Accounting and various aspects of finance
shokrollah khajavi; soraya weysihesar
Abstract
Dividend policy is one of the most important topics in financial literature. CEOs with a high level of authority are motivated to use dividends payout as a strategy to build a reputation in capital markets, aiming to obtain external financing on favorable terms. However, the expected net value of such ...
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Dividend policy is one of the most important topics in financial literature. CEOs with a high level of authority are motivated to use dividends payout as a strategy to build a reputation in capital markets, aiming to obtain external financing on favorable terms. However, the expected net value of such a reputation depends on the likelihood of external financing, which is associated with low profitability and high volatility of cash flows. Therefore, this study aims to investigate the effect of CEO authority on the dividends payout probability in the conditions of low profitability and high volatility of cash flow. In doing so, 128 companies listed on the Tehran Stock Exchange were examined from 2014 to 2021. The results show that the CEO authority has a negative and significant effect on the payment and increase of dividends. Furthermore, low profitability and high volatility of cash flow increase the negative effect of the CEO's authority on the increase of dividends. However, this factor does not have a significant moderating effect on the relationship between CEO authority and dividends payout. Additionally, financial limitations do not have a significant moderating effect on the relationship between CEO authority and payment and increase of dividends. IntroductionThe decision to pay dividends represents one of the most critical choices for managers. The theoretical foundation linking the CEO's behavior and the company's dividend payment is grounded in agency theory. Agency theory suggests that managers, who have control over the company's cash flows, might prioritize their own interests over distributing cash to shareholders. Paying dividends to shareholders diminishes the resources under managers' control, and consequently, reduces their power. Additionally, paying dividends heightens the likelihood of capital market scrutiny on the company, as it often leads to an increased probability of sourcing external financing for investment projects. Financing projects internally circumvents this oversight and the risk that funds may not be accessible or may only be available at high costs. Therefore, agency theory predicts that managers have incentives to portray financial weakness, thereby justifying their decisions not to pay or increase dividends. On the other hand, there are instances where a company's cash flow may be uncertain, such as when the company experiences low profitability and high volatility of cash flow. These two increase the probability of using external financing and are not influenced by powerful CEOs. Therefore, the uncertainty in cash flow overshadows the decisions related to dividends. This is attributed to the fact that powerful CEOs often have greater concerns regarding credit and reputation. Investors often view CEO power as indicative of a greater misalignment between managerial and shareholder interests, signaling weak internal governance and heightened risk of entrenchment or expropriation. Therefore, to provide funds to companies managed by powerful CEOs, investors demand higher returns, which results in an increase in the cost of external financing. Research indicates that powerful CEOs, akin to managers of firms with weak governance structures, encounter higher costs when raising external financing. Furthermore, when anticipating an increase in the need for external funds, these CEOs have a stronger incentive to mitigate reputational concerns by paying dividends. Therefore, powerful CEOs are more likely to pay dividends to invest in reputation, particularly in scenarios of lower profitability and higher cash flow volatility. Based on these considerations, the purpose of this research is to investigate the effect of CEO power on the probability of paying dividends under conditions of low profitability and high volatility of cash flow. Research Questions or HypothesisIn line with the research’s objective, this study seeks to answer the question: Does CEO power affect the probability of paying dividends? Also, do low profitability and high volatility of cash flow have a moderating effect on the relationship between CEO power and the probability of paying dividends? MethodsThe statistical population of this study comprises companies listed on the Tehran Stock Exchange. The research hypotheses were tested on 128 companies over an eight-year period from 2014 to 2021, using multiple regression model and logistic regression. The data necessary for measuring the variables and testing the research hypotheses were primarily sourced from the Rahavard Novin software, audited financial statements, and other reports available on the companies’ websites, Codal and the Securities and Exchange Organization. ResultsThe results show that the power of the CEO has a negative and significant effect on the payment and increase of dividends. Additionally, conditions of low profitability and high volatility of cash flow further amplify the negative effect of the CEO power on the increase of dividends. However, these conditions do not have a significant moderating effect on the relationship between the CEO power and the payment of dividends. Similarly, financial constraints do not have a significant moderating effect on the relationship between the CEO power and the payment and increase of dividends. Discussion and ConclusionThe negative effect of the CEO power on the payment and increase of dividends is in line with agency theory. This theory posits that managers, who have control over the company’s cash flows, might prioritize their own interests over distributing cash to shareholders. Paying dividends to shareholders diminishes the resources under managers' control, and consequently, reduces their power. Additionally, paying dividends heightens the likelihood of capital market scrutiny on the company. Therefore, managers may prefer to present a picture of financial weakness, leading them to be less inclined to pay dividends. The research also revealed that while financial constraints, as well as the combined effect of low profitability and high volatility of cash flow, have a negative and significant relationship with the payment and increase of dividends, financial constraints do not significantly moderate the relationship between CEO power and the payment and increase of dividends. Furthermore, low profitability and high volatility of cash flow do not have a significant moderating effect on the relationship between CEO power and the payment of dividends. However, they do exacerbate the negative effect of CEO power on the increase of dividends. The findings align with the signaling theory of dividend policy. The Information content or signaling theory predicts that in a signaling equilibrium, where a reduction in dividends is associated with a decrease in shareholder wealth, managers are motivated to avoid such outcomes. Therefore, they choose a dividend policy where the declared dividend is lower than the expected dividend. This approach allows them to maintain consistent cash dividend even if subsequent cash flows turn out to be lower than expected. This consideration leads to the prediction that when future cash flow is highly volatile, the dividend payout ratio will be lower. In fact, this implies that when facing uncertainty in cash flow, companies prefer to maintain a low dividend ratio due to the dividend signaling property. They aim to avoid the subsequent losses of dividend cuts, as reducing dividends may lead to a significant drop in the company’s value. The absence of a significant impact from financial constraints and the interaction of low profitability and high volatility of cash flow on the decisions of powerful CEOs to pay dividends indicates that managers likely weigh other factors when determining dividends. Additionally, the need to maintain and build the reputation of powerful CEOs does not depend on paying dividends.
