Governance Reforms and Dividend Policy

This study examines the differences in dividend policy determinants before and after the 1998–1999 Korean financial reform. The main goal of the Korean financial reforms was to improve the protection of minority shareholders and increase transparency of firms. According to La Porta et al (2002), legal protection of shareholders empowers investors to enforce firms to disgorge excess cash, especially when firms have limited growth opportunity, which is consistent with agency theory of dividend. La Porta et al. find the results based on the cross sectional differences in legal protection of shareholders of 33 countries. We test the association between dividend and legal protection of shareholders based on the structural changes in legal governance mechanism within one country, Korea. We conjecture that the strengthened shareholder protection through the financial reform affects firms’ dividend policy in a way to reduce agency costs of free cash flow. By examining dividend resumption, we find that in the post-reform period, dividend resumption is significantly and positively related to profitability and retained earnings. Our findings are consistent with the agency and life cycle theory of dividend in that matured firms with limited growth opportunity are more likely to pay dividends. The fact that we find this relationship only after the reform implies that legal protection empowers investors to extract cash from firms whose managers have greater opportunities to squander it. In addition, we find that stock prices of dividend-resuming firms rise significantly surrounding the announcement of dividend resumption in the post-reform period, while stock prices of dividend-resuming firms do not rise in the pre-reform period. This result implies that only in the post-reform period, the dividend resumption news convey positive information regarding firm value. Lastly we find that in the post-reform period, the cumulative abnormal returns surrounding the announcement of dividend resumption are negatively related to investment opportunity proxied by market-to-book ratio and positively related to dividend yield. This result suggests that investors react more favorably when firms with limited growth opportunities resume dividends and pay larger dividends. In conclusion our findings imply that strengthened legal protection of shareholders has a clearly positive effect on dividend payment.