A cultural explanation for the agency model of dividends

1. A cultural explanation for the agency model of dividends

2. A nice quote “If we learn anything from the history of economic development, it is that culture makes almost all of the difference.” (Max Weber, 1930)

3. The main idea • culture may affects agency relations • therefore agency relations across different cultures may lead to slightly differing economic outcomes • we show this on a case of dividends

4. Agency model of dividends (La Porta et al., 2000) • dividend policies address agency problems btw. managers and investors • the main premise is that unless profit is paid out to the SHs, managers or controlling owners will be diverting the cash for personal use or invest in projects with private benefits • dividends may reduce this inefficiency and benefit outside SHs • they serve as a disciplining tool • the greater the SH rights, the higher dividends firms pay

5. Our story • culture may affect motivations and expectations of both managers and investors and therefore affect the relative costs and benefits of managerial opportunism

6. Culture’s consequences for dividends • in societies with cultural dimensions that exaggerate agency conflicts shareholders may require managers to pay out higher dividends to minimize the more pronounced agency costs • in societies with cultural dimensions that encourage lower agency costs (or lower perception of agency costs) firms are allowed to pay lower dividends. • this can happen through acceptance of rules and/or of personal power, or through group coordination

7. How to sell this story? • our idea is an intuitive one, but we have to address two important issues: • provide a sound theoretical background • come up with a reasonable measure of culture

8. Culture and economics • for theoretical support we rely on new institutional economics • societal believes, norms and values constrain economic interaction(North, 1990 and Williamson, 2000) • a system of social analysis: resource allocation on the micro-economic level has to be consistent with the informal institutions (including culture) on the top level of this system • also law and legal institutions positioned at an intermediate level must be in line with the informal institutions at the highest level • it implies that the prevailing informal institutions in a society serve as sources of motivation and justification for economic interaction (Greif, 1994) • culture as “societal common knowledge” thus constrains economic interaction (Greif and Laitin, 2004)

9. Some other papers • empirical findings on culture and legal protection: • Stulz and Williamson (JFE 2003) • Licht et al. (IRLE 2005 and JCE 2007) • legal reforms can be expected to result in better economic performance only if the modification is a more suitable manifestation of the underlying societal beliefs and values • reforms are more likely to succeed when people they affect choose to accept them (Berkowitz et al,. 2003)

10. Cultural dimensions • definition: culture represents shared values and beliefs • we borrow measures developed in cross-cultural psychology • they build on a common postulate that all societies confront similar basic issues or problems when they come to regulate human activity • different cultures cope with these basic issues in different ways • each society’s preferred ways of dealing with the basic issues lie at the essence of its culture • it is thus possible to characterize cultures by measuring the prevailing value emphases on the key dimensions • we use cultural dimensions of Hofstede (1980)

11. Cultural dimensions of Hofstede • individualism vs. collectivism • related to the integration of individuals into primary groups • power distance • refers to the different solutions to the basic problems of human inequality • uncertainty avoidance • related to the level of stress in a society in the face of an unknown future • famininity/masculinity • division of emotional roles between men and women • long-term vs. short-term orientation • related to the choice of focus for people’s efforts

12. Individualism • describes the degree to which individuals are supposed to look after themselves as opposed to remain integrated into groups • high IND scores indicate a society in which the ties between individuals are loose and decisions are taken based on individual needs – the US • low IND scores typify societies of a more collectivist nature that are characterised by closer ties between individuals, mutual responsibility, and decision-making based on what is best for the group - China

13. Power distance • measures the extent to which the less powerful members of a society expect and accept that power is distributed unequally • low PDI societies stress equality in power and wealth, and opportunity for everyone – e.g. Israel, Sweden and Ireland • high PDI countries comprehend inequality as the basis of societal order where those in power emphasise their position and accentuate authority – e.g. Mexico, the Arab countries and India

14. Uncertainty avoidance • the extent to which societies feel threatened by uncertain or unknown situations • high UA cultures shy away from ambiguous situations – e.g. Greece, Portugal and Japan • low UA typifies countries in which individuals more readily accept uncertainty and are less rule-oriented – e.g. Singapore, Denmark, Sweden • both familiar and unfamiliar risks are accepted, and people commonly change jobs and start activities for which there are no rules • organisations try to cope with uncertainty and ambiguity through technology, rules and rituals

15. Examples

16. Hypothesis 1 • high IND is associated with pursuit of personal interests rather than deference to others’ decisions and interests • this is compatible with managers pursuing their own interests and maximizing their private benefits • it is also compatible with giving power to investors and encouraging them to stand up and fight for their rights • so, investors demand disciplining mechanisms to restrict managerial self-dealing which results is higher dividends • in low IND societies, managers are expected to assume a broad responsibility for all stakeholders in their firm • investors therefore perceive agency conflicts as less severe and do not use dividends for disciplining

17. Hypothesis 2 • investors in low PDI countries are less tolerant of inequality  they may attempt to minimize power and wealth differentials through constraining the behaviour of managers (high dividends) • power is seen as something undesirable, those in power seek to underplay their position and authority, higher dividends are seen as fair • high PDI societies accredit those in power more of the right to enjoy the benefits of being in power; the powerful are entitled to privileges and are expected to use their power to increase personal wealth  agency costs are accepted and tolerated

18. Hypothesis 3 • members of a high uncertainty avoiding culture agree that rules should not be broken even when individuals think it is in the society’s best interests • they avoid the uncertainty of deciding for themselves whether or not to follow a rule • in high uncertainty avoidance cultures where rule orientation is high shareholders anticipate that managers follow preset rules and undertake activities in shareholders’ best interests • use of high dividend payouts as means of disciplining managers is less relevant.

19. Data • COMPUSTAT Global • 6982 firms from 41 countries • relative to La Porta et al. (2000) with 33 countries, we include CEE countries, China and India • Hofstede dimensions • www.geert-hofstede.com • two main measures: • dividend-to-earnings and dividends-to-sales ratio • may depend on a country’s accounting conventions and may easily be manipulated • diversion of resources may occur before earnings are reported and thus the dividend-to-earnings ratio may overestimate the share of true earnings that is paid out in form of dividends

20. Results • a panel with country-firm dimensions • we control for country random effects • dividends and sales growth are industry adjusted • the dependent variable is dividend to earnings

21. Results – cultural dimensions

22. Results – cultural dimensions

23. Conclusions • culture is significantly associated with dividend payments • this indicates that culture affects agency relations • individualism, low power distance and low uncertainty avoidance are associated with higher dividend payments • moreover, these cultural dimensions have higher explanatory power than legal protection