Dividend payout and executive compensation: theory and Canadian evidence

Abstract

PurposeThis paper seeks to present and test a model of the association between dividend payout and executive compensation.Design/methodology/approachThe authors develop a model based on Bhattacharyya whereby managerial quality is unobservable to shareholders, and therefore first‐best contracts are not possible. In the second‐best world, compensation contracts motivate high quality managers to retain and invest firm earnings, while low quality managers are motivated to distribute income to shareholders. These hypotheses arising from the model are tested on data for Canadian firms' dividend payouts over the period 1993‐1995 using tobit regression analyses.FindingsConsistent with the predictions of the Bhattacharyya model, the results show that, ceteris paribus, earnings retention (dividend payout) is positively (negatively) associated with executive compensation. These results hold when payout is defined as common dividends plus common share repurchases.Research limitations/implicationsThe Canadian data provide only limited information on the components of executive compensation. A more useful test would be possible with more detailed information on, for example, salary, bonus, and benefits.Originality/valueSeveral recent papers have documented an association between dividends and executive compensation. This paper presents and tests a model that provides a potential explanation for this link.

Dividend payout and executive compensation: theory and evidence from New Zealand

“…The weaker pay‐performance sensitivity documented among NZ firms combined with less CEO compensation disclosure may affect the previously documented association between dividend policy and managerial compensation as reported by Bhattacharyya et al . (,b), Bhattacharyya and Elston (), Bhattacharyya et al . ().…”

“…Following Bhattacharyya et al . (,b), the empirical proxy for C j is income available to common shareholders. There are at least three reasons for this.…”

“…Following Bhattacharyya et al . (,b), our empirical results include two sets of tobit regression models. The first tests Equation , as shown below: where PAYOUT is cash dividends declared to common shareholders divided by net income available to common shareholders (i.e.…”

“…The Table results are consistent with the predictions of Bhattacharyya's model. There is a risk, of course, that these results could be driven by variables that impact dividend policy (e.g., Bhattacharyya et al ., ,b), but which have been excluded from our analysis. To control for these variables, we perform the following tobit regression analysis.…”

“…net income less preferred dividend requirement); COMPENSATION is compensation earned by the manager; DIVIDEND is cash dividends declared to common shareholders; and LNINCOME is the log of net income available to common shareholders. Prior studies of executive compensation and dividend payout have found evidence consistent with Bhattacharyya's screening model using Canadian (Bhattacharyya et al ., ) and US data (Bhattacharyya et al ., ) . Bhattacharyya and Elston () and Bhattacharyya et al .…”