividends and repurchases as firm-level governance improves. Common law firms unconditionally

payout more via dividends and substitute from dividends to repurchases as firm-level governance

improves.

The results on the level of payout via dividends and repurchases support an outcome model

with a continuous relation between firm- and country-level governance. In weak legal regimes higher

firm-level governance relates to higher dividend and repurchase payout. Higher dividend payout is

expected to be persistent and is a necessary commitment mechanism in weak legal regimes. In strong

legal regimes higher firm-level governance facilitates a substitution from dividends to repurchases,

which provides greater flexibility to both firms and shareholders. These results are robust to an

IV approach to address the simultaneous choice of payout policy and firm-level governance. With

a better understanding of firm-level governance and payout levels, Section 4.2 moves to payout

initiation decisions.

4.2 Payout Initiation

La Porta et al. (2000) frame the relation between country-level governance and payout in terms of

dividend payout ratios, and Mitton (2004) adds firm-level governance. In the previous section I add

share repurchases, but firm-level governance should also affect investor ability to extract payout

at any level and in any form. Firm-level governance should affect payout initiation, continuation,

and omission, not just level conditional on payment. In this section I address the dividend and

repurchase initiation decision and it’s relation to firm- and country-level governance. I present only

panel linear probability models because they allow a more conventional IV approach, but my results

are qualitatively similar with panel logit models.13 The dependent variables in these regressions

are indicator variables for dividend payers and share repurchasers. The same possible endogeneity

between payout policy and firm-level governance exists in the propensity to pay models, so Table 5

13. Panel logit models with an IV require the control function approach and block bootstrap standard errors. SeeFootnote 12 and Section 5.2.

15

instruments Gov41 with the leave-out average of Gov41. These models include the same set of

independent variables as before to proxy growth opportunities, size, and life-cycle. The propensity

to pay models include profitability (E/A) because the dependent variable no longer conditions on

net income, as well as all firm-years, regardless of net income. All models control for unobserved

heterogeneity with firm REs, year FEs, and cluster standard errors by firm.

Columns 1 and 2 show that in civil law countries, both cash dividends and share repurchases are

less likely as firm-level governance improves. The coefficients are small, but the economic magni-

tudes are meaningful. For cash dividends a coefficient of −0.0030 and a Gov41 standard deviation

of 6.8 translate to a 2.1 % point decrease in dividend payers on a sample mean of 91 %. Results

are stronger yet for share repurchases where a coefficient of −0.0073 translates to a 4.9 % point

decrease in share repurchasers on a sample mean of 62 %. This is consistent with the outcome

model in which increases to shareholder rights facilitate a delay in dividend and repurchase initia-

tion. However, Table 4 shows that once initiated, both dividend and repurchase payout increases

in firm-level governance for firms in civil law countries.

Columns 3 and 4 show that in common law countries cash dividends are less likely and share

repurchases are more likely as firm-level governance improves. These results are again consistent

with a more nuanced outcome model where, firms are able to delay dividends and substitute from

dividends to repurchases by improving shareholder rights. Again, the coefficients are small, but

the economic magnitudes are meaningful. For cash dividends a coefficient of −0.0079 and a Gov41

standard deviation of 11 translate to a 8.4 % point increase in dividend payers on a sample mean

of 85 %. Results are again stronger for share repurchases where a coefficient of 0.0047 translates to

a 5.1 % point increase in share repurchasers on a sample mean of 39 %.

The coefficient on the standard payout predictors are consistent with the literature. Both cash

dividends and share repurchases are more likely as profitability, size, and life-cycle increase. Both

cash dividends are share repurchases are less likely as growth opportunities increase. Interestingly

the growth opportunities coefficients do not differ between civil and common law countries, for

either cash dividend or share repurchase initiation.14

In conclusion, firm-level governance affects payout decisions in both level and initiation, for

14. In untabulated results the relation between payout policy and growth opportunities does not depend on firm-level governance. In regressions with interactions between growth opportunities and payout policy the interactioncoefficients are not significantly different from zero.

16

both dividends and repurchases, but the relations vary across governance regimes. In weak gov-

ernance regimes increases in firm-level governance relate to increases in levels of both dividends

and repurchases. Further, because investors are confident that they will be able to extract payout

in the future, they allow firms to delay dividend and repurchase initiation. In weak legal regimes

the relation between firm-level governance and initiation of dividends and repurchases is negative.

However, in strong legal regimes increases in firm-level governance lead to a substitution from div-

idends to repurchases. This substitution occurs in both levels and initiation. If both country- and

firm-level governance are high, then shareholders have mechanisms to control expropriation and

repurchases provide firms with flexibility and shareholders with tax advantages. These results are

robust to the standard payout predictors, unobserved firm and year heterogeneity, an IV to address

possible endogeneity, and standard errors clustered by firm.

5 Robustness

This section tests robustness under several different scenarios. These scenarios include alternative

payout ratio definitions and regressions that accommodate left-censored payout ratios and binary

payout initiation. These robustness tests also include a more sophisticated measure of country-

level governance and an alternative firm-level governance measure using either a U.S.- or U.K.-

based director. This alternative firm-level governance measure provides an out of sample test that

validates my core results in a much larger panel of data.

5.1 Alternative Payout Ratios

Scaling cash dividends and share repurchases by net income is consistent with the literature, but

not the only option. Alternative denominators include operating cash flows and sales. Untab-

ulated results are qualitatively similar with with operating cash flows and sales as payout ratio

denominators.

5.2 Alternative Specifications

Linear panel regressions are commonly used in the literature and easily interpreted, particularly

with an IV, but are not exactly the correct models. With respect to payout ratios, it is not possible

17

for a firm to pay out less than zero percent of net income. This is less of a concern for dividend

payout ratio models given that 89 % of sample firm-years pay dividends, but more of a concern for

share repurchase payout ratio models given that only 53 % of sample firm-years repurchase. A panel

Tobit model left-censored at zero properly incorporates the censored distribution for payout ratios,

but requires the less conventional control function approach to incorporate an IV (Wooldridge

2002, page 612). The control function approach includes the first-stage error term in the second

stage to control for the endogeneity of Gov41. Because the first-stage error term is an estimated

independent variable I block bootstrap (by firms) second-stage standard errors 500 times. The

block bootstrap also corrects standard errors for within-firm correlation. These models include

firm REs and year FEs to control for unobserved heterogeneity. These untabulated panel Tobit

results are qualitatively similar.

The linear assumption is not exactly correct for the propensity to pay models, either. Again,

the correction is the control function approach with a panel logit model. All models include firm

REs, year FEs, and block bootstrap (by firms) standard errors 500 times. The untabulated panel

logit results are qualitatively similar.

The similarity of results from these alternative specifications suggests that my main results are

not driven by either Gov41 endogeneity or model misspecification.

5.3 Alternative Country-level Governance

The differences between common and civil law countries are significant and pertain directly to the

shareholder rights environment, but there are more refined country-level governance measures. La

Porta et al. (1997, 1998) propose the anti-director rights index as a more fundamental approach to

country-level governance, but Spamann (2010) identifies problems with the anti-director index. A

better alternative country-level governance measure is the anti-self-dealing index, which Djankov

et al. (2008) build from the ground up to measure the likelihood of shareholder expropriation

through related party transactions. Further, the anti-self-dealing index incorporates both laws and

enforcement.

The anti-self-dealing index varies by country and falls between zero and one. Table 6 repeats

the linear panel payout ratio and propensity to pay models from Tables 4 and 5. The civil law

countries map perfectly to the lowest anti-self-dealing indexes and the common law countries map

18

perfectly to the highest anti-self-dealing index, so I omit the regressions split on low and high

anti-self-dealing index and present only the interaction regressions. Columns 1 and 2 present the

results for payout level regressions with dividend and repurchase payout ratios. Columns 3 and

4 present the results for payout initiation regressions with dividend payer and share repurchaser

indicator variables. All models include firm REs, year FEs, and cluster standard errors by firm. I

drop firm-years with non-positive net income for the payout ratio regressions in columns 1 and 2.

Throughout, these results are qualitatively similar to those in Tables 4 and 5 and suggest that the

baseline results are not due to one particular measure of country-level governance. With respect

to payout level, regardless of country-level governance both dividend and repurchase payout ratios

increase in firm-level governance, although at just outside the 10 % significance level for share

repurchases (column 2). The significantly negative interaction term in column 1 confirms that

as country-level governance improves firms with higher firm-level governance substitute from cash

dividends to share repurchases.

Columns 3 and 4 present results for payout initiation decisions. Regardless of anti-self-dealing

index both dividend and repurchase initiations decrease in firm-level governance. As before in

Table 5, country-level governance does not affect dividend initiations, but does reduce repurchase

initiations. All other payout predictors either have the expected sign or are small in magnitude.

5.4 Alternative Firm-level Governance

The use of additive governance measures is common in the finance literature (e.g., Gompers et

al. 2003; Bebchuk et al. 2009; Aggarwal et al. 2011), but the equal weighting of indicator vari-

ables for 41 attributes is sufficiently arbitrary. It would be better to hand-select several of the

individual attributes, as do Bebchuk et al. (2009), but Aggarwal et al. (2011) provide aggregated

Gov41. Gov41 is less susceptible than the Gompers et al. (2003) and Bebchuk et al. (2009) to

these complaints because it is based on four major dimensions rather than only anti-takeover pro-

visions. Regardless, an alternative firm-level governance measure would address concerns about

check-the-box governance measures and confirm my results.

One easily observable attribute that should have de facto (as opposed to de jure) effects on

payout policy is the service of an independent U.S.- or U.K.-based director on the board of a

non-U.S. or non-U.K. firm. There is a sizable literature on positive outcomes associated with

19

independent directors (for a literature review see Hermalin and Weisbach 2001). In an international

setting Dahya, McConnell, and Travlos (2002) study the Cadbury Committee’s 1992 Code of Best

Practice recommendation that boards of U.K. firms include at least three outside directors and

separate the chairman and CEO positions. They find that after the Code of best Practice CEO

turnover increases, the negative relation between CEO turnover and performance strengthens, and

that this relation is strongest in Code of Best Practice adopters. Aggarwal et al. (2011) find that

foreign institutional ownership, particularly U.S. institutional ownership, leads to changes in firm-

level governance and outcomes, such as CEO turnovers and improved firm valuations. Based on the

evidence of governance attributes of both independent directors and institutional investors, U.S.-

and U.K.-based directors provide an alternative firm-level governance measure based on a simple

channel, rather than the equal weighting of 41 attributes. In untabulated results the correlations

between either U.S.- or U.K.-based director indicator variables and Gov41 are less than 30 % in

levels and less than 4 % in changes.

Data from BVD provide information on boards of directors for firms around the world, including

director home country. The U.S. (U.K.) Director indicator variable is one if a firm-year has at least

one U.S. (U.K.) director, and zero otherwise. As with Gov41, the relation between directors and

payout policy is endogenous because they are simultaneous choices. I use the same IV identification

strategy as with Gov41 and instrument U.S. (U.K.) Director with the average of the U.S. (U.K.)

Director indicator variable for all other firms in the same country-year. This identification strategy

requires that the only way that U.S. (U.K.) directorship at the country-year level can affect payout

is by influencing the appointment of other U.S. (U.K.) directors.

Another benefit of the U.S. or U.K. director firm-level governance measure is that it is free of

the data availability constraints of Gov41, which is only available for the largest firms in a short

panel over 2004 to 2008. For comparability, I limit this sample to the same 21 countries as above

and the BVD data allow me to lengthen the panel to 2002 to 2011 and widen the panel from 1900

firms to 9461 firms. This increases the sample almost tenfold from 7566 observations to 59,581

observations. To some degree this is an out of sample test in that the sample is larger in both the

cross section and the time series, and uses a firm-level governance measure that is not mechanically

related to the main firm-level governance measure. For brevity, Table 7 only presents results for

the U.K. Director alternative firm-level governance in the sample of non-U.K. firms. Results are

20

qualitatively similar with the U.S. Director indicator variable, although in some cases with weaker

statistical significance. This is likely because in this sample U.K. directors are more common than

U.S. Directors by 3203 to 1709. These results confirm my main conclusion that the response to

firm-level governance depends on the country-level governance. Overall there is continued support

for the La Porta et al. (2000) outcome model with increased dividends in weak legal regimes and

substitution from dividends to repurchases in strong legal regimes.

Columns 1 and 4 repeat the payout ratio models and drop firm-years with non-positive net

income. In civil law countries both dividend and repurchase payout ratios increase in firm-level

governance, although the dividend payout ratio coefficient is only significantly positive at just

outside the 10 % level. In common law countries dividend payout ratios decrease in firm-level

governance, while repurchase payout ratios increase. This is further evidence of substitution from

dividends to repurchase once country-level governance meets a threshold. Columns 5 and 8 repeat

the dividend and repurchase initiation regressions using all observations, regardless of net income.

Again, higher firm-level governance delays dividend initiation in both civil and common law coun-

tries. With respect to repurchases, in low legal regimes the U.K. director point estimate is negative,

but not statistically significant. In high legal regimes there is further evidence of increases in firm-

level governance leading to accelerated repurchase initiation and substitution from dividends to

repurchases. All other payout predictors have the expected signs.

In all, these out-of-sample tests with a U.K.-based director indicator variable as an alternative

firm-level governance measure confirm my earlier results in a larger sample. These results provide

additional support for a more nuanced outcome model. In weak legal regimes additional shareholder

rights at the firm level result in higher payout of all sorts. In strong legal regimes additional

shareholder rights at the firm level result in a substitution from dividends to repurchases. Given

that repurchases are a less-binding commitment than dividends both higher firm- and country-

level governance are necessary to make this shift. Both firms and shareholders are better off with

repurchases, but shareholders require a stronger governance environment to allow the firm this

flexibility.

21

6 Conclusion

Tests of payout policy in a panel of 1900 firms across 21 countries over 2004 to 2008 support the La

Porta et al. (2000) outcome model in both firm- and country-level governance, where the firm-level

governance measure is Gov41. In weak legal regimes increases in firm-level governance relate to

increases in dividend and repurchase payout ratios. Conditional on weak shareholder rights at the

country-level, shareholders use additional rights to extract higher payout. Further the economic

size of the effect is significant, with a 3.7 % point increase in dividend payout ratios per standard

deviation increase in Gov41.

In strong legal regimes shareholders use additional shareholder rights to substitute from divi-

dends to repurchases. Given additional shareholder rights in a strong shareholder rights environ-

ment, shareholders accept lower stable dividends and higher discretionary repurchases. Given the

financial flexibility that repurchases afford firms and the tax advantages that repurchases afford

shareholders, the results here are also consistent with the La Porta et al. (2000) outcome model.

With respect to payout initiation decisions, in weak legal regimes both dividends and repur-

chases are less likely as firm-level governance improves. This is consistent with improved firm-level

governance facilitating delayed payout initiation, which is a costly governance mechanism for firms

with valuable growth opportunities. In strong legal regimes, dividend initiations decrease in firm-

level governance, but repurchase initiations increase. This is consistent with an outcome model in

which improvements to firm-level governance, conditional on high country-level governance, facili-

tate a shift from rigid dividends to flexible repurchases.

Throughout, my results are robust to firm REs and year FEs to control for unobserved het-

erogeneity, standard errors clustered at the firm-level to control for within-firm correlation, an

IV approach to correct for simultaneity in payout and firm-level governance decisions, alternative

specifications, and alternative firm- and country-level governance measures. In all, the results are

consistent with the literature on the value of firm-level governance across the spectrum of country-

level governance regimes. Improvements to firm-level governance provide value through observable

channels, although the exact mechanism differs depending on the country-level governance regime.

22

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24

Table 1: Observations by country and year

Sample is Worldscope annual data over 2000 to 2000 with available Gov41, excluding U.S.firms. Country is country of incorporation.

Country 2004 2005 2006 2007 2008 Total

Australia 68 109 107 101 73 458Austria 14 16 16 17 16 79Belgium 10 17 20 23 17 87Canada 118 125 126 111 94 574Denmark 13 15 17 16 14 75Finland 20 22 22 21 13 98France 46 57 60 65 62 290Germany 61 66 70 70 61 328Greece 10 17 16 18 19 80Hong Kong 27 59 58 58 44 246Ireland 9 9 11 11 5 45Italy 34 54 57 52 37 234Japan 479 568 574 564 545 2,730Netherlands 23 28 31 28 23 133New Zealand 11 12 12 12 9 56Norway 8 14 12 10 13 57Portugal 11 11 10 11 13 56Spain 12 29 28 31 33 133Sweden 27 28 30 28 25 138Switzerland 40 42 44 41 31 198United Kingdom 126 380 359 314 292 1,471Total 1,167 1,678 1,680 1,602 1,439 7,566

25

Tab

le2:

Des

crip

tive

stat

isti

cs

Val

ues

are

tim

e-se

ries

mea

ns

ofco

untr

y-y

ear

med

ian

sby

Gov

41qu

anti

les,

wh

ere

qu

anti

les

are

abov

ean

db

elow

cou

ntr

y-y

ear

med

ian

Gov

41.

Sam

ple

isW

orld

scop

ean

nu

ald

ata

over

2000

to20

00w

ith

avai

lab

leG

ov41

,ex

clu

din

gU

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firm

s.C

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mon

Law

isE

ngli

shle

gal

orig

in,

Civ

ilL

awis

all

oth

erle

gal

orig

ins.

Cou

ntr

yis

cou

ntr

yof

inco

rpor

atio

n.

Gov

41is

firm

-lev

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vern

an

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easu

re.

V/A

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lue

ofto

tal

asse

tsd

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book

valu

eof

tota

las

sets

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earn

ings

bef

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div

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by

tota

lass

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dA

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ge

into

tal

asse

tsd

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tota

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sets

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div

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book

valu

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ity.

D/Y

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mm

ond

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end

sd

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net

inco

me.

R/Y

issh

are

rep

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has

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edby

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inco

me.

Rati

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are

Win

sori

zed

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mon

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cou

ntr

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Cou

ntr

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ov41

Qu

anti

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bse

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ion

sV

/AE

/Ad

A/A

Siz

eR

E/B

ED

/Y

R/Y

Au

stra

lia

Low

52.8

01.

336.

968.

4794

.77

26.2

247.1

80.0

0H

igh

38.8

01.

527.

568.

0196

.59

27.9

155.0

40.0

0B

elgi

um

Low

9.80

1.25

4.61

2.71

81.5

446.2

328.8

23.1

4H

igh

7.60

1.34

6.19

4.68

85.9

855.7

335.9

511.1

4C

anad

aL

ow68

.80

1.34

5.08

5.92

95.2

546.5

78.9

60.0

0H

igh

46.0

01.

426.

418.

7197

.13

54.2

017.4

50.2

8H

ong

Kon

gL

ow27

.00

1.07

5.40

8.54

96.1

842.2

336.8

10.0

0H

igh

22.2

01.

235.

9510

.72

96.2

841.9

842.0

90.0

0Ir

elan

dL

ow5.

401.

394.

144.

2374

.86

63.7

713.8

41.7

8H

igh

3.60

1.36

1.76

8.89

89.2

239.4

723.4

34.2

3N

ewZ

eala

nd

Low

6.60

1.25

7.42

5.04

91.6

212.7

065.2

80.2

2H

igh

4.60

1.87

9.21

7.44

93.2

023.6

683.1

91.5

9U

nit

edK

ingd

omL

ow16

2.80

1.44

6.13

7.40

81.0

355.6

326.4

90.0

0H

igh

131.

401.

497.

096.

9788

.54

56.8

940.3

60.0

0

26

Pan

elB

:C

ivil

law

cou

ntr

ies

Cou

ntr

yG

ov41

Qu

anti

leO

bse

rvat

ion

sV

/AE

/Ad

A/A

Siz

eR

E/B

ED

/Y

R/Y

Au

stri

aL

ow9.

201.

347.

7211

.87

72.7

463.7

327.5

50.0

0H

igh

6.60

1.32

7.16

8.75

81.5

064.2

027.8

40.6

7D

enm

ark

Low

9.80

1.55

8.82

4.98

89.9

686.4

725.7

419.3

2H

igh

5.20

1.89

10.4

36.

1993

.90

81.6

626.2

018.2

1F

inla

nd

Low

11.0

01.

415.

782.

2379

.77

53.8

347.2

10.0

0H

igh

8.60

1.53

8.75

4.21

86.7

969.8

559.1

33.4

5F

ran

ceL

ow31

.80

1.29

5.55

4.48

87.8

913.8

934.8

91.4

9H

igh

26.2

01.

305.

055.

2592

.88

15.5

531.9

25.2

9G

erm

any

Low

38.2

01.

214.

186.

3390

.79

47.1

222.7

80.0

0H

igh

27.4

01.

294.

625.

3291

.97

56.0

925.1

10.0

0G

reec

eL

ow10

.40

1.20

5.82

12.8

488

.00

20.9

242.3

90.0

1H

igh

5.60

1.44

8.43

9.93

90.5

733.2

947.0

82.0

8It

aly

Low

26.2

01.

113.

094.

6085

.02

19.6

241.0

40.0

0H

igh

20.6

01.

274.

805.

9781

.50

22.5

654.0

40.0

0Jap

anL

ow36

9.40

1.16

3.06

2.85

91.4

656.9

221.3

10.4

9H

igh

176.

601.

213.

443.

3689

.69

60.9

421.8

90.5

9N

eth

erla

nd

sL

ow15

.60

1.28

4.44

3.73

78.2

244.6

327.4

51.0

3H

igh

11.0

01.

297.

023.

3984

.78

46.5

631.4

911.1

8N

orw

ayL

ow6.

601.

668.

4611

.42

80.9

154.9

75.9

32.8

5H

igh

4.80

1.72

8.49

17.1

090

.81

57.0

321.3

426.1

5P

ortu

gal

Low

7.60

1.15

4.25

4.47

86.6

419.4

242.2

51.0

3H

igh

3.60

1.19

2.92

10.6

583

.71

22.1

033.6

912.8

0S

pai

nL

ow14

.60

1.62

6.56

8.95

72.0

738.2

842.0

00.0

0H

igh

12.0

01.

456.

368.

2577

.90

42.8

639.8

61.9

6S

wed

enL

ow16

.60

1.45

6.45

7.57

94.2

350.5

434.5

20.0

0H

igh

11.0

01.

325.

225.

0591

.52

56.1

641.3

90.0

0S

wit

zerl

and

Low

23.4

01.

295.

120.

8873

.16

78.9

323.8

32.2

4H

igh

16.2

01.

515.

630.

6385

.48

72.4

323.2

015.7

1

27

Table 3: Country- versus firm-level governance

Dependent variables are dividend payout ratios (D/Y). Linear panel regressions include firm randomeffects (REs), year fixed effects (FE), and cluster standard errors by firm. Sample is Worldscopeannual data over 2000 to 2000 with available Gov41, excluding U.S. firms. D/Y is cash commondividends divided by net income. Observations with non-positive net income are dropped. CommonLaw is one if firm’s country has an English legal origin, zero otherwise. Anti-self-dealing Index iscountry-level governance measure. Gov41 is firm-level governance measure. dA/A is change in totalassets divided by total assets. Size is country-year percentile ranking by total assets. RE/BE isretained earnings divided by book value of equity. Ratios are Winsorized at 5% in each tail.

(1) (2) (3) (4) (5)D/Y D/Y D/Y D/Y D/Y

Common Law 10.66∗∗∗ 11.20∗∗∗

(9.03) (8.16)

Anti-self-dealing Index 19.94∗∗∗ 18.88∗∗∗

(8.05) (7.23)

Gov41 0.172∗∗∗ -0.0420 0.0630(3.53) (-0.75) (1.25)

dA/A -0.372∗∗∗ -0.364∗∗∗ -0.357∗∗∗ -0.371∗∗∗ -0.366∗∗∗

(-11.38) (-11.17) (-10.98) (-11.36) (-11.23)

Size -0.0360 -0.0243 -0.0301 -0.0344 -0.0278(-0.66) (-0.44) (-0.54) (-0.63) (-0.51)

RE/BE -0.0482∗∗ -0.0554∗∗ -0.0581∗∗∗ -0.0478∗∗ -0.0553∗∗

(-2.82) (-3.25) (-3.35) (-2.80) (-3.24)

Firm REs Yes Yes Yes Yes Yes

Year FEs Yes Yes Yes Yes Yes

Observations 6,802 6,802 6,802 6,802 6,802

t statistics in parentheses∗ p < 0.05, ∗∗ p < 0.01, ∗∗∗ p < 0.001

28

Table 4: Firm-level governance and payout level

Dependent variables are payout ratios (D/Y and R/Y). Linear panel regressions include firm randomeffects (REs), year fixed effects (FE), and cluster standard errors by firm. Sample is Worldscopeannual data over 2000 to 2000 with available Gov41, excluding U.S. firms. D/Y is cash commondividends divided by net income. R/Y is share repurchases divided by net income. Observationswith non-positive net income are dropped. Common Law is one if firm’s country has an Englishlegal origin, zero otherwise. Gov41 is firm-level governance measure. Instrument for Gov41 is meanGov41 for all other firms in same country-year. dA/A is change in total assets divided by totalassets. Size is country-year percentile ranking by total assets. RE/BE is retained earnings dividedby book value of equity. Ratios are Winsorized at 5% in each tail.

Civil Law Common Law All

(1) (2) (3) (4) (5) (6)D/Y R/Y D/Y R/Y D/Y R/Y

Gov41 with IV 0.544∗∗∗ 0.325∗∗ -0.976∗∗∗ 0.302∗∗∗ 0.395∗∗ 0.315∗∗

(3.85) (2.82) (-9.05) (3.55) (2.99) (2.94)

Gov41 with IV × -1.157∗∗∗ 0.0122Common Law (-7.59) (0.10)

Common Law 67.39∗∗∗ -4.621(9.81) (-0.83)

dA/A -0.331∗∗∗ -0.305∗∗∗ -0.420∗∗∗ -0.219∗∗∗ -0.364∗∗∗ -0.261∗∗∗

(-7.64) (-7.01) (-8.41) (-5.36) (-11.14) (-8.83)

Size -0.0805 -0.0984 0.251∗ 0.0918 0.0224 -0.0273(-1.20) (-1.76) (2.56) (1.65) (0.41) (-0.67)

RE/BE -0.0155 0.0959∗∗∗ -0.0721∗∗ 0.0155 -0.0460∗∗ 0.0551∗∗∗

(-0.70) (5.31) (-2.95) (0.87) (-2.75) (4.30)

Firm REs Yes Yes Yes Yes Yes Yes

Year FEs Yes Yes Yes Yes Yes Yes

Observations 4,260 4,260 2,542 2,542 6,802 6,802

t statistics in parentheses∗ p < 0.05, ∗∗ p < 0.01, ∗∗∗ p < 0.001

29

Tab

le5:

Fir

m-l

evel

gove

rnan

cean

dp

ayou

tin

itia

tion

Dep

end

ent

vari

able

sar

ein

dic

ator

vari

able

sfo

rp

ayou

tst

atus.

Lin

ear

pan

elre

gres

sion

sin

clu

de

firm

ran

dom

effec

ts(R

Es)

,ye

ar

fixed

effec

ts(F

E),

and

clu

ster

stan

dar

der

rors

by

firm

.S

amp

leis

Wor

ldsc

ope

annu

ald

ata

over

2000

to20

00w

ith

avail

ab

leG

ov41,

excl

ud

ing

U.S

.fi

rms.

Div

iden

dP

ayer

s(S

har

eR

epu

rch

aser

s)h

ave

pos

itiv

eca

shco

mm

ond

ivid

end

s(s

har

ere

pu

rch

ase

s).C

om

mon

Law

ison

eif

firm

’sco

untr

yh

asan

En

glis

hle

gal

orig

in,

zero

oth

erw

ise.

Gov

41is

firm

-lev

elgo

vern

ance

mea

sure

.In

stru

men

tfo

rG

ov41

ism

ean

Gov

41

for

all

oth

erfi

rms

insa

me

cou

ntr

y-y

ear.

E/A

isea

rnin

gsb

efor

ein

tere

std

ivid

edby

tota

las

sets

.d

A/A

isch

ange

into

tal

ass

ets

div

ided

by

tota

las

sets

.S

ize

isco

untr

y-y

ear

per

centi

lera

nkin

gby

tota

las

sets

.R

E/B

Eis

reta

ined

earn

ings

div

ided

by

book

valu

eof

equ

ity.

Rati

os

are

Win

sori

zed

at5%

inea

chta

il.

Civ

ilL

awC

omm

onL

awA

ll

(1)

(2)

(3)

(4)

(5)

(6)

Div

iden

dP

ayer

Sh

are

Rep

urc

has

erD

ivid

end

Pay

erS

har

eR

epu

rch

aser

Div

iden

dP

ayer

Sh

are

Rep

urc

hase

r

Gov

41w

ith

IV-0

.003

00∗∗

-0.0

0725∗∗

-0.0

0787∗∗∗

0.00

471∗∗

-0.0

0377∗∗∗

-0.0

0674∗∗

(-2.

64)

(-3.

04)

(-6.

76)

(2.8

4)(-

3.4

2)

(-3.1

5)

Gov

41w

ith

IV×

-0.0

0286∗

0.0

105∗∗∗

Com

mon

Law

(-2.2

5)

(4.4

4)

Com

mon

Law

0.1

31∗

-0.6

95∗∗∗

(2.2

3)

(-6.4

9)

E/A

0.00

331∗

0.00

370

0.00

382∗∗

0.00

488∗

0.0

0366∗∗∗

0.0

0387∗∗

(2.4

9)(1

.64)

(2.9

7)(2

.44)

(3.9

4)

(2.6

0)

dA

/A-0

.000

145

-0.0

0015

8-0

.000

137

-0.0

0192∗∗

-0.0

000640

-0.0

0105∗

(-0.

42)

(-0.

27)

(-0.

52)

(-3.

07)

(-0.3

0)

(-2.4

7)

Siz

e0.

0048

1∗∗∗

0.00

156

0.00

924∗∗∗

0.00

483∗∗∗

0.0

0644∗∗∗

0.0

0302∗∗∗

(6.5

9)(1

.70)

(9.3

3)(5

.13)

(11.1

2)

(4.5

6)

RE

/BE

0.00

160∗∗∗

0.00

208∗∗∗

0.00

0954∗∗∗

0.00

122∗∗∗

0.0

0129∗∗∗

0.0

0159∗∗∗

(6.2

6)(6

.55)

(4.2

8)(4

.41)

(7.5

2)

(7.6

3)

Fir

mR

Es

Yes

Yes

Yes

Yes

Yes

Yes

Yea

rF

Es

Yes

Yes

Yes

Yes

Yes

Yes

Ob

serv

atio

ns

4,62

94,

629

2,93

72,

937

7,5

66

7,5

66

tst

ati

stic

sin

pare

nth

eses

∗p<

0.0

5,∗∗

p<

0.0

1,∗∗∗p<

0.0

01

30

Table 6: Alternative country-level governance

Dependent variables are payout ratios (D/Y and R/Y) and indicator variables for payout status.Linear panel regressions include firm random effects (REs), year fixed effects (FE), and clusterstandard errors by firm. Sample is Worldscope annual data over 2000 to 2000 with available Gov41,excluding U.S. firms. D/Y is cash common dividends divided by net income. R/Y is share repur-chases divided by net income. Observations with non-positive net income are dropped. DividendPayers (Share Repurchasers) have positive cash common dividends (share repurchases). Anti-self-dealing Index is country-level governance measure. Gov41 is firm-level governance measure. Instru-ment for Gov41 is mean Gov41 for all other firms in same country-year. E/A is earnings beforeinterest divided by total assets. dA/A is change in total assets divided by total assets. Size iscountry-year percentile ranking by total assets. RE/BE is retained earnings divided by book valueof equity. Ratios are Winsorized at 5% in each tail.

Payout Level Payout Initiation

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

D/Y R/YDividend

PayerShare

Repurchaser

Gov41 with IV 0.545∗∗ 0.228 -0.00554∗∗∗ -0.0104∗∗∗

(2.72) (1.45) (-3.39) (-3.35)

Gov41 with IV × -1.014∗∗ 0.0693 -0.00101 0.0102∗

Anti-self-dealing Index (-3.28) (0.29) (-0.44) (2.16)

Anti-self-dealing Index 69.90∗∗∗ -11.75 0.121 -0.753∗∗

(4.67) (-1.04) (1.06) (-3.28)

E/A 0.00374∗∗∗ 0.00262(4.07) (1.75)

dA/A -0.359∗∗∗ -0.262∗∗∗ -0.0000702 -0.00104∗

(-10.95) (-8.83) (-0.33) (-2.44)

Size -0.0302 -0.0273 0.00635∗∗∗ 0.00343∗∗∗

(-0.55) (-0.67) (11.07) (5.12)

RE/BE -0.0557∗∗∗ 0.0580∗∗∗ 0.00132∗∗∗ 0.00173∗∗∗

(-3.29) (4.53) (7.67) (8.24)

Firm REs Yes Yes Yes Yes

Year FEs Yes Yes Yes Yes

Observations 6,802 6,802 7,566 7,566

t statistics in parentheses∗ p < 0.05, ∗∗ p < 0.01, ∗∗∗ p < 0.001

31

Tab

le7:

Alt

ern

ativ

efi

rm-l

evel

gove

rnan

ce

Dep

end

ent

vari

able

sar

ep

ayou

tra

tios

(D/Y

and

R/Y

)an

din

dic

ator

vari

able

sfo

rp

ayou

tst

atu

s.L

inea

rp

an

elre

gre

ssio

ns

incl

ud

efi

rmra

nd

omeff

ects

(RE

s),

year

fixed

effec

ts(F

E),

and

clu

ster

stan

dar

der

rors

by

firm

.S

amp

leis

Wor

ldsc

op

ean

nu

al

data

over

2000

to2000

wit

hav

aila

ble

Gov

41an

db

oard

ofd

irec

tors

dat

afr

omB

ure

auV

anD

yck

(BV

D).

U.S

.an

dU

.K.

firm

sare

excl

ud

ed,

as

wel

las

cou

ntr

ies

wit

hou

tG

ov41

.D

/Yis

cash

com

mon

div

iden

ds

div

ided

by

net

inco

me.

R/Y

issh

are

repu

rch

ases

div

ided

by

net

inco

me.

Ob

serv

ati

on

sw

ith

non

-pos

itiv

en

etin

com

ear

ed

rop

ped

.D

ivid

end

Pay

ers

(Sh

are

Rep

urc

has

ers)

hav

ep

osit

ive

cash

com

mon

div

iden

ds

(sh

are

rep

ur-

chas

es).

Com

mon

Law

ison

eif

firm

’sco

untr

yh

asan

En

glis

hle

gal

orig

in,

zero

oth

erw

ise.

U.K

.D

irec

tor

ison

eif

firm

-yea

rh

as

on

eor

mor

eU

.K.-

bas

edd

irec

tors

.In

stru

men

tfo

rU

.K.

Dir

ecto

ris

mea

nU

.K.

Dir

ecto

rfo

ral

lot

her

firm

sin

sam

eco

untr

y-y

ear.

E/A

isea

rnin

gs

bef

ore

inte

rest

div

ided

by

tota

las

sets

.d

A/A

isch

ange

into

tal

asse

tsd

ivid

edby

tota

las

sets

.S

ize

isco

untr

y-y

ear

per

centi

lera

nkin

gby

tota

las

sets

.R

E/B

Eis

reta

ined

earn

ings

div

ided

by

book

valu

eof

equit

y.R

atio

sar

eW

inso

rize

dat

5%in

each

tail

.

Civ

ilL

awC

omm

onL

awC

ivil

Law

Com

mon

Law

(1)

(2)

(3)

(4)

(5)

(6)

(7)

(8)

D/Y

R/Y

D/Y

R/Y

Div

iden

dP

ayer

Sh

are

Rep

urc

has

erD

ivid

end

Pay

erS

hare

Rep

urc

hase

r

U.K

.D

ir.

wit

hIV

14.9

822

.47∗∗∗

-15.

96∗∗

9.72

8∗∗∗

-0.6

16∗∗∗

-0.1

64-0

.196∗∗

0.2

79∗∗∗

(1.5

3)(4

.77)

(-3.

24)

(4.5

4)(-

4.75

)(-

1.13

)(-

2.7

9)

(4.4

6)

E/A

0.00

338∗∗∗

0.00

120∗∗∗

0.0

0506∗∗∗

0.0

0179∗∗∗

(10.

12)

(3.3

2)(2

0.7

9)

(8.6

9)

dA

/A-0

.370∗∗∗

-0.1

20∗∗∗

-0.3

63∗∗∗

-0.0

844∗∗∗

-0.0

0040

3∗∗

-0.0

0077

6∗∗∗

-0.0

0141∗∗∗

-0.0

0117∗∗∗

(-22

.54)

(-16

.31)

(-20

.10)

(-12

.51)

(-2.

69)

(-4.

64)

(-14.0

7)

(-11.4

1)

Siz

e0.

106∗∗∗

0.01

010.

289∗∗∗

0.04

63∗∗∗

0.00

477∗∗∗

0.00

233∗∗∗

0.0

0436∗∗∗

0.0

0166∗∗∗

(7.3

2)(1

.74)

(12.

18)

(6.7

7)(2

3.70

)(1

1.34

)(2

0.5

9)

(10.2

7)

RE

/BE

0.07

12∗∗∗

0.02

18∗∗∗

0.05

09∗∗∗

0.00

252

0.00

0942∗∗∗

0.00

0426∗∗∗

0.0

00552∗∗∗

0.0

00154∗∗∗

(15.

41)

(9.9

2)(1

1.80

)(1

.86)

(19.

11)

(9.9

8)(1

9.6

5)

(7.3

0)

Fir

mR

Es

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yea

rF

Es

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Yes

Ob

serv

atio

ns

29,3

1029

,310

14,2

0814

,208

36,6

5436

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22,7

57

22,7

57

tst

ati

stic

sin

pare

nth

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0.0

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p<

0.0

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01

32