Managerial ability and dividend policy : evidence from U.S. market

Abstract

Dividends have long been acknowledged as profit-distributing mechanisms in classical corporate policy and are important in key investment and financial decision-making. Dividends have continued to be famously debated by scholars for almost a century. On various perspectives, many scholars have debated back and forth on their relevancy to firm performance and value.

Academic research on corporate policy and decision-making are associated with managerial traits. The principal perception is that decisions vary in accordance with different styles and abilities of managers. More able managers tend to be risk takers. The ability of managers is found to be positively associated with corporate performance since their decisions are reflected by organisational success. This relationship also extends to demographic characteristics, educational background, specific behaviour, tenure, and reputation.

Although there is rich literature on both dividends and managerial ability, only a small amount attempts to explore the said relationship. Dividends are only found to be negatively associated with managerial overconfidence. Therefore, this study aims to make a valuable contribution to financial literature by examining how managerial ability is related to dividend policy in order to shed light on how corporate decisions vary in accordance with managerial ability. Specifically, the research questions are: 1) Does managerial ability affect the propensity to pay dividends? 2) For dividend-paying firms, does managerial ability affect the payout ratio? 3) Are the results robust with different dividend measurements and managerial ability? Unlike other studies, this study applies the new measure developed by Demerjian et al. (2012). The process is simply explained by removing key firm-specific characteristics that might support or hinder managerial ability for comparison within the industry.

The relationship direction could potentially be explained by three contradictory postulations. Firstly, since it is sustainable, managerial ability is believed to be an integral composition to promote quality earnings and encourage firms to pay higher dividends. Secondly, on the contrary, more able managers can opt to retain operational proceeds for expansion, rather than making a distribution to shareholders. Lastly, more able and less able managers can use the dividend policy to send signals to the market. It is not necessary for a firm with more able managers to pay dividends.

An empirical study was conducted using 19,745 firm-year observations of US listed firms reported by the annual Compustat/CRSP Merged Database from 1990 to 2011. The empirical results are in agreement with the earnings quality hypothesis. Specifically, the results from logistic regression show a positive association between managerial ability and the firm’s propensity to pay dividends. Focusing on dividend-paying firms, those with more able managers tend to pay higher dividend payouts. Since dividends are considered as long-term commitments to shareholders, more able managers can manage resources more wisely to sustainably boost firm performance. Eventually, firms are encouraged to increase dividend payout. The results are also robust regarding alternative payouts, the measurement of managerial ability, and possible reverse causality.

This study is beneficial in several meaningful ways. It is the first study to investigate the association between managerial ability and dividend policy. In addition it provides strong evidence regarding the effect of managerial ability on other corporate decisions by showing that managerial ability matters in dividend policy. Thus, the findings display important public policy implications. Finally, this study is also useful for practitioners in different perspectives.