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Why are Firms With Entrenched Managers More

Likely to Pay Dividends?
Article in Review of Accounting and Finance February 2009
DOI: 10.1108/14757700910934256 Source: RePEc

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Why Are Firms with Entrenched Managers More Likely to

Pay Dividends?

Carrie Haoqing Pan*

August 30, 2006

Abstract
I find that firms with entrenched managers, as measured by strong managerial power resulting
from anti-takeover protections, are more likely to pay dividends. Whereas most of the sample
firms exhibit a decreasing propensity to pay over the period 1990-2003, firms with the most
entrenched managers do not. These results are consistent with the hypothesis that firms choose a
combination of governance provisions and dividend policy to maximize value. Paying dividends
reduces a firms cash holdings, which can be used to deter hostile takeovers. In equilibrium,
shareholders of firms with weak investment opportunities find it ex ante optimal to provide
managers with takeover protections to induce them to distribute cash rather than build a warchest
against unwanted takeovers.

*Ph.D. Candidate, Department of Finance, Fisher College of Business, The Ohio State University, Columbus,
OH 43210. Tel: (614) 292-2830, Email: pan_62@cob.osu.edu. I would like to thank my dissertation chair, Ren
Stulz, for his continuous support and guidance. I am grateful to Rdiger Fahlenbrach for many insightful discussions
and for sharing with me the PERMNOs for the IRRC database. I also thank Henrik Cronqvist, Phil Davies, Harry
DeAngelo, David Hirshleifer, Angie Low, Bernadette Minton, and the participants at the Fin923 seminar at the Ohio
State University for helpful comments and suggestions. All errors are my own responsibility.

1. Introduction
This paper investigates the relation between managerial entrenchment and dividend policy
for a large number of U.S. industrial firms over the period 1990-2003. Conventional wisdom
suggests that managers dislike dividends because cash distribution on a regular basis greatly
reduces their ability to pursue their own objectives, and consequently, firms are less likely to pay
dividends as managers become more entrenched. However, this paper finds that firms with
entrenched managers are more likely to pay dividends, and argues that, to maximize firm value,
it is ex ante optimal for shareholders at some firms to allow managers to be entrenched.
In corporations with diffused ownership, managers, when not closely monitored, are often
found to pursue their own goals instead of maximizing shareholder wealth. This conflict of
interests is manifest when managers are entrenched. They make value-destroying acquisitions
(e.g., Jensen (1986), Morck, Shleifer and Vishny (1990), Lang, Stulz and Walkling (1991)),
consume perquisites at the expense of shareholders (e.g., Bertrand and Mullainathan (2003),
Yermack (2004)), choose capital structures for reasons other than value maximization (e.g.,
Jensen and Meckling (1976), Stulz (1988), Berger, Ofek and Yermack (1997)) and even
influence their own compensation (Fahlenbrach (2004)). This paper adds to this literature by
investigating how managerial entrenchment is related to firms payout policies.
Managers have no obvious reason to prefer dividends. As Easterbrook (1984) and Jensen
(1986) point out, paying dividends reduces cash subject to managerial discretion, therefore
imposing additional discipline on firm managers, either through better capital market monitoring
or through fewer inefficient investments. This line of argument implies that managers have a
strong preference against dividend payments; thus, when they become entrenched, they will tend
to stop or reduce dividends.
I measure entrenchment by the amount of power managers possess relative to shareholders,
and take the view that powerful managers are more entrenched. My measure of entrenchment,
the governance index (the G index) developed by Gompers, Ishii and Metrick (2003), is based
on the total number of anti-takeover provisions firms adopt. A higher index value is a sign of
weaker (stronger) shareholder (managerial) power, and consequently, a greater potential for
managerial entrenchment. Using the governance index as a proxy for managerial entrenchment, I
find no evidence that entrenched managers are less likely to pay dividends. In fact, the
propensity to pay dividends is the highest for firms whose managers are potentially most

entrenched. Logit regression estimates indicate that a one standard deviation increase in the level
of managerial entrenchment increases the propensity to pay dividends by 5.1 percentage points.1
Given that the unconditional probability of paying dividends among all industrial firms in the
Compustat database was only 25 percent in 2003, this effect is also economically significant.
Furthermore, firms with the greatest management power exhibit no decline in the propensity to
pay over time, in sharp contrast to the general behavior documented by Fama and French (2001),
who show that U.S. industrial firms experienced a much lower propensity to pay dividends in the
80s and the 90s.
I test three hypotheses that could potentially explain these results, which are inconsistent with
the conventional agency theories of dividends of Jensen (1986) and Easterbrook (1984). The first
hypothesis builds on the well-known characteristic of dividend policy dividends are sticky.
Once a firm starts to pay dividends, managers are extremely reluctant to cut back or terminate
dividends (Lintner (1956), Allen and Michaely (2003), Brav, Graham, Harvey and Michaely
(2005)), making the entrenchment of management irrelevant to dividend policy. Under this
hypothesis, if a firm is already paying dividends, the level of management entrenchment has no
impact on its dividend policy. The second hypothesis, the dividend signaling hypothesis, comes
from another strand of literature which argues that firms may use dividends as a signaling device
to convey private information to the market (e.g., Miller and Rock (1985), John and Williams
(1985)). In this case, firms pay dividends to signal that they practice good governance so that in
the future, they will be able to raise capital on attractive terms. A reputation for good governance
is valuable as long as there is a strictly positive probability that the firm will need external
financing. Since firms with numerous provisions are often thought to have weak shareholder
rights, they have a greater incentive to signal through dividends.
My third hypothesis, the optimal entrenchment hypothesis, is based on the view that firms
choose anti-takeover provisions and payout policy simultaneously to enhance value. Both antitakeover provisions and large cash holdings can help deter hostile takeovers. However, large
cash reserves have potentially high agency costs, especially for firms with large free cash flows
and weak investment opportunities.2 Paying out extra cash as dividends reduces the agency costs,
1

A contemporaneous paper by John and Knyazeva (2006) also finds that firms with weak corporate governance are
more likely to use dividends and on average pay higher dividends.
2
See Pinkowitz (2000) for evidence on cash holdings and takeover probabilities. See Jensen (1986), Easterbrook
(1984), and Harford (1999) on the costs of cash holdings.

but also leaves managers more vulnerable to hostile takeovers. This takeover vulnerability may
cause managers to be unwilling to disgorge cash. Ex ante, it is efficient for shareholders at firms
with weak growth opportunities to surrender some power to induce managers to (continue to)
pay dividends rather than pile up cash to fend off unwanted takeovers. One way to do so is to
adopt anti-takeover provisions. Under this hypothesis, the positive relationship between
propensity to pay dividends and managerial entrenchment represents an equilibrium outcome
whereby firms maximize value by choosing the optimal combination of governance provisions
and payout policy.
Overall, I find evidence that is broadly consistent with Hypothesis 3, the optimal
entrenchment hypothesis, but not with the other two. The results from this analysis can be briefly
summarized as follows. First, changes in the governance index are usually followed by changes
in dividend policy, evidence that does not support Hypothesis 1. I find that an increase in the
governance index is weakly associated with an increase in the likelihood of initiating dividends
among firms that have not yet paid dividends, and with a decrease in the likelihood of
terminating dividends among dividend payers. Therefore, as managers become more entrenched
due to increased takeover protection, they are more likely to distribute cash to shareholders
through dividends.
Second, the likelihood of an increase in the level of entrenchment is significantly associated
with contemporaneous and future changes in dividend policy. In particular, in logit regressions
that estimate the probability of an increase in the governance index, the dummy variable that
represents dividend initiation, both concurrently and in the following year, has a significant
positive coefficient, suggesting that firms may take on more anti-takeover provisions to induce
future changes in dividend policy. Evidence on takeovers indicates that cash is inversely related
to the probability of hostile takeovers, and on average firms with more provisions receive a
higher premium.3 These results are consistent with the idea that to maximize value, shareholders
at some firms find it optimal to adopt anti-takeover provisions to induce managers to pay
dividends. The enhanced valuation comes from three sources. First, cash distribution reduces the
agency costs of free cash flow, which is likely high for firms with weak growth opportunities.
Second, strong takeover defenses increase target firms bargaining power during a takeover
contest, allowing them to capture a higher premium. Third, takeover protections alleviate
3

This confirms the results in Comment and Schwert (1995), who report similar findings with poison pills.

managerial myopia, and consequently, allow managers to focus on maximizing value in the longrun. The cross sectional difference in the relation between entrenchment and dividend policy
reflects the tradeoff that shareholders make between these costs and benefits.
Finally, I provide evidence on a subset of firms that had a G score in 1990 and existed prior
to 1982. This helps to address the concern that my results might be driven by the changes in firm
population, and allows me to investigate Hypothesis 3 further. Using this sample does not change
my conclusions. Furthermore, there is some evidence suggesting that dividend payers tend to
become high G firms. Poisson regression results indicate that being a payer in 1982 is positively
associated with a firms G score in 1990, a result that is robust to various settings. Under
Hypothesis 3, it is ex ante optimal for firms with more anti-takeover provisions to protect
managers from takeovers to some extent in order to induce them to disgorge cash through
dividends, and these results are consistent with this view.4
The rest of the paper proceeds as follows. Section 2 discusses the related literature on payout
policy. Section 3 outlines the methodology and the sample. Empirical results are presented in
section 4. In section 5, I test the three hypotheses. Section 6 discusses the robustness of the
results, and section 7 concludes.

2. Agency conflicts and payout policy

Despite a large body of literature on dividends and payout policy, financial economists have
yet to reach a consensus on why firms pay dividends and what determines the payout ratio.
Theories based on signaling models, tax clienteles or catering incentives are usually confronted
with conflicting empirical results.5 Perhaps one exception is the agency theory derived from the
conflict of interests between firm managers and outside shareholders as a result of the separation
of ownership and control. The central idea is that paying dividends reduces the amount of cash
left in the firm, and consequently lowers the deadweight agency costs. For example, in

These results are also consistent with some recent research. For example, Chidambaran, Palia and Zheng (2006)
argue that firms choose governance endogenously. They investigate a broader measure of governance, including
board of directors, pay-performance sensitivity, shareholder rights, institutional ownership and CEO turnover. Lehn,
Patro and Zhao (2006) report that valuation multiples in the early 80s are significantly related to the G index during
the 1990s, evidence also suggesting that the governance index (the G index) is endogenously chosen.
5
See Allen and Michaely (2003) for a detailed review on payout policy. For empirical evidence on signaling models,
see Aharony and Swary (1980), Asquith and Mullins Jr. (1983), and Benartzi, Michaely and Thaler (1997); for tax
clienteles, see Richardson, Sefcik and Thompson (1986), Michaely and Thaler (1995), Binay (2001), and Graham
and Kumar (2004); for catering incentives, see Baker and Wurgler (2004) and Hoberg and Prabhala (2005).

Easterbrook (1984), managers are forced to raise external funds more frequently in the capital
markets. This lowers the agency costs as managers are better monitored by the outside capital
markets. Jensen (1986) suggests that paying dividends reduces firms free cash flow, hence
potential wasteful investments are fewer and agency costs are lower. Although these theories
differ in how agency costs are reduced, they all imply that outside shareholders benefit from
dividend payments, in spite of the apparent tax inefficiencies in the U.S.6
Empirical evidence is generally consistent with the notion that dividends help address the
agency conflicts between managers and shareholders. La Porta, Lopez-De-Silanes, Shleifer and
Vishny (2000), LLSV hereafter, test the agency theory of dividends in an international setting.
They examine the differences in dividend policy across 33 countries, and show that payout ratio
is systematically related to the degree of shareholders legal power. They argue that shareholders
use their legal power to extract dividends to avoid being expropriated by corporate insiders.
DeAngelo, DeAngelo and Stulz (2005) show that in the U.S., firms are more likely to pay
dividends when retained earnings represent a larger fraction of total equity (or total assets), a
proxy they use for firm maturity. More interestingly, they study the twenty-five largest dividend
payers and show that payouts reduce cash that would otherwise have accumulated to a level far
exceeding their future investment needs, exposing shareholders to serious agency problems
(Table 9, p. 33). Their result is also consistent with the notion that firms pay dividends to
mitigate agency problems.
One implicit assumption of the conventional agency theories, as in Jensen and Meckling
(1976), Jensen (1986), and Easterbrook (1984), among others, is that any managerial
entrenchment is undesirable because entrenched managers will always behave in ways that are
costly to shareholder wealth. However, others have argued that under certain circumstances some
entrenchment is optimal. Stein (1988) demonstrates that takeover pressures can lead managers to
focus excessively on short-term profits at the expense of long-term shareholder interests. Hence
it is optimal to limit the takeover probability when such problem is severe. In Knoeber (1986)
and Almazan and Suarez (2003), the optimal compensation contracts require shareholders to
6

In the U.S., the tax inefficiency of dividends comes in three ways. First, individual dividend incomes are taxed
twice, once at the corporate level and once at the personal level. Technically, investors can avoid paying taxes on
capital gains by holding on to their shares indefinitely. Second, investors can choose when to realize capital gains,
and are only required to pay tax when they do so, but they do not have such choice for dividend incomes. Third,
until the end of 2002, the tax rates on individual dividend income had been higher than that on capital gains. This
disadvantage disappears with the implementation of the U.S. Job and Growth Tax Relief Reconciliation Act of 2003,
which was made retroactive since January 2003.

relinquish some power to the managers, thereby allowing them to become entrenched, in order to
minimize the total compensation costs shareholders have to pay to the incumbent managers.7
Furthermore, managers might also find it in their best interests to restrict their own
opportunistic behavior, therefore lowering the potential agency costs. Zwiebel (1996) presents a
model in which managers voluntarily take on debt as a commitment to efficient investment when
they are under constant takeover threats. Since the model considers net debt, it also implies that
under certain circumstances, managers voluntarily pay dividends. Stulz (1988) suggests that
managers can increase leverage to increase their share of voting rights, and consequently,
enhance their bargaining power during a takeover contest, which in turn leads to a higher
expected premium. For small values of managers share of voting rights, the increase in the
expected premium dominates the decrease in the takeover probability, and as a result,
shareholders benefit from a higher firm value. 8
This suggests that there are circumstances in which some level of entrenchment is optimal. If
dividends reduce the amount of cash at a managers disposal, therefore restricting his ability to
pursue a personal agenda, then paying dividends represents a cost to the manager who will have
strong incentives to lower this cost. On the other hand, managers also value the benefits of
controlling the firm, which are constantly threatened by the takeover markets. It is therefore
possible to provide managers with a value-maximizing incentive contract, including some
protections from the takeover markets, that leads to a dividend payment as a commitment by the
managers not to empire-building. I find strong support for this argument.
Throughout my analysis, I focus on the propensity to pay dividends, rather than the payout
ratio as in LLSV, because it is unclear what the optimal payout ratio is for any given firm.
Regardless of the underlying theory, a firms optimal payout ratio should maximize shareholder
value, which could conceivably depend on many considerations. For example, consider two
firms that are identical except for their ability to take on more debt. It is rational for firms with

In Knoeber (1986), when deferred compensation represents a large portion of a managers total compensation, it is
in the interests of both shareholders and the manager to limit takeover probabilities by adopting takeover defenses,
in particular, golden parachutes and shark repellent. As a result, shareholders surrender some power to the manager s
a credible commitment to not behave opportunistically in the event of hostile takeovers. Similarly, Almazan and
Suarez (2003) examine the optimal level of entrenchment and severance pay. In their model, shareholders minimize
the total cost of inducing the incumbent CEO to undertake the desired actions, and sometimes find it more costefficient not to have a strong board.
8
To the extent that the debt financing also mitigates agency conflicts (Jensen (1986)), the increase in leverage also
increases shareholder value.

little debt capacity to pay out less to minimize the expected costs of bankruptcy. Using the
propensity to pay instead of the payout ratio should minimize such problems. Nonetheless, I also
examine payout ratios in section 6.3 and find that payout ratios are also higher when managers
are more entrenched.

3. Methodology and sample construction

3.1

Methodology

The goal of this paper is to understand whether cross-sectionally, the propensity to pay
dividends is related to the degree of managerial entrenchment, controlling for other firm
characteristics. I take two approaches in estimating the logit regression models a FamaMacBeth (1973) type procedure and an approach using pooled regressions estimated by the
Generalized Estimating Equations (GEE) technique.
Fama and French (2001) and others use a Fama-MacBeth-like two step procedure in their
analysis. While this approach avoids the unbalanced panel problem and takes into account the
estimation error due to the correlation of the residuals across firms, it does not yield any
information on the goodness-of-fit for the model. More importantly, it underestimates the
standard errors when both the residuals and the explanatory variables are positively correlated at
the firm level (Petersen (2005)). This is problematic because the main variable of interest, the G
index, and the response variable, a binary variable that equals 1 if a firm is a payer, are both
auto-correlated at the firm level.
To address this issue, I run pooled regressions using the Generalized Estimating Equations
technique with cluster robust standard errors.9 I allow for clustering at the firm level and use an
AR(1) working correlation matrix, assuming observations across firms are independent and a
firms dividend status follows an AR(1) process. Finally, DeAngelo, DeAngelo and Skinner
(2004) document that among all the potential candidate firms that are able to pay dividends, the
decision not to pay is primarily concentrated in high growth technology industries. This suggests
that industry specific factors are important in firms dividend decision. I therefore include

The GEE method, introduced by Liang and Zeger (1986), accounts for correlated responses in generalized linear
regression models. For the pooled regressions, I report t-stat calculated using the empirical standard errors from the
covariance matrix in the following form. The standard errors calculated this way are consistent.
1

K
K
K
( ) = i 'V 1 i ' i 'V 1Cov(Y )V 1 i i 'V 1 i '

i
i
i
i
i

i =1
i =1

i =1

industry dummies (Fama and French 30 industry classification)10 and year dummies to capture
potential industry effects and time trends in firms dividend decisions. The inference and
conclusions presented in this paper are mostly drawn from the pooled regression results.

3.2

Sample

The main proxy for entrenchment is the governance index (G index) developed by Gompers,
Ishii and Metrick (2003), GIM hereafter. The basic ingredients for this index are anti-takeover
provisions from various Investor Responsibility Research Center (IRRC) publications. For each
firm in the IRRC database, GIM construct a governance index by aggregating the number of
anti-takeover provisions (ATPs) it adopts, adding one for each provision that weakens
shareholder power. As such, the G index captures the balance of power between shareholders
and managers. The IRRC reports twenty-four unique ATPs at the state level and the firm level,
therefore the G index ranges from 0 to 24. A high value indicates greater potential for
management entrenchment for at least two reasons. First, a higher G index is a sign of stronger
(weaker) managerial (shareholder) power. Second, the anti-takeover provisions isolate managers,
to some extent, from the market for corporate control. The greater power managers possess and
the lack of capital market monitoring can lead to severe agency problems as managers become
more entrenched.
One weakness of the G index is that it treats all ATPs equally, whereas some may be more
effective in deterring takeover attempts than others. Bebchuk, Cohen and Ferrell (2004), BCF
hereafter, propose an entrenchment index (the E index) that is constructed in a similar fashion to
the G index but uses only six of the twenty-four ATPs.11 The authors argue that these six ATPs
are most responsible for managerial entrenchment, and show that the E index drives the main
results on firm valuation and abnormal stock returns, while at the same time it offers a much
higher signal to noise ratio. The E index ranges from 0 to 6, with a higher value indicating
stronger managerial power. Using this alternative proxy does not change my results.
I use all firms in the Investor Responsibility Research Center (IRRC) database, which
contains the G index, as well as detailed information on each of the 24 anti-takeover provisions.
10

An alternative industry classification does not change my results. The results are very similar if I classify firms
into 17 industries, using the Fama and French 17 industry classification.
11
The six anti-takeover provisions are staggered boards, limits to amend by-laws, supermajority requirements for
mergers, supermajority requirements for charter amendments, poison pills and golden parachutes.

This database covers over 1,400 large firms for six publication years 1990, 1993, 1995, 1998,
2000, and 2002. 12 I then obtain accounting data and stock related information for these
companies from Compustat and CRSP, respectively, by matching 6-digit CUSIP. Information on
institutional holdings is collected from Thomson Financial Institutional (13F) Holdings database,
and information on new equity issuance and takeovers come from the Security Data
Corporations databases.
While my sample covers a fourteen year period from 1990 to 2003, the IRRC publications
are only available in six years. Following GIM, I assume that the G index does not change
between two consecutive publications, and for any sample firm, the G index from one
publication year carries on for subsequent years until the next publication becomes available.
Financials (SIC 6000-6999) and utilities (SIC 4900-4949) account for roughly 15-20% of the
IRRC firms, and are excluded from this analysis. To make sure a firm is publicly traded, the
sample is further restricted to firms with CRSP share code of 10 or 11. The rest of the sampling
procedure primarily follows Fama and French (2001).13 A detailed description of the sampling
procedure and variable definition is provided in the Appendix.
In most of the analysis, I control for the level of shareholder monitoring, which is often
considered an important corporate governance mechanism. However, the effect on payout policy
of a high level of shareholder monitoring is not clear. On the one hand, it can pressure managers
to distribute more cash to minimize the potential wasteful investments. On the other hand,
shareholders may agree to leave more cash within the firm because they can better monitor the
managers to use cash more efficiently. One commonly used proxy for shareholder monitoring is
the percentage of shares held by institutional investors. However, some institutions are better
monitors than others, and institutions with large equity stakes (block institutions) and public
pension funds are usually considered to be more effective in overseeing the firm. I therefore use
the fraction of shares held by institutional investors, block institutions (hold at least 5% common
shares outstanding), and public pension funds to proxy for the level of active shareholder
monitoring.14 For each firm in a given year t, the information on institutional holding is taken

12

2004 data is also available. However, the current analysis requires accounting information in 2004, which is not
available for the majority of sample firms. Therefore the cutoff year for G index is 2002.
13
See Fama and French (2001), pages 40-41.
14
I obtain the list of public pension funds from Cremer and Nair (2005), who provide this information in the
Appendix.

from the quarter immediately before the end of fiscal year, as reported in the 13F filings from
Thomson Financial Institutional Holding database.
Using the governance index limits my analysis to large firms since the IRRC database
consists of primarily large firms and covers most of the value weighted market.15 In 1990, it
covered over 93 percent of the market capitalization of the combined NYSE, AMEX and Nasdaq
markets (see Gompers, Ishii and Metrick (2003), p. 111). However, this sample bias should not
be a big concern for my analysis. Ideally, I would need a sample of firms that are potential
candidates to pay dividends and understand whether their propensity to pay depends on the level
of managerial entrenchment. Since dividends are paid primarily by large and mature firms, the
IRRC sample firms are precisely those that I am interested in. Moreover, firms can only pay
dividends when they are able to generate stable enough earnings, usually when they become
mature. Paying dividends is one corporate decision that these firms need to make. In contrast, for
many fast growing young firms with volatile earnings, paying dividends is simply not an option.
Therefore, a study using large firms should do better in capturing the tradeoffs that firms actually
make in their dividend decisions.

3.3

Sample statistics

The final sample consists of 2,116 firms and 14,465 unique firm-year observations. Table 1
reports the number of firms, the fraction of dividend payers, the sample average of the G index
and the E index, and the changes in the two governance indices for each of the sample years
from 1990 to 2003. These results confirm several stylized facts observed in the prior literature.
First, similar to Fama and French (2001), the current sample which consists of primarily large
firms also exhibits a decline in the fraction of dividend payers. In 1990, 74.3 percent of firms
paid dividends. The fraction of payers dropped to 41.9 percent in 2002, before climbing back to
44.7 percent in 2003. Second, over time there is not much variation in the governance indices at
the firm level (Gompers, Ishii and Metrick (2003)). The changes in the G index have a mean of
0.315 and a median (not reported) of 0. Third, as noticed by GIM and others, IRRC added a large
number of smaller firms in 1998. This has a non-trivial impact on the subsequent analysis, an
issue that I will try to address in section 4.3 B.

15

The firms in IRRC database come from the Standard & Poors 500 and the annual lists of the largest corporations
from Fortune, Forbes, and Businessweek.

10

Table 2 reports summary statistics for portfolios sorted into G index quintiles. The
breakpoints for G1 (G<=6) and G5 (G>=13) quintiles differ slightly from those in GIM (<=5 for
G1 and >=14 for G5). Since I work with a more restricted sample, this change allows me to
obtain a reasonably similar number of firms in the two extreme quintiles.16 The top three rows
report the average number of firms in each year, the fraction of firms that pay dividends and that
repurchase shares, respectively. The following rows present the average of fourteen years of
annual median values across firms. The last column reports the difference between the two
extreme quintiles.
There are noticeable differences between high G and low G firms. The fraction of dividend
payers is 31.8 percentage points higher in the top G quintile than in the bottom G quintile
(significant at 1% level). High G firms tend to be larger, older, more levered, and face poorer
investment opportunities. A typical firm in the top G quintile is about twice the size of a typical
firm in the bottom G quintile, and is also about twice as old (32.2 vs 15.6 years). Retained equity
usually represents a significantly larger fraction of total equity (or total assets) for high G firms.
Furthermore, moving from the bottom to the top G quintile, the percentage of common shares
held by institutional investors and by public pension funds tend to increase, but there is no
significant difference in block institutional holdings. Finally, firms in the top G quintile hold
significantly less cash than firms in the bottom G quintile. The ratio of cash to total non-cash
assets for firms in the top G quintile is less than half of that for firms in the bottom G quintile.
This is consistent with Opler, Pinkowitz, Stulz and Williamson (1999), who show that firms with
strong growth opportunities, riskier cash flows, and limited access to the capital markets have
relatively high ratios of cash to total non-cash assets. I explore this further in section 5.3.

4. Empirical results
Fama and French (2001) identify three firm characteristics as important determinants of a
firms likelihood to pay dividends size, profitability, and investment opportunities. In addition,
DeAngelo, DeAngelo and Stulz (2005) suggest that firms are more likely to pay dividends when
they enter into the mature stage of their lifecycle. As firms mature, they will become less reliant
on outside capital, with a capital mix consisting of more earned capital relative to contributed

16

This is desirable because much of my analysis is based on the G quintiles, and having a different base across
quintiles makes inference much more complicated.

11

capital. Using the ratio of retained earnings to total capital as a proxy for a firms lifecycle stage,
they show that the variables RE/TE and RE/TA have strong explanatory power in estimating a
firms likelihood to pay dividends. In the analysis that follows, I control for these firm
characteristics, and examine whether my proxy for entrenchment, the G index, has any additional
explanatory power in explaining firms propensity to pay dividends. I start with descriptive
statistics on the fraction of payers, and then run logit regressions to estimate the propensity to
pay for all sample firms.

4.1

The fraction of dividend payers

Table 3 reports the percentage of dividend payers in portfolios sorted by the G index and by
variables that proxy for the four firm-level determinants. I use the market value of equity as a
proxy for size, EBIAT/A (the ratio of earnings before interest but after taxes to total assets) for
profitability, dA/A (annual growth rate of total assets) and V/A (the ratio of book value of debt
plus market value of equity to total assets) for growth opportunities, and RE/TA (RE/TE) for a
firms ability to generate retained equity.17
It is clear from Table 3 that the incidence of paying dividends is significantly higher among
firms whose managers are more entrenched. Controlling for the above firm level determinants,
the fraction of dividend payers still increases with the G index, and for most cases,
monotonically. For example, in the bottom size decile, the fraction of dividend payers increases
from 18 percent to 51 percent as we move from the bottom G quintile to the top. In the top size
decile, the increase is less dramatic but it is still 15 percentage points. This is not surprising
because in this size decile, the fraction of dividend payers is very high to begin with (81 percent).
In each G quintile, the fraction of dividend payers increases with size, profitability, and RE/TE
(or RE/TA), but the effect of investment opportunity becomes obscure once I control for the G
index. Within each G quintile, the fraction of payers is hump shaped across deciles sorted by
investment opportunities. In contrast, the fraction of payers increases monotonically from the
bottom to the top G quintile for almost all the investment opportunity deciles.
Since managers are more powerful when the G index is high, the results in Table 3 suggest
that, ceteris paribus, more powerful managers are, perhaps surprisingly, more likely to pay

17

Using other alternative variables such as total assets, NYSE size percentiles, and annual sales growth rate do not
have any material impact on my results.

12

dividends. Next, I turn to logit regressions to estimate the likelihood of paying dividends,
evaluating all these firm-level variables jointly.

4.2

The propensity to pay dividends

The basic logit regression follows Fama and French (2001). Similar to their study,
I include a size variable, NYPCTL (the size percentile ranked by the market value of equity using
NYSE breakpoints), a profitability variable, EBIAT/A, and a growth opportunity variable, V/A. I
also include RE/TA, a variable from DeAngelo, DeAngelo and Stulz (2005), as a proxy for a
firms maturity.18

4.2.A. Logit regression results

Table 4 summarizes these results. For each specification, I present results from FamaMacBeth regressions side by side with those from the pooled regressions using the GEE
technique. The parameter estimates for the Fama-MacBeth regressions are time series averages
of coefficient estimates in the cross sectional logit regressions for fourteen years from 1990 to
2003, and the associated t-values are calculated using the AR(1) adjusted standard errors to
reflect the fact that paying dividends is a highly persistent corporate behavior at the firm level.19
The first two columns labeled model 1 report results using the same model specification as
Fama and French (2001), and model 2 presents results with two additional explanatory variables
RE/TA and LAGMLEV (the ratio of total debts to total firm value, measured at the beginning of
the year). I control for the leverage ratio because debt can limit the entrenchment of firm
managers. Jensen (1986) notes that debt imposes a regular stream of interest payments on firm
managers and reduces cash available subject to management discretion. Consistent with Fama
and French (2001) and DeAngelo, DeAngelo and Stulz (2005), I also find that firms are more
likely to pay dividends if they are larger and more profitable, face poorer investment
opportunities, and have a greater portion of capital in the form of retained earnings.

18

The main results hold if I replace V/A with the annual growth rate of assets (dA/A) or annual growth rate of sales
(SGR). I obtain very similar, but slightly stronger results using RE/TE instead of RE/TA.
19
In the time series t-test, I calculate the AR(1) adjusted standard error as SE* = SE 1 + , where is the first
1
order autoregression coefficient of the time series coefficient estimates, and SE is the unadjusted standard error.

13

The main variable of interest is the entrenchment variable, the G index. Model 3 shows that
while all the firm characteristics remain statistically significant, the G index has a positive
coefficient with large t-values (10.65 in FM, 7.06 in pooled). Adding the G index also raises the
pseudo R2 from 0.279 to 0.298, suggesting that the G index is able to help explain a firms
propensity to pay dividends. Decomposing the G index into the E index and the O index (= G
index E index) leads to the same conclusions (model 4). Interestingly, my results suggest that a
firms propensity to pay dividends is always positively and significantly associated with the O
index. Bebchuk, Cohen and Ferrell (2004) argue that the anti-takeover provisions in the O index
may not be as relevant to managerial entrenchment as those in the E index, and show that the O
index is not able to explain the abnormal stock returns.
The last two columns of the table summarizes results with an additional control variable that
proxy for the level of shareholder monitoring the percentage of common shares held by
institutional investors (IHPCT). 20 Dividend policy might be closely related to institutional
investing for many reasons. Institutions are in general large shareholders, who not only monitor
managers more efficiently but also facilitate takeovers (Shleifer and Vishny (1986)). Built on this
argument, Allen, Bernardo and Welch (2000) present a model in which some firms pay
dividends to attract institutions to achieve a higher valuation. Grinstein and Michaely (2005)
provide empirical evidence that payout policy does affect institutional holdings, but they find no
evidence that institutions influence firms payout policy. Adding institutional holding variables
does not change any of the inferences, as the coefficients of the governance indices remain
positive and significant.
The results in Table 4 also show that the propensity to pay dividends is negatively associated
with the percentage of shares held by institutional investors. Institutional holdings variables are
usually inversely related to the propensity to pay. One possible explanation is that institutional
oversight and dividends work as substitutes in controlling the agency problems faced by
shareholders. Overall, these results convey a consistent message firms with entrenched
managers are more likely to pay dividends.

4.2.B. Are the effects economically significant and robust?

20

In unreported tests, I replace the total institutional holdings (IHPCT) with the percentage of common shares held
by block institutions (IBPCT), and by the 18 public pension funds (IPPCT), all measured at the beginning of the
period. The results are very similar to those using IHPCT.

14

Having established the statistical significance, this section presents the economic significance
of the impact of managerial entrenchment on the propensity to pay dividends. For ease of
interpretation, I run pooled regressions and present the marginal effects in Table 5.21 Model 2
shows that one standard deviation increase in the G index increases the propensity to pay
dividends by 5.1 percentage points.22 Equivalently, the likelihood to pay dividends for a typical
firm with most entrenched managers (G5 quintile) is 14 percentage points larger than an
otherwise similar firm but with the least entrenched managers (G1 quintile). Given that in 2003
only 25 percent of all industrial firms in the Compustat database paid dividends, this effect is
also economically significant.
The next column in Table 5 presents results using an indicator variable for each G quintile
instead of the G index. There is no obvious reason for the G index to have a linear relationship
with the propensity to pay, hence using indicator variables could lead to more insights if the
relationship is nonlinear. As firms move from the bottom G quintile (G1, omitted) to the top G
quintile (G5), the marginal effects of the indicator variables increase in magnitude, as do the
associated t-values. Moreover, the G index has a much larger effect on the propensity to pay
when it is high. If a firms G index increases from 5.1 to 8, which is equivalent to moving from
the G1 quintile to the G2 quintile, its likelihood to pay dividends increases by 2.3 percentage
points. However, when a firm has a higher G index, a smaller increase in the G index (from 11 to
13.2, which is equivalent to moving from G4 to G5), will increase its likelihood to pay by as
much as 4.3 percentage points.
Firms may initiate dividends when they reach the mature stage of their lifecycle, when
earnings become stable and when growth opportunities diminish.23 While my analysis includes
RE/TA, a variable that DeAngelo, DeAngelo and Stulz (2005) argue proxies for a firms lifecycle
stage, it remains a concern that my measure of entrenchment, the G index, captures nothing more
than the maturity of a firm. The summary statistics in Table 2 show that a typical firm in the top
G quintile is about twice as old as a typical firm in the bottom G quintile (32.2 vs 15.6 years). To
address this concern, I add a variable that reflects the age of a firm, Firmage, defined as the

21

I calculate the marginal effect for each firm-year observation, and report the average across all observations.
The G index has a standard deviation of 2.81 in the current sample.
23
Consistent with this view, Grullon, Michaely and Swaminathan (2002) find that dividend increase is usually
accompanied by a subsequent decrease in firms systematic risk.
22

15

number of years elapsed since the firm first appeared in Compustat. 24 The rest of Table 5
summarizes regression results with this additional variable.
Firmage always has large, positive, and significant coefficients. Hence older firms are much
more likely to pay dividends, even after controlling for the level of retained earnings (RE/TA).
With the current sample, holding all else equal, the propensity to pay dividends increases by 9
percentage points if a firm is ten years older. As expected, including Firmage has a considerable
impact. It reduces the marginal effect of the G index by as much as 56%. Nonetheless, the G
index remains positive and significant, suggesting that even after controlling for Firmage, firms
with more entrenched managers have a significantly higher propensity to pay dividends. This
finding is largely driven by firms with the most entrenched managers, as showed by regression
results using indicator variables for the G quintiles. Once I control for firm age, only the
coefficient for G5 (the top G quintile) is significantly positive at the conventional 5% level.
Hence, contrary to the traditional wisdom, firms with more entrenched managers exhibit a
significantly higher propensity to pay dividends relative to other firms, holding constant a host of
variables that reflect size, profitability, growth opportunity, and maturity.

4.3

The change in the propensity to pay over time

The use of takeover defenses increased dramatically in the late 1980s. Anti-takeover
provisions not only make it more difficult for a potential raider to take control of a firm, but also
allocate extensive power to the incumbent management. Built on the total number of provisions a
firm has, the G index has been widely used to study corporate governance related issues. Results
from these studies are generally consistent with the notion that entrenched managers tend to
pursue their own interests at the expense of shareholders through non-value maximizing
investment and financing policies. However, to the extent that paying dividends restricts
managers ability to take self-serving actions, it is surprising that entrenched managers do not
avoid paying dividends.
One possible explanation for these results is that payout policy is sticky. If managerial
entrenchment leads to a lower propensity to pay dividends, it could take a long time to become
observable. Fama and French (2001) provide compelling evidence of a decreasing propensity to
24

I also run similar analysis using Firmage defined as the number of years elapsed since the firm first appeared in
CRSP. The results remain essentially the same. However, one problem with using Firmage is that a firm could exist
long before it first appeared in CRSP or Compustat, making it a noisy proxy for the true age of the firm.

16

pay dividends in the 1980s and the 1990s, and show that the decline is shared by all U.S.
industrial firms. If entrenched managers are reluctant to distribute cash, then we would expect
the propensity to pay to decline faster for firms with more entrenched managers in the 90s, after
the anti-takeover provisions became widely used. However, I find that this is not the case.

4.3.A. Changes in the propensity to pay Full sample analysis

Fama and French (2001) define the change in the propensity to pay as the difference
between the expected and the actual percentage of payers, with a positive value indicating a
lower propensity to pay. I estimate the change in the propensity to pay in a similar fashion. I add
RE/TA to the set of firm characteristics in their study, which includes size, profitability, and
investment opportunities. The probabilities associated with firm characteristics are first estimated
using an earlier out-of-sample time period. Assuming that the sensitivities of the propensity to
pay dividends to firm characteristics do not change over time, I apply these sensitivity estimates
to the sample firms and calculate their expected probability to pay.
The base period for estimation runs from 1973 to 1989.25 For each year in the base period, I
run a logit regression using all Compustat firms that meet the sample criteria. The averages of
these seventeen coefficient estimates are then applied to each sample firm to estimate its
expected propensity to pay year by year from 1990 to 2003. For each firm-year, I define the
change in the propensity to pay as the difference between the expected probability and the actual
dividend status of the firm in that year, controlling for other firm characteristics. For each G
quintile, I present the mean values of the change in the propensity to pay across firms in Panel A
of Table 6.26
The majority of the sample firms exhibit a lower propensity to pay that becomes more
pronounced over time. While firms in the bottom G quintile show a significantly lower
propensity to pay in all fourteen sample years, those in the top G quintile do not show any
significant lower propensity to pay (at 10% level) in 11 out of 14 years. Therefore, the lower
propensity to pay in Fama and French (2001) is shared by all the sample firms except those in the

25

I choose 1973 as the beginning year because Compustat started covering all Nasdaq, NYSE and AMEX firms in
1973.
26
Mathematically, the group mean is equivalent to the change in the propensity to pay in Fama and French (2001).

17

top G quintile, i.e., firms whose managers are most entrenched.27 These firms are not only more
likely to pay dividends, but they also maintain a high propensity to pay over time.

4.3.B. Changes in the propensity to pay Sub-sample analysis

One caveat with the above analysis is that a large number of small firms was added to the
IRRC database in 1998. This shows up clearly in Panel A of Table 6, as the change in the
propensity to pay increases abruptly by a considerable amount for the two bottom quintiles.
Since smaller firms tend to have lower G scores and tend not to pay dividends, most of these
newly added firms will cluster in the lower G quintiles, leading to an overstatement on the actual
changes in the propensity to pay for firms with low G scores. To address this concern, I restrict
my analysis to firms whose G index was available in 1995 or earlier. This restriction reduces the
sample to 1,226 firms with a total of 11,419 firm-year observations. Using the restricted sample
introduces a survival bias, but it also places a lower bound on the change in propensity to pay for
low G firms, and therefore represents a more conservative estimate of the relationship between
changes in the propensity to pay and the G index.
Table 6 Panel B summarizes the results with this restricted sample. As expected, removing
newly-added firms from 1998 onwards leads to a smaller decline in the propensity to pay for
firms with low G scores, but does not have any material impact on firms with high G scores. In
all sample years, firms in the bottom G quintile exhibit a significantly lower propensity to pay. In
contrast, only in 2002 did firms in the top G quintile exhibit a lower propensity to pay that is
marginally significant. In other years, the change in the propensity to pay is either not
significantly different from zero or significantly negative.
These results indicate clearly that my earlier conclusion holds even under this conservative
setting. The adoption of takeover defenses empowers managers, but it does not lead to a lower
likelihood of paying dividends. Rather, the subset of firms with the most powerful managers
shows no sign of a lower propensity to pay over the period 1990-2003, in sharp contrast to the
general behavior of U.S. industrial firms in Fama and French (2001).

27

These results hold if I change the base period to 1978-1989 (not reported). I use 1978 because this is the year
when the fraction of payers started declining (Fama and French (2001)), and using this base period will bias my
results towards not finding a decline in the propensity to pay. Furthermore, the Tax Reform Act of 1986 introduced
major changes to the tax rates on corporate profits, capital gains, and individual dividend income. I also estimate the
changes in the propensity to pay using the base period of 1987-1989. This does not change my inferences either.

18

5. Why do entrenched managers pay dividends Three hypotheses

Existing evidence suggests that managers at firms with strong anti-takeover defenses are
more likely to pursue their own interests rather than those of shareholders (see e.g., Gompers,
Ishii and Metrick (2003), Cremers and Nair (2005) on firm valuation, Masulis, Wang and Xie
(2005) on acquisitions). Paying dividends reduces cash subject to managers discretion, therefore
restricting their ability to take self-serving actions. This implies that entrenched managers do not
favor dividends. In contrast, my results suggest that entrenched managers, resulting from
takeover protections, are more likely to distribute cash to shareholders via dividends. There are
three possible explanations for this puzzling finding:
Hypothesis 1 Entrenchment irrelevance hypothesis: Managers choose dividends primarily
based on firms existing payout policy. The governance index, which I use to measure
management entrenchment, is therefore irrelevant to a firms payout policy. Firms would pay out
profits the same way even if the anti-takeover provisions were not there.
Hypothesis 2 Dividend signaling hypothesis: Firms pay dividends to signal that they
practice good corporate governance so that in the future, they will be able to raise capital on
attractive terms. A reputation for good governance is valuable as long as firms need to access the
capital markets, even only occasionally. The reputation concern is higher for firms with more
anti-takeover provisions, and consequently, they will have a greater incentive to pay dividends.
Hypothesis 3 Optimal entrenchment hypothesis: Firms install anti-takeover provisions to
enhance value. Paying dividends reduces a firms cash holding, which can be used to deter
hostile takeovers. Ex ante, it is more efficient for shareholders at firms with weak growth
opportunities to surrender some power to induce managers to (continue to) pay dividends rather
than accumulate cash to fend off unwanted takeovers.

The first hypothesis is grounded on the stylized fact that firms tend to smooth dividends. In a
classic study, Lintner (1956) finds that dividends are largely determined by the existing payout
ratio, and only substantial and sustainable changes in earnings lead to gradual changes in
dividends. In other words, dividend policy is sticky. Furthermore, he observes that once
established, firms are extremely reluctant to terminate or cut dividends, an insight that still holds
today. Brav, Graham, Harvey and Michaely (2005) survey 384 financial executives at the
beginning of the 21st century and report that ninety-four percent of executives at firms that pay

19

dividends admit that they try to avoid reducing dividends. The authors further remark: Today,
some executives tell stories of selling assets, laying off a large number of employees, borrowing
heavily, or bypassing positive NPV projects, before slaying the sacred cow by cutting
dividends. (p. 500).
These survey results raise the possibility that managers do not stop paying dividends unless
they are unable to pay. Given that a typical firm in the top G quintile is 32.2 years old, it is quite
plausible that these firms had already been paying dividends at the time when the anti-takeover
provisions were installed in the 80s. Because dividends policy is sticky, managers may simply
maintain the existing dividend policy after the firm adopted anti-takeover provisions. With this
hypothesis, managerial entrenchment resulting from takeover protections is unrelated to the
dividend policy, and therefore, any change in the governance index is not related to changes in
dividend policy.
Under Hypothesis 2, managers pay dividends to signal that they practice good corporate
governance. This hypothesis is built on the idea that dividends and takeovers are substitutes in
mitigating the agency conflicts between managers and shareholders. In order to raise external
funds on attractive terms, firms need to show that they will not expropriate shareholders. Paying
dividends serves as one such mechanism. A reputation for good corporate governance is valuable,
as long as there is a strictly positive probability that the firm will need to raise funds from the
capital markets (Bulow and Rogoff (1989)), a condition that is quite realistic. This hypothesis is
very similar to the substitution model in La Porta, Lopez-De-Silanes, Shleifer and Vishny (2000),
who mainly focus on the relation between dividends and shareholders legal protection.
Since firms with more anti-takeover provisions are known for weak shareholder rights,
managers of these firms will have a greater incentive to signal that they are good governance
firms.28 Consequently, these firms are more likely to pay dividends, especially when they have
good growth opportunities that require a large amount of capital far exceeding their own
internally generated cash. Hypothesis 2 implies that high G firms are more likely to pay
dividends, especially those with good growth opportunities.
Hypothesis 3 implies that my empirical findings are a value-maximizing equilibrium
outcome. Firms choose anti-takeover provisions and payout policy simultaneously to enhance
28

This implicitly assumes that managers value the benefit of control the most. Therefore it is not desirable for the
managers to simply give shareholders more rights and expose themselves to the greater risk of being removed in
takeovers, but rather choose some other ways to signal that they practice good corporate governance.

20

value. Prior literature suggests that takeover defenses have mixed effects on shareholder wealth.
On the one hand, takeover defenses could reduce shareholder wealth if protected managers
become more entrenched, taking self-serving actions more frequently. On the other hand, they
might also increase firm value either through a higher expected takeover premium (Comment
and Schwert (1995)), or via a reduction in managerial myopic behavior (Stein (1988)).29 Under
this hypothesis, shareholders tradeoff between the net benefits of anti-takeover provisions and
the total costs they incur, and choose a combination of governance provisions and payout policy
that maximizes firm value.
These costs and benefits vary across firms, depending largely on the growth opportunities
available to them. The costs mainly come from two sources, the agency costs of free cash flow
and the adverse selection costs due to information asymmetry. Since the probability of managers
investing in negative NPV projects is greater when firms have limited investment opportunities,
the agency costs of free cash flows should be a decreasing function of a firms growth
opportunities. For firms with weak growth opportunities, paying dividends lowers these costs by
reducing the amount of cash under management discretion (Jensen (1986)). In contrast, when
firms face strong growth opportunities, larger cash holdings become valuable since they lower
the costs of external funds, either in the form of transaction costs or of adverse selection costs in
the spirit of Myers and Majluf (1984). Therefore, the optimal amount of cash that minimizes the
total costs to shareholders differs across firms, depending on their growth opportunities.
Consistent with this view, in the current sample, non-payers, usually fast-growing firms, have a
ratio of cash to total non-cash assets about three times that of payers (the median values are 0.33
and 0.11, respectively).30
While a lower level of cash holdings mitigates the agency problems, it can make firms more
vulnerable to hostile takeovers. With a large amount of cash, target firms are able to take actions

29

Comment and Schwert (1995) find that the adoption of poison pills does not reduce takeover probabilities, but it
does raise the takeover premium received. Two studies by Georgeson & Co also report that firms with poison pills
received higher takeover premiums than those without. See News Release, Georgeson & Co, Companies Protected
by Poison Pills Received Premiums 69% Higher in Takeover Contests than Companies without Pills (March 31,
1988). See also Georgeson Shareholder, Mergers & Acquisitions: Poison Pills and Shareholder value, 1992-1996,
available at http://www.georgesonshareholder.com/pdf/m&apoisonpill.pdf. One caveat with the Georgeson study is
that it includes takeovers pre-dating the use of poison pills that do not require shareholder approval. I thank Harry
DeAngelo for pointing this out.
30
The difference in the ratio of cash to total non-cash assets between payers and non-payers is similar across the G
quintiles. The ratios for payers (non-payers) are 0.18 (0.33) and 0.06 (0.19), for firms in the bottom G quintile and in
the top G quintile, respectively.

21

that make the acquisition more costly to the potential bidders and therefore deter unwanted
takeovers. For example, firms can repurchase shares to fight against hostile bidders. Bagwell
(1991) argues that share repurchases change the marginal shareholder of the target firm,
therefore increase the acquisition costs to the bidder. Stulz (1988) presents a model in which
target management can deter takeovers by increasing their control of voting rights, which may
also be achieved via share repurchases. Using a sample of hostile takeovers over the period
1985-1994, Pinkowitz (2000) offers empirical evidence that cash decreases hostile takeover
probability by deterring potential bidders.
If cash serves as a hostile takeover deterrent, then firms with low cash holdings are more
subject to hostile takeovers, which in turn might have unfavorable effects. Stein (1988) argues
that takeover pressures can lead to managerial myopia, namely, managers focus heavily on the
short-term profits rather than on long-term objectives.31 He shows that even when managers act
in the best interest of shareholders, the perfect equilibrium is ex ante inferior to what the
equilibrium would be if managers were banned from costly signaling. To reduce such valuedestroying behavior resulting from managerial myopia, shareholders at firms with low cash
holdings may find it ex ante efficient to provide managers with some protections against
takeovers. In contrast, firms that hold more cash do not need as many provisions because they
face smaller probability of hostile takeovers.
Under this hypothesis, firms choose a combination of governance provisions and payout
policy that maximizes shareholder value. For fast-growing firms, the costs of adverse selection
outweigh the agency costs of free cash flow. They accumulate more cash by not distributing
profits. Their large cash holdings also help deter hostile takeovers, and consequently, they will
have fewer anti-takeover provisions. On the other end of the spectrum, firms with weak growth
opportunities have higher agency costs of free cash flow, making higher payout ratios more
efficient. At the same time, to reduce the adverse consequences of managerial myopia or the
agency costs of free cash flows, these firms will adopt more anti-takeover provisions to limit the
probability of hostile takeovers.
Since cash and anti-takeover provisions can both deter hostile takeovers, Hypothesis 3
implies that firms with fewer anti-takeover provisions should not face greater probability of
31

In Steins model, takeover pressures lead to managerial myopia as long as managers are better informed about the
firms future prospect than shareholders and they have some discretion in decision making, assumptions that are
quite realistic.

22

hostile takeovers because they hold large amounts of cash. Furthermore, to the extent that antitakeover provisions allow target managers to gain greater bargaining power in the event of a
takeover, Hypothesis 3 also implies that firms with more provisions should receive higher
premiums.

5.1. Is the G index irrelevant to dividend policy? Evidence on Hypothesis 1

This hypothesis implies that my main result thus far, a positive relation between a firms
propensity to pay dividends and its G score, is spurious. To test this hypothesis, I focus on the
changes in entrenchment and the changes in dividend policy. For Hypothesis 1 to be true, there
must be no relationship between the two changes. If, on the contrary, entrenchment leads to
managers pursuing personal interests and cutting dividends, one would expect firms to be more
likely to terminate (initiate) dividends as managers become more (less) entrenched.
The power of this test is limited by the fact that the governance index is fairly stable at the
firm level. Changes in the G index are available in five years, 1993, 1995, 1998, 2000 and 2002,
with a mean value of 0.315 and a median of 0. I run logit regressions to estimate the probabilities
of dividend initiation (termination) in the year of a change in the G index (G), as well as the
probability of the cumulative change in dividend status in two years starting from the year when
the G index changes. If it takes time for the entrenched managers to alter dividend policy, the
cumulative change in dividend status should work better at capturing this effect. Furthermore,
since the primary interest is the consequences of an increase in the G index that leads to greater
entrenchment, I also construct an indicator variable (GINC) that takes on the value of 1 when G
index increases, and 0 otherwise. For initiations, I only use those firms that do not pay a dividend
prior to the estimation year. Similarly, for terminations, I study dividend payers only. In each
regression, I control for firm characteristics that are known to influence firms dividend decision,
including size (NYPCTL), profitability (EBIAT/A), maturity (RE/TA), growth (V/A), leverage
(MLEV), and institutional ownership (IHPCT). These results are presented in Panel A of Table 7.
An increase in the G index is associated with a higher probability of initiating dividends, but
only significantly so for the cumulative initiations over the two year horizon. The results on
dividend termination are less conclusive. Although the coefficients on G, the change in the G
index, are always negative, they are never significant. Interestingly, GINC, the indicator variable
representing an increase in the G index, has a significant inverse relationship with the probability

23

of terminating dividends over the two-year horizon (the right most column in Panel A of Table 7).
An increase in the G index shifts the balance of power towards firm managers, making them
potentially more entrenched. However, these results suggest that, ceteris paribus, as managers
become more entrenched, they are more likely to initiate dividends if they have not done so in
the past, and more importantly, less likely to terminate dividends if they have been paying
dividends.
Overall, these results do not support the entrenchment irrelevance hypothesis. Instead, results
from the analysis using the changes in the G index are consistent with the evidence presented in
Tables 4 and 5 ceteris paribus, entrenched managers are more likely to pay dividends.

5.2. Do firms pay dividends to signal good governance? Evidence on Hypothesis 2

As long as a firm is not able to finance its investment projects internally, it will need to seek
external financing. This forces the firm to place itself under extensive market scrutiny. Firms
with bad corporate governance or entrenched managers will find it difficult to raise capital on
favorable terms. Managers at these firms can pay dividends to establish a reputation for good
corporate governance so that they can raise funds at a lower cost in the future. This motivation is
especially strong when firms face good growth opportunities and need large amounts of external
funds. With this hypothesis, firms with numerous anti-takeover provisions and strong growth
opportunities should exhibit a higher propensity to pay dividends. To test this hypothesis, I create
a dummy variable for high growth firms (HG) based on the annual growth rate of sales, and let it
interact with the G index in regression models that are similar to those in Table 5. Under
Hypothesis 2, the interactive term should have a positive coefficient in these regressions.
These results are reported in Panel A of Table 8. As expected, high growth firms are much
less likely to pay dividends. However, while the interaction terms do have positive coefficients,
they are almost never significant. Therefore, ceteris paribus, having more anti-takeover
provisions does not increase the propensity to pay dividends for growth firms.
I then consider firms capital raising activities, which is a more direct measure of their needs
for outside capital. For Hypothesis 2 to be true, fast growing firms that have higher G scores and
pay dividends should raise external capital more frequently. I examine seasoned equity issuances
using data from SDCs New Issuance database. For each sample firm from 1990 to 2003, I look
at whether it has a seasoned equity offering in the subsequent one- and two-year horizons, and if

24

it does, the proceeds from the issuance. In general, a higher fraction of low G firms issue new
equities, and the amount of issuance scaled by the market value of firm equity is also higher for
both one-year and two-year horizons (not reported). These results confirm the findings in Table 2,
which show that firms with smaller G scores usually have stronger growth opportunities.
To test Hypothesis 2, I run logit regressions to estimate the probability of seasoned equity
issuance over the next one- and two-year horizons, controlling for firm size, leverage, average
sales growth rate and average Market-to-Book ratio, both are calculated over the past three years.
Panel B of Table 8 summarizes these results.
The main variables of interests are the three indicator variables, G5 and G1 for firms that
belong to the two extreme G quintiles and Payer for firms that pay dividends, and their
interactions. Under Hypothesis 2, firm with higher G scores should have more equity issuance in
the near future, with the effect being stronger for dividend payers. However, the results in Panel
B of Table 8 do not support this view. In fact, only those dividend payers with low governance
scores are more likely to issue seasoned equities in the next year (Model 1 and 2) and over the
next two years (Model 5 and 6), those with high governance scores do not. I also perform a
similar analysis with a sample that only includes firms in the two extreme quintiles. Using this
restricted sample leads to a bias towards finding support for Hypothesis 2. The results using this
restricted sample are presented in columns 3, 4, 7, and 8. Nonetheless, the results are not
consistent with Hypothesis 2. Overall, I find little support for the dividend signaling hypothesis.

5.3. Is this a value-maximizing equilibrium outcome? Evidence on Hypothesis 3

Under Hypothesis 3, some firms find it optimal to provide managers with takeover
protections in order to induce managers to pay out cash. To investigate this possibility, I again
focus on the changes, but this time, I regress the changes in the G index on the contemporaneous
or future dividend changes. The purpose of this analysis is to examine whether firms change their
governance provisions in order to induce changes in the dividend policy in the near future. I
construct a set of indicator variables, including one for G index increases (GINC), one for G
index decreases (GDEC), one for dividend initiations in the year of the change in the G index
(INI), one for initiations in the subsequent year (INI_1), and two dividend termination variables
(TER, TER_1) that are defined similarly. Hypothesis 3 implies a positive relation between GINC
and INI (INI_1), and this is indeed what I find.

25

Panel B of Table 7 presents the results from these logit regressions, controlling for size,
profitability, growth, leverage, and institutional holdings. In general, GINC is significantly
positively associated with the two dividend initiation variables, INI and INI_1, consistent with
the notion that firms provide managers with greater takeover protections to induce them to pay
dividends. In comparison, the dividend termination variables are never significant, and none of
the dividend change variables is significantly associated with GDEC, the dummy variable
indicating a decrease in the G index.
Hypothesis 3 also implies that firms with fewer anti-takeover provisions do not face a higher
hostile takeover probability relative to those with more provisions, but firms with more
provisions tend to receive higher takeover premiums. To investigate this possibility, I identify
acquisitions that are classified as a merger or seek to acquire a majority interest through
Thomson Financials Security Data Corporation (SDC) Mergers & Acquisition database, and
examine the actual takeover attempts and takeover premiums received by the firms in the sample
over the period of 1990-2003. I consider all takeover attempts since my primary interest is the
probability of a firm being targeted, regardless of the final outcome. Out of 2,116 firms in the
sample, 369 received a takeover bid, 28 are recorded as hostile targets by the SDC. 32 Some of
the target firms received more than one offer, yielding a total number of 464 incidences with
unique firm-announcement dates.
Panel A of Table 9 summarizes the results on takeover counts and offer premiums. Antitakeover provisions allow managers to be more powerful when the bidder has emerged. This
leads to a higher expected premium. I define the takeover premium as the percentage premium of
offer price to target stock price one week prior to the announcement date. The two right most
columns in Panel A indicate that firms in the top G quintile do receive significantly higher
premiums (about 10 percentage points) than firms in the bottom G quintile. In an untabulated
analysis, I calculate takeover premiums using target stock price one day before, or the average
price two days before the announcement date. These alternative definitions do not change my
results.
32

I follow Pinkowitz (2000) who uses SDC classification to define hostile takeovers. One potential caveat is that
this classification may not accurately capture the true nature of the deal. Schwert (2000) notes that the distinction
between hostile and friendly offers is usually ambiguous. Merger deals often start with confidential negotiations
before the first public announcement. Depending on the outcome of the private negotiation, the nature of the public
announcement (hostile or friendly) could differ considerably from the true nature of the private negotiation. Schwert
shows that although different measures of hostility, including the SDC classification that is used here, are positively
correlated, the correlations are not high (0.181 to 0.502, Table 2, p. 2605).

26

I find no significant difference in the percentage of firms receiving takeover bids across G
quintiles. Over the sample period, 3.7 percent of the firms in the bottom G quintile were takeover
targets, compared to 3.1 percent in the top G quintile. Interestingly, firms with the largest
number of provisions experience significantly more hostile takeover bids. The percentage of
firms that are hostile takeover targets in the top G quintile is considerably higher than that in the
bottom G quintile. Conditional on being targeted, 12.5 percent of the takeover attempts received
by firms in the top G quintile are classified as hostile, compared to 1.9 percent and 5.7 percent
for the bottom two G quintiles, respectively. Therefore, firms with fewer provisions do not
experience hostile takeovers more frequently than those with numerous provisions. This is
because these firms tend to have large cash reserves, which also serve as a deterrent to hostile
takeovers. Table 2 indicates that firms in the bottom G quintile hold more than twice as much
cash as do those in the top G quintile. Pinkowitz (2000) finds that large cash holdings deter
hostile acquisitions, and I show that this is also true with the current sample.
Using data on takeovers, I estimate the probability of receiving a hostile bid in a logit
regression setting that is similar to Pinkowitz (2000). Panel B of Table 9 summarizes these
results. Cash is measured by the ratio of cash to total non-cash assets (Cash/NCAssets). The
control variables include cumulative raw returns over the previous calendar year, firm size,
measured as the logarithm of market value of equity deflated to 2003 dollars using the CPI,
leverage ratio, Market-to-Book ratio, annual sales growth rate, and return on equity. In all
regression models, the likelihood of becoming a hostile takeover target decreases in cash,
indicating that a higher level of cash holdings is associated with a smaller hostile takeover
probability. These results hold if I replace the control variables with variables similar to those in
Comment and Schwert (1995), who use the average ratios over the past four years. This is
consistent with the idea that cash deters hostile takeovers.
Furthermore, the last two columns indicate that high G firms, those in the top G quintile in
particular, are associated with high hostile takeover probabilities. It is possible that these firms
adopt more anti-takeover provisions precisely because they are more threatened by hostile
takeovers. This would be possible if it is in general easier to find an alternative group to replace
the incumbent management team for firms in the top G quintile. To the extent that firm-specific
human capital is more important for younger, growth companies, mature firms could inherently
face a greater threat of hostile takeovers. Anti-takeover provisions allow them to be in a strong

27

position to fight the hostile bidders so that they can remain independent if the terms are not
sufficiently favorable. This concurs with the results in Panel A of Table 9 firms with more
provisions receive significantly higher premiums than those with fewer provisions. On the other
hand, although a large cash reserve effectively reduces the probability of a hostile takeover, it
does not increase the premiums when bids occur (Pinkowitz (2000)).
Overall, evidence on takeover premiums and subsequent changes in dividend policy is
generally consistent with the optimal entrenchment hypothesis. Paying dividends reduces a
firms cash holdings, making the firm unable to build a warchest of cash against hostile
takeovers. At firms with weak growth opportunities, it is ex ante more efficient for shareholder
to limit the probability of hostile takeovers and benefit from higher expected premiums by
adopting anti-takeover provisions to enhance value.

6. Robustness checks and discussions of the findings

Contrary to the conventional wisdom, I find that firms with entrenched managers are more
likely to pay dividends. The evidence favors the optimal entrenchment hypothesis shareholders
at firms with weak investments opportunities find it value-maximizing to surrender some power
to the managers in order to induce them to distribute cash rather than pile up cash to fight against
hostile takeovers. To check the robustness of these results, I conduct a series of robustness
checks, including replacing the G index with an alternative proxy for entrenchment, analyzing a
sub-sample of firms, examining the total payout ratios, and using different firm-level
independent variables. None of these checks changes my results in any material manner.

6.1. Alternative proxy for entrenchment

One could argue that the G index is not a good enough proxy for managerial entrenchment,
thus my results are a joint test of the validity of the G index as a measure of managerial
entrenchment and the underlying relation between entrenchment and dividend policy. 33 To
address this issue, I consider an alternative measure of entrenchment. I use a measure of CEO
entrenchment proposed by Landier, Sraer and Thesmar (2005), who argue that a CEO is more
33

Even if managers are protected against the threat of takeovers, firms can have other corporate governance
mechanisms that prevent managers from becoming entrenched. For example, shareholder monitoring, managerial
ownership, and the usage of debt are three well-recognized control mechanisms that restrict management
entrenchment (see e.g., Jensen (1986), Shleifer and Vishny (1997) and Stulz (1990)).

28

likely to be challenged / disciplined if other top executives are independently appointed, and
therefore they are more likely to hold different opinions. They propose a proxy for such
independence the fraction of top executives who joined the company before the current CEO
was appointed (INDDIR). A lower value of INDDIR indicates greater potential for CEO
entrenchment. This variable is less subject to the endogeneity concern. While a more
independent top management team will limit the entrenchment of the CEO, at a priori it does not
have any direct implication for dividend policy, which should be chosen to maximize firm value.
Using data from the Executive Compensation database via WRDS, I construct the variable
INDDIR following Landier, Sraer and Thesmar (2005). The Executive Compensation database
begins in 1992. It covers about one third of the sample firms, yielding a sub-sample of 728
unique firms with a total 8,409 firm-year observations.
As expected, the variable INDDIR is inversely correlated with both the governance index and
the entrenchment index. It has a correlation coefficient of -0.144 with the G index, and a
coefficient of -0.070 with the E index, both are significant at the 1% level. With this sub-sample,
I run logit regressions using INDDIR instead of the G index to estimate the propensity to pay
dividends. Results from these regressions are presented in Table 10. In all regression
specifications except those in which I control for Firmage, the coefficients for INDDIR are
negative and significant at the 5% level. Since a lower level of INDDIR implies a greater
potential for CEO entrenchment, these results are consistent with the main findings of this paper,
namely, the more entrenched the CEO is (a lower INDDIR value), the more likely he/she will
pay dividends.
Although both INDDIR and the G index are proxies for managerial entrenchment, they do
differ in many ways. While INDDIR focus on the CEO, assuming that the restriction on CEOs
entrenchment comes from the disciplinary power from other top executives, the G index could be
applied to all top executives. When I include INDDIR and the G index together in a regression
model (Model 5), they both remain significant but their t-statistics deteriorate, indicating that
both variables have independent explanatory power in explaining the propensity to pay dividends.
However, when Firmage is controlled for, only the G index remains significant.
Overall, none of my earlier results changes with this alternative measure of entrenchment,
and all the evidence suggest that firms with more entrenched managers/CEOs are more likely to
pay dividends.

29

6.2. Sub-sample analysis

The main conclusions presented earlier are drawn from cross sectional analyses over the
period 1990-2003. However, firms come in and drop out of the sample, raising the concern that
my results might be driven by changes in the population of firms over time. I therefore
investigate a subset of sample firms that have a governance index available in 1990 and existed
no later than 1982. Since most of the anti-takeover provisions became widely used in the late 80s,
when the takeover market was active, a close examination of this sub-sample allows me to better
understand the characteristics and motivations of firms that adopted different takeover
protections. I find similar results using this sub-sample.
Given that a typical firm in the top G quintile is 32.2 years old, it is quite plausible that these
firms had already been paying dividends at the time when the anti-takeover provisions were
installed in the 80s. To further understand why firms ended up with different governance
provisions, I focus on a subset of firms that first appeared in the Compustat database in 1982 or
earlier. I choose 1982 as the cut off year because the first poison pill that does not require
shareholder approval was introduced by Lexon in 1983. This sub-sample consists of 5,454 firmyear observations and 721 unique firms, about a third of the full sample. In 1982, the bottom G
quintile had 99 firms, 75 percent of which paid dividends, compared to 111 firms in the top G
quintile with 94 percent payers. A typical firm in the bottom G quintile started paying dividends
in 1972, compared to 1964 for those in the top G quintile.

A closer look at the firm

characteristics (not reported for brevity) reveals that overall, this subset of firms appears to be
quite representative of the entire sample.
To find out what determines the G index in 1990 for these firms, I run Poisson regressions
using an indicator variable that represents their dividend status in 1982, and other firm
characteristics that might influence their perceived takeover probabilities, also measured in 1982.
This approach implicitly assumes that all anti-takeover provisions are equally important, and the
G index simply represents the occurrence of adopting such provision. However, some antitakeover provisions are more effective to deter takeover attempts, and consequently firms may be
more likely to adopt these than others. I therefore also run similar regressions for the E index
from Bebchuk, Cohen and Ferrell (2004). Furthermore, since it is unclear when a firm adopted
the anti-takeover provisions, using firm level variables in 1982 to predict these indices prevents

30

us from using information that was not available when the provisions were installed. However,
firm characteristics change over time. Using recent data can lead to more accurate estimates. I
therefore also perform the same analysis for 1989. Table 11 Panel A summarizes these results.
It is clear from Table 11 that firms tend to adopt more ATPs by 1990 if they were older
(Firmage), larger (LogA), and paid dividends (Payer) in 1982. Other firm characteristics, such as
profitability (EBIAT/A), leverage (MLEV), or growth opportunities (SGR), do not have any
explanatory power. Using the E index yields similar results. In both cases, Firmage and Payer
are significantly related to the level of governance indices in 1990. These Poisson regression
results, albeit weak, suggest that firms tend to have high governance scores in 1990 if they paid
dividends in 1982.
I then group these firms into quintiles based on their G scores in 1990, and examine their
changes in the propensity to pay dividends through out the sample period. Panel B in Table 11
reports the change in the propensity to pay, estimated using the base period 1973-1981. With this
restricted sample, the changes in the propensity to pay is much smaller than the full sample, due
largely to a survival bias that is more pronounced for the bottom G quintile. Nonetheless, firms
in the top G quintile do not exhibit a lower propensity to pay, while firms in the other quintiles
do, especially in more recent years. Again, there is no evidence that entrenched managers are less
likely to pay dividends.

6.3. Share repurchases and payout ratios

Firms also distribute profits through share repurchases, which have increased considerably
since the 80s (see Bagwell and Shoven (1989)). Agency theory suggests that what shareholders
are really concerned about is the profits left within the firm, or the amount paid out, rather than
the form of the payout. It is possible that, although firms with numerous anti-takeover provisions
are more likely to pay dividends, they do not distribute a higher fraction of total profits. If this is
the case, then the conclusions presented earlier would be less convincing.
Table 12 presents results on share repurchases and total payouts. Following Fama and French
(2001), I use annual changes in a firms treasury stock to estimate its share repurchases activities.
Panel A confirms the evidence in Fama and French (2001) share repurchases are more popular
among dividend payers. On average roughly half of dividend payers repurchased shares over the
sample period 1990-2003, but only one third of non-payers did. However, there is no significant

31

difference across G quintiles. Although firms with more entrenched managers are more likely to
pay dividends, their activities on share repurchases are comparable to those with less entrenched
managers.
Panel B to panel D presents the amount of share repurchases, the amount of dividends, and
the amount of total payouts scaled by earnings available to common shareholders (on the left)
and by the market value of equity (on the right). Firms do not differ significantly in the amount
of share repurchases across the G quintiles, but they pay out a significantly larger portion of
earnings when they have higher G scores, primarily through dividends. This indicates that firms
with more entrenched managers are not only more likely to pay dividends, but they also
distribute significantly more profits in the form of dividends, a result that is consistent with the
notion that at these firms, shareholders find it value maximizing to provide managers with
takeover protections to induce them to distribute cash.

6.4. Alternative variables

I also check the robustness of the results using alternative variables. In untabulated tests, I
replace some variables with alternative measures, including using the logarithm of total assets as
a size variable, annual asset growth rate (dA/A) or sales growth rate (SGR) as proxies for growth
opportunities, RE/TA as a proxy for maturity, or using the original cutoff points in Gompers, Ishii
and Metrick (2003) for the G quintiles. Using these alternative variables lead to similar results
and my conclusions remain the same.

7. Conclusion
I investigate the relationship between managerial entrenchment and dividend policy for a
large number of firms over the period 1990-2003. In particular, I study the relation between a
firms propensity to pay dividends and the degree of managerial entrenchment, proxied by the
Gompers, Ishii and Metrick (2003) governance index (the G index). I find that, contrary to the
conventional wisdom, entrenched managers are not less likely to pay dividends, and argue that
firms choose a combination of governance provisions and dividend policy that maximizes firm
value. At firms with weak growth opportunities, shareholders find it value-maximizing to
surrender some power to the managers to induce them to pay dividends rather than keep the cash
to deter unwanted takeovers.

32

Logit regressions show a strong positive relation between a firms G index, proxied for the
degree of entrenchment, and its propensity to pay dividends, after controlling for known
determinants of firms dividend decisions, i.e., size, profitability, growth opportunity and
maturity. Furthermore, the lower propensity to pay in Fama and French (2001) is found for most
of the sample firms, but not for firms with the most entrenched managers (top G quintile). These
results hold up well under a series of robustness checks.
An increase in the governance index weakly increases the probability of dividend initiation,
but decreases the probability of dividend termination. Furthermore, the likelihood of an increase
in the governance index is significantly associated with contemporaneous and future changes in
dividend policy. While these findings are broadly consistent with the optimal entrenchment
hypothesis, they do not support the hypothesis that managerial entrenchment is irrelevant to
dividend policy. It is also not the case that managers pay dividends to signal for good corporate
governance so that they can raise capital on favorable terms in the future.
The governance index developed by Gompers, Ishii and Metrick (2003) offers a
parsimonious measure of shareholder power. It is often assumed that the lower the index, the
better the quality of corporate governance. However, this paper shows that caution should be
taken when using this index. While anti-takeover provisions entrench firm managers, possibly
leading to value-reducing activities, in some circumstances it might be ex ante optimal for
shareholders to empower managers in order to maximize shareholder wealth. In terms of
dividend policy, this paper argues that for firms with weak growth opportunities, a value
maximizing strategy for shareholders might be to surrender some power to firm managers in
order to induce them to distribute cash.

33

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37

Appendix:
Sampling procedure:
My sampling procedure follows Fama and French (2001). To be included in the sample, in
any year t, a firm needs to have the following data items available from Compustat total assets
(6), total assets in year t-1, interest expense (15), income before extraordinary items (18),
preferred dividends (19), common shares outstanding (25), dividends per share (26), fiscal year
end market price (199). Sample firms must have shareholders equity (216), or total liabilities
(181), or common equity (60) plus preferred stock carrying value (130). In addition, firms must
also have preferred stock liquidating value (10), or preferred stock redemption value (56), or
preferred stock carrying value (130) to be included in the sample. I also use, but not require, the
following data items long-term debt (9), debt in current liabilities (34), sales (12), retained
earnings (36), deferred taxes (50), cash and short-term investments (1), and net property, plant
and equipment (8).
Following Fama and French (2001), I remove extremely small firms (BE<$250,000 or
A<$500,000) from the sample. To ensure sample firms are publicly traded, I include only those
firms whose CRSP share codes are 10 or 11 at the fiscal year end. Finally, firms (SIC 6000
6999) and utility firms (SIC 4900 4949) are excluded from the sample.
Variable definitions:
BE = Shareholders equity (216) [or total liabilities (181), or common equity (60) + preferred
stock carrying value (130)] Preferred stock liquidating value (10) [or preferred stock
redemption value (56), or preferred stock carrying value (130)];
ME = Fiscal year end market price (199) * Common shares outstanding (25);
EBIAT = Income before extraordinary items (18) + Interest expense (15) +
Deferred taxes (50) if available;
Y = Income before extraordinary items (18) Preferred dividends (19) + Deferred taxes (50)
if available;
V = Total assets (6) BE + ME;
RE/TE = RE (36) / BE;
RE/TA = RE (36) / A (6);
D = Long-term debt (9) + Debt in current liabilities (34);
MLEV = D / V;
dA/A = (A (6)t A (6)t-1) / A (6)t;
SGRt = Sales (12)t / Sales (12)t-1 1;

38

Table 1: Number of firms, fraction of dividend payers and the governance index
For any year t, payers are firms with positive dividend per share values (Compustat data 26) in that year. %Payer is
the fraction of firms that pay a dividend in year t. G index is the governance index from Gompers, Ishii and Metrick
(2003). E index is the entrenchment index from Bebchuk, Cohen and Ferrell (2004). Change in G index (E index) is
the change in G index (E index) from the previous IRRC publication across, and values reported are the average
change across all the firms in that year.

YEAR

# of firms

%Payer

G index
Mean

E index
Mean

1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003

907
889
855
969
947
1,000
968
902
1,254
1,135
1,114
1,034
1,264
1,227

0.743
0.741
0.745
0.696
0.697
0.675
0.676
0.665
0.547
0.554
0.530
0.515
0.419
0.447

9.15
9.17
9.18
9.29
9.32
9.34
9.40
9.37
8.74
8.80
9.02
9.04
9.03
9.05

2.02
2.03
2.02
2.08
2.09
2.08
2.08
2.08
1.98
1.98
2.12
2.12
2.19
2.20

1990-2003

14,465

0.605

9.12

2.08

39

Change in G
index

Change in E
index

0.359

0.087

0.243

0.048

0.250

0.093

0.296

0.172

0.415

0.216

0.315

0.128

Table 2: Summary statistics

This table presents the time series averages of cross-sectional medians over the period 1990-2003, all measured at
the end of the fiscal year. %Payer (%Repurchase) is the percentage of firms that pay dividends (repurchase shares).
A, ME and BM are total assets (in millions US$), market value of equity (in millions US$), and book-to-market
ratio, respectively. NYPCTL is the size percentile ranked using NYSE ME break points at the end of fiscal year;
EBIAT/A is the ratio of earnings before interest but after tax to total assets; RE/TE (RE/TA) is the ratio of retained
earnings over market value of equity (total assets); dA/A is the annual asset growth rate; V/A is the ratio of total
firm value (book value of total debt + market value of equity) to total assets; SGR is the annual sales growth rate.
MLEV is market leverage ratio calculated as book value of debts over market value of the firm (book value of debts
plus market value of equity). Firmage is the number of years elapsed since a firm first appeared in Compustat.
Cash/NCAssets, Cash/Sales, and Cash/Lag(NetPPE) are cash and short-term investments as a percentage of total
non-cash assets, sales, and previous year Net PP&E, respectively. IHPCT, IBPCT, and IPPCT are the percentage of
common shares outstanding held by institutional investors, by block institutions (with holdings >= 5%), and the 18
largest public pension funds. The last column reports the difference in group means between G5 and G1, as well as
t-test results for equal means. *, **, and *** represents 10%, 5% and 1% significant level, respectively.
G1
G<=6

G2
7<G<=8

G3
9<G<=10

G4
11<G<=12

G5
G>=13

Difference
G5 - G1

# of firms
%Payer
%Repurchse

202
0.497
0.397

236
0.530
0.423

257
0.608
0.448

209
0.735
0.482

130
0.815
0.465

0.318***
0.068*

GINDEX
EINDEX
A
ME
NYPCTL
EBIAT/A
RE/TA
RE/TE
Firmage
dA/A
V/A
SGR
BM
MLEV
Cash/NCAssets
Cash/Sales
Cash/Lag(NetPPE)
IHPCT
IBPCT
IPPCT

5.107
0.429
710.5
752.3
60.1
0.071
0.254
0.522
15.6
0.068
1.492
0.084
0.522
0.123
0.073
0.063
0.263
0.521
0.115
0.021

8.000
1.500
764.9
773.7
60.6
0.067
0.246
0.515
20.0
0.059
1.391
0.071
0.551
0.148
0.069
0.061
0.257
0.559
0.126
0.023

9.357
2.071
1038.8
961.4
65.1
0.068
0.241
0.539
24.4
0.051
1.413
0.058
0.531
0.165
0.056
0.048
0.203
0.585
0.133
0.026

11.000
3.000
1495.8
1358.1
71.9
0.074
0.289
0.649
31.0
0.052
1.410
0.055
0.526
0.175
0.039
0.034
0.126
0.621
0.120
0.029

13.214
3.929
1626.9
1413.5
72.4
0.071
0.280
0.654
32.2
0.046
1.351
0.060
0.570
0.190
0.031
0.026
0.116
0.605
0.120
0.029

8.107***
3.500***
916.43***
661.18***
12.286***
0.000
0.026**
0.132***
16.607***
-0.022**
-0.141***
-0.024**
0.048*
0.068***
-0.041***
-0.037***
-0.147***
0.085**
0.005
0.008***

40

Table 3: Fraction of dividend payers by firm categories, 1990-2003

This table reports the fraction of dividends payers in portfolios sorted by the G index and by other firm characteristics. All
variables are measured at the fiscal year end. ME is market value of equity; EBIAT/A is the ratio of earnings before
interest but after tax to total assets; RE/TA (RE/TE) is retained earnings over total assets (total equity); dA/A is the annual
growth rate of assets; V/A is the ratio of total firm value (book value of total debts + market value of equity) to total assets.
G (G index) is Gompers, Ishii and Metrick(2003) governance index.
(RE<0)
G1 (<=6)
G2
G3
G4
G5 (>=13)
G1 (<=6)
G2
G3
G4
G5 (>=13)

Low

0.18
0.30
0.27
0.33
0.51

0.50
0.45
0.43
0.52
0.70

0.17
0.20
0.25
0.47
0.63

G1 (<=6)
G2
G3
G4
G5 (>=13)

0.12
0.16
0.17
0.38
0.47

0.33
0.35
0.48
0.56
0.64

G1 (<=6)
G2
G3
G4
G5 (>=13)

0.12
0.16
0.17
0.38
0.47

0.28
0.33
0.39
0.58
0.64

G1 (<=6)
G2
G3
G4
G5 (>=13)

0.29
0.31
0.40
0.62
0.66

G1 (<=6)
G2
G3
G4
G5 (>=13)

0.43
0.42
0.39
0.58
0.79

3
4
5
Panel A: Size (ME) deciles
0.46
0.47
0.51
0.57
0.46
0.52
0.45
0.53
0.61
0.67
0.68
0.80
0.78
0.74
0.77

High

0.46
0.52
0.59
0.76
0.81

0.49
0.53
0.69
0.72
0.86

0.47
0.53
0.68
0.78
0.87

0.58
0.53
0.79
0.86
0.89

0.81
0.71
0.87
0.91
0.96

0.55
0.64
0.68
0.81
0.86

0.57
0.59
0.72
0.77
0.82

0.58
0.58
0.74
0.81
0.88

0.51
0.47
0.67
0.75
0.79

0.54
0.63
0.76
0.82
0.90

0.57
0.61
0.76
0.84
0.92

0.72
0.68
0.81
0.84
0.95

0.78
0.80
0.88
0.82
0.93

0.74
0.70
0.77
0.84
0.87

0.75
0.68
0.82
0.85
0.93

0.85
0.83
0.85
0.90
0.95

0.78
0.80
0.91
0.88
0.96

0.57
0.60
0.66
0.79
0.82

0.51
0.49
0.60
0.72
0.84

0.41
0.49
0.56
0.70
0.74

0.31
0.35
0.42
0.57
0.71

0.55
0.50
0.66
0.80
0.87

0.49
0.49
0.60
0.77
0.89

0.47
0.48
0.64
0.81
0.78

0.44
0.40
0.60
0.68
0.58

Panel B: Profitability (EBIAT/A) deciles

0.36
0.45
0.52
0.53
0.59
0.39
0.54
0.53
0.61
0.57
0.46
0.59
0.60
0.64
0.65
0.62
0.69
0.76
0.75
0.79
0.74
0.78
0.81
0.85
0.85
Panel C: RE/TA deciles
0.41
0.55
0.48
0.53
0.48
0.50
0.50
0.50
0.61
0.57
0.59
0.63
0.61
0.65
0.66
0.70
0.72
0.76
0.87
0.83
0.79
0.79
0.86
0.82
0.88
Panel C: RE/TE deciles
0.43
0.41
0.41
0.45
0.53
0.41
0.45
0.49
0.60
0.61
0.52
0.57
0.63
0.63
0.71
0.65
0.67
0.74
0.78
0.77
0.76
0.74
0.83
0.83
0.87
Panel D: Annual asset growth (dA/A) deciles
0.45
0.59
0.59
0.57
0.60
0.45
0.58
0.65
0.59
0.60
0.50
0.62
0.72
0.75
0.68
0.70
0.69
0.84
0.82
0.80
0.85
0.85
0.91
0.83
0.83
Panel E: Market-To-Book (V/A) deciles
0.45
0.54
0.46
0.48
0.53
0.49
0.54
0.52
0.62
0.57
0.51
0.59
0.61
0.63
0.66
0.67
0.71
0.77
0.74
0.78
0.74
0.79
0.85
0.83
0.84

41

Table 4: Logit Regression results

Dependent variable is Payert, =1 if a firm is a payer in year t, =0 otherwise. Each model specification contains two types of results The coefficient estimates for FM
(Fama-MacBeth) are the time series average of cross sectional logit regression coefficient estimates over period 1990-2003. t-values are in parenthesis. In FM, t-values
are calculated using AR(1) adjusted standard errors. In the pooled regressions, t-values are calculated using cluster robust standard errors, assuming observations are
correlated within a firm but independent across firms. G index is the governance index from Gompers, Ishii and Metrick (2003). E index is the entrenchment index from
Bebchuk, Cohen and Ferrell (2004). O index is the difference between G index and E index. NYPCTL is a firms size percentile ranked using NYSE ME break points.
EBIAT/A is the ratio of earnings before interest but after tax to total assets. V/A is the ratio of total firm value (book value of total debts + market value of equity) to
total assets. RE/TA is the ratio of retained earnings over total assets. LAGMLEV is the market leverage ratio at the beginning of the year. IHPCT is the percentage of
common shares outstanding held by institutions, calculated using holding information reported in the quarter immediately before the end of fiscal year t. Pooled
regressions in model 2 through 6 include Fama and French 30 industry classifications, obtained from Ken Frenchs website.
1
FM

2
Pooled

FM

3
Pooled

G index

FM
0.155
(10.65)

4
Pooled
0.096
(7.06)

E index
O index

Intercept
NYPCTL
EBIAT/A

-0.464
(-2.92)
0.029
(6.46)
4.254
(11.29)

0.134
(1.36)
0.011
(8.99)
-0.363
(-2.32)

-0.457
(-14.63)

-0.046
(-4.84)

RE/TA
V/A
LAGMLEV

-2.362
(-8.22)
0.036
(15.12)
1.394
(4.29)
3.929
(30.21)
-0.488
(-13.05)
2.693
(11.77)

-0.142
(-0.41)
0.014
(9.65)
-1.093
(-5.26)
1.456
(7.77)
-0.066
(-5.10)
-0.522
(-3.03)

-3.653
(-9.97)
0.033
(14.57)
1.556
(5.36)
3.955
(30.80)
-0.452
(-13.39)
2.545
(16.18)

-0.924
(-2.50)
0.015
(9.50)
-1.125
(-5.29)
1.524
(7.81)
-0.064
(-4.77)
-0.552
(-3.17)

FM

Pooled

0.121
(2.95)
0.175
(2.82)

0.062
(2.37)
0.115
(6.64)

-3.692
(-8.12)
0.033
(12.00)
1.567
(4.90)
3.952
(28.38)
-0.455
(-14.02)
2.545
(16.52)

-0.995
(-2.70)
0.015
(9.50)
-1.127
(-5.28)
1.531
(7.85)
-0.065
(-4.79)
-0.547
(-3.13)

IHPCT
Industry
Year
PseudoR2
Number of firms
Number of obs

No
Yes
0.132
1,768
12,290

Yes
Yes
0.279
1,768
12,249

Yes
Yes
0.298
1,768
12,249

42

Yes
Yes
0.298
1,768
12,249

FM
0.171
(12.46)

-2.860
(-11.44)
0.038
(20.82)
1.938
(5.80)
3.814
(23.23)
-0.472
(-14.20)
2.416
(11.26)
-1.948
(-8.10)

6
Pooled
0.097
(7.10)

-0.891
(-2.40)
0.015
(9.82)
-1.108
(-5.17)
1.520
(7.77)
-0.063
(-4.70)
-0.556
(-3.18)
-0.177
(-1.49)
Yes
Yes
0.305
1,768
12,239

FM

Pooled

0.158
(4.56)
0.178
(3.39)

0.064
(2.44)
0.115
(6.65)

-2.884
(-9.23)
0.038
(15.87)
1.920
(5.23)
3.820
(21.68)
-0.474
(-14.55)
2.411
(11.35)
-1.926
(-9.31)

-0.961
(-2.59)
0.015
(9.81)
-1.111
(-5.15)
1.526
(7.80)
-0.064
(-4.72)
-0.551
(-3.15)
-0.173
(-1.46)
Yes
Yes
0.306
1,768
12,239

Table 5: Pooled logit regression results, 1990-2003

Dependent variable is Payert, which equals 1 if a firm pays dividends in year t, 0 if it does not. G index is Gompers,
Ishii and Metrick (2003) governance index. G2 is an indicator variable that equals 1 if a firm belongs to the second
G index (G2) quintile, and 0 otherwise. Similarly, G3G5 are indicator variables for G3G5 quintiles. NYPCTL is
a firms size percentile ranked using NYSE ME break points; EBIAT/A is the ratio of earnings before interest but
after tax to total assets; RE/TA is the ratio of retained earnings over total assets; V/A is the ratio of total firm value
(book value of total debts + market value of equity) to total assets. LAGMLEV is market leverage at the beginning
of the year. IHPCT is the percentage of common shares outstanding held by institutions, calculated using holding
information reported in the quarter immediately before the end of fiscal year t. Firmage is the number of years
elapsed since a firm first appears in Compustat. Marginal effects are reported, and t-values calculated using robust
standard errors (clustering at the firm level) are in parenthesis. *, ** and *** represents 10%, 5% and 1%
significant level, respectively.
1
G index

2
0.018***
(7.06)

G2

4
0.008***
(3.11)

0.023*
(1.95)
0.064***
(4.49)
0.081***
(5.25)
0.124***
(6.44)

G3
G4
G5

Intercept

0.005
(0.42)
0.025*
(1.84)
0.025*
(1.73)
0.053***
(2.79)

-0.027
(-0.41)
0.003***
(9.65)
-0.209***
(-5.26)
0.279***
(7.77)
-0.013***
(-5.10)
-0.100***
(-3.03)

-0.172**
(-2.50)
0.003***
(9.50)
-0.209***
(-5.29)
0.283***
(7.81)
-0.012***
(-4.77)
-0.102***
(-3.17)

-0.066
(-0.99)
0.003***
(9.60)
-0.210***
(-5.31)
0.283***
(7.81)
-0.012***
(-4.84)
-0.103***
(-3.18)

-0.239***
(-4.03)
0.002***
(8.30)
-0.178***
(-4.67)
0.243***
(6.93)
-0.009***
(-3.65)
-0.109***
(-3.52)
0.009***
(13.66)

-0.194***
(-3.41)
0.002***
(8.35)
-0.178***
(-4.66)
0.243***
(6.93)
-0.009***
(-3.66)
-0.109***
(-3.52)
0.010***
(14.01)

Industry
Year

Yes
Yes

Yes
Yes

Yes
Yes

Yes
Yes

PseudoR2
# of firms
# of obs

0.279
1,768
12,249

0.298
1,768
12,249

0.297
1,768
12,249

0.344
1,768
12,249

NYPCTL
EBIAT/A
RE/TA
V/A
LAGMLEV
Firmage

0.005
(0.45)
0.026*
(1.88)
0.026*
(1.77)
0.054***
(2.84)

Yes
Yes

-0.234***
(-3.92)
0.002***
(8.59)
-0.175***
(-4.56)
0.242***
(6.89)
-0.009***
(-3.59)
-0.109***
(-3.52)
0.009***
(13.67)
-0.029
(-1.37)
Yes
Yes

-0.188***
(-3.28)
0.002***
(8.63)
-0.175***
(-4.56)
0.241***
(6.89)
-0.009***
(-3.61)
-0.110***
(-3.52)
0.010***
(14.02)
-0.027
(-1.31)
Yes
Yes

0.345
1,768
12,249

0.349
1,768
12,239

0.349
1,768
12,239

IHPCT

43

6
0.008***
(3.18)

Table 6: Changes in the propensity to pay, 1990-2003

This table reports the average changes in the propensity to pay across firms in each G quintile for each year over the
period 1990-2003. Logit regression coefficients are first estimated for the base period 1973-1989 using all firms in
Compustat that meet the sample criteria. The explanatory variables include NYPCTL, EBIAT/A, RE/TA and V/A, as
defined in Table 4 and 5. For each year from 1990 to 2003, the time series averages of these coefficient estimates are
used to estimate the probability to pay dividends for each individual firm. For each firm-year, the change in the
propensity to pay is defined as the difference between the expected probability and the actual dividend status of the firm
in that year, controlling for other firm characteristics. The mean values of the changes in the propensity to pay are
reported on the left, associated P-values are reported on the right.

G5

G1

G2

P-value
G3

G4

G5

-0.038
-0.032
-0.026
-0.039
-0.025
-0.004
0.022
0.030
0.011
0.042
0.057
0.072
0.135
0.097

0.000
0.001
0.001
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000

0.016
0.285
0.692
0.003
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000

0.006
0.002
0.001
0.003
0.003
0.002
0.001
0.003
0.000
0.000
0.000
0.000
0.000
0.000

0.565
0.532
0.542
0.240
0.409
0.011
0.012
0.035
0.001
0.002
0.002
0.000
0.000
0.000

0.074
0.161
0.274
0.092
0.270
0.897
0.501
0.382
0.743
0.236
0.119
0.058
0.000
0.006

Panel B: Restricted Sample (firms with G index available in 1995 or earlier)

1990
0.154
0.073
0.077
0.014
-0.038
0.000
1991
0.113
0.032
0.087
0.015
-0.032
0.001
1992
0.123
0.012
0.092
0.015
-0.026
0.001
1993
0.152
0.104
0.085
0.029
-0.039
0.000
1994
0.196
0.156
0.080
0.021
-0.025
0.000
1995
0.247
0.139
0.084
0.066
-0.004
0.000
1996
0.200
0.161
0.092
0.068
0.022
0.000
1997
0.196
0.165
0.086
0.061
0.030
0.000
1998
0.186
0.193
0.106
0.069
0.008
0.000
1999
0.141
0.185
0.110
0.065
0.028
0.002
2000
0.103
0.221
0.145
0.058
0.017
0.070
2001
0.150
0.249
0.152
0.103
0.040
0.013
2002
0.151
0.262
0.172
0.152
0.065
0.017
2003
0.107
0.253
0.135
0.121
0.039
0.071

0.016
0.285
0.692
0.003
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000
0.000

0.006
0.002
0.001
0.003
0.003
0.002
0.001
0.003
0.001
0.001
0.000
0.000
0.000
0.000

0.565
0.532
0.542
0.240
0.409
0.011
0.012
0.035
0.020
0.036
0.068
0.002
0.000
0.002

0.074
0.161
0.274
0.092
0.270
0.897
0.501
0.382
0.816
0.429
0.634
0.280
0.071
0.244

G1
Panel A: Full Sample
1990
0.154
1991
0.113
1992
0.123
1993
0.152
1994
0.196
1995
0.247
1996
0.200
1997
0.196
1998
0.333
1999
0.311
2000
0.319
2001
0.384
2002
0.433
2003
0.344

Expected - Actual
G2
G3
G4

0.073
0.032
0.012
0.104
0.156
0.139
0.161
0.165
0.271
0.273
0.351
0.373
0.448
0.406

0.077
0.087
0.092
0.085
0.080
0.084
0.092
0.086
0.148
0.165
0.220
0.229
0.302
0.246

0.014
0.015
0.015
0.029
0.021
0.066
0.068
0.061
0.104
0.098
0.098
0.147
0.226
0.210

44

Table 7: Changes in the G index and dividend status

This table uses data in 1993, 1995, 1998, 2000 and 2002. G is the change in the G index from previous IRRC
publication. The regressions also include NYPCTL, EBIAT/A, RE/TA, V/A, MLEV, as defined in Table 4 and 5, and
dummy variables for industry and year. In Panel A, the firm characteristic variables are measured in the year of G
changes. In Panel B, they are measured in the year prior to G changes. INI (TER) is an indicator variable, and it equals 1
if a firm initiates (terminates) dividends in the year of a G index change, 0 otherwise. INI_1 (TER_1) is similarly defined
for dividend initiation (termination) in the year following a change in the G index. Marginal effects are reported, and tvalues calculated using robust standard errors (clustering at the firm level) are reported in parenthesis. *, ** and ***
represents 10%, 5% and 1% significant level, respectively.
Panel A: Logit regression results. Dependent variables are changes in dividend status, controlling for industry and year.
Dividend Initiation (INI)
Dividend Termination (TER)
Year t
Year t and t+1
Year t
Year t and t+1
G

0.007
(1.61)

G inc dummy

PseudoR2
# of events
# of firms
# of obs

0.013*
(1.83)
0.009
(0.86)

0.103
39
824
1,156

0.101
39
824
1,156

-0.003
(-1.09)
0.028*
(1.74)

0.177
86
824
1,073

0.176
86
824
1,073

-0.005
(-1.53)
-0.004
(-0.66)

0.066
56
921
2,716

0.066
56
921
2,716

-0.014*
(-1.78)
0.111
91
921
2,596

Panel B: Logit regressions results. Dependent variables are changes in the G index.
1
2
5
6
7
8
11
G Index Increase Dummy
G Index Decrease Dummy
INI
TER

0.107*
(1.72)
-0.085
(-1.41)

INI_1

0.115**
(1.96)
-0.079
(-1.25)

TER_1

Industry/Year
PseudoR2
# of events
# of firms
# of obs

0.114*
(1.86)
-0.092
(-1.56)

No
0.048
1,335
2,001
4,375

No
0.128
1,245
2,001
4,098

0.035
(0.88)
0.008
(0.21)
0.083
(1.41)
-0.075
(-1.18)

Yes
0.059
1,335
2,001
4,375

Yes
0.139
1,245
2,001
4,098

45

12

0.035
(0.87)
0.013
(0.33)
0.005
(0.13)
0.041
(1.22)

No
0.031
429
2,001
4,375

0.111
91
921
2,596

No
0.080
395
2,001
4,098

0.015
(0.36)
0.038
(1.14)
Yes
0.039
429
2,001
4,375

Yes
0.090
395
2,001
4,098

Table 8: Growth and potential need for external capital

Panel A presents logit regression results with high growth dummy variables, controlling for the effects of industry, year,
and other firm characteristics including size (NYPCTL), profitability (EBIAT/A), investment opportunities (V/A),
RE/TA, leverage ratio at the beginning of the period (LAGMLEV), and institutional ownership (IHPCT). HG is a
dummy variable that equals 1 for high growth firms, defined by the percentile rankings of annual sales growth rate, and 0
otherwise. Panel B reports results from logit regressions to estimate the probability of seasoned equity issuance in the
following one- and two-year horizons, over the period 1990-2003. All the regressions include industry and year dummies.
Dependent variables are SEO issuance dummy, equals 1 if a firm issue seasoned equity in year t+1, or throughout year
t+1 to year t+2, and 0 otherwise. LogA is the logarithm of total assets. MBn3 is the average Market-to-Book ratio over
the past 3 years. SGRn3 is the average annual sales growth rate over the past 3 years. MLEV is the market leverage ratio,
calculated as total debts divided by the sum of total debts and market value of equity. Marginal effects are reported in
both panels, and t-values calculated using robust clustered standard errors (clustering at the firm level) are in parenthesis.
*, **, and *** represents 10%, 5% and 1% significant level, respectively.
Panel A: Logit regressions. Dependent variable is Payer dummy.
HG=1 for top 30% SGR
HG=1 for top 20% SGR
1
2
3
4
GINDEX
0.017***
0.017***
(6.87)
(6.73)
G2
0.019
0.020
(1.60)
(1.57)
G3
0.059***
0.061***
(4.06)
(4.11)
G4
0.078***
0.077***
(4.95)
(4.85)
G5
0.120***
0.117***
(6.07)
(5.86)
HG
-0.031**
-0.026***
-0.024**
-0.017**
(-2.55)
(-3.05)
(-2.04)
(-1.98)
GINDEX*HG
0.002
0.002
(1.57)
(1.42)
HG*G2
0.014
0.008
(1.36)
(0.81)
HG*G3
0.017
0.007
(1.57)
(0.64)
HG*G4
0.013
0.009
(1.22)
(0.92)
HG*G5
0.017
0.021*
(1.55)
(1.82)
PseudoR2
# of firms
# of obs

0.315
1,768
12,239

0.315
1,768
12,239

0.314
1,768
12,239

46

0.314
1,768
12,239

HG=1 for top 10% SGR

5
6
0.018***
(7.01)
0.021*
(1.78)
0.063***
(4.35)
0.080***
(5.11)
0.125***
(6.39)
-0.019
-0.021*
(-1.22)
(-1.95)
0.001
(0.66)
0.020
(1.45)
0.014
(0.84)
0.014
(1.05)
0.006
(0.41)
0.313
1,768
12,239

0.312
1,768
12,239

Panel B: Logit regression to estimate the probability of seasoned equity issuance.

Dep var is SEO issuance dummy in the next 1yr
Dep var is SEO issuance dummy in the next 2yrs
1
2
3
4
5
6
7
8
Payer
-0.034*** -0.041***
-0.020*
-0.019
-0.053*** -0.065***
-0.035*
-0.032
(-6.04)
(-6.32)
(-1.80)
(-1.48)
(-5.37)
(-5.56)
(-1.80)
(-1.46)
G5
0.006
-0.008
-0.015
-0.012
0.015
-0.002
-0.027
-0.015
(0.83)
(-0.48)
(-1.41)
(-0.58)
(1.09)
(-0.06)
(-1.40)
(-0.36)
G1
0.016**
0.004
0.035***
0.016
(2.51)
(0.47)
(3.23)
(1.03)
G5*Payer
0.020
-0.003
0.024
-0.016
(1.06)
(-0.14)
(0.66)
(-0.33)
G1*Payer
0.023*
0.036*
(1.91)
(1.76)
Intercept
LogA
MBn3
SGRn3
MLEV

PseudoR2
# of events
# of firms
# of obs

-0.181***
(-12.49)
0.006***
(3.45)
0.000
(1.12)
0.008*
(1.66)
0.053***
(3.59)

-0.176***
(-11.93)
0.006***
(3.42)
0.000
(1.17)
0.009*
(1.68)
0.054***
(3.65)

-0.228***
(-8.36)
0.008**
(2.48)
0.003**
(2.06)
-0.003
(-0.43)
0.080***
(2.86)

-0.229***
(-8.58)
0.008**
(2.49)
0.003**
(2.07)
-0.003
(-0.42)
0.080***
(2.85)

-0.250***
(-9.81)
0.008**
(2.37)
0.000
(1.44)
0.018
(1.39)
0.118***
(4.29)

-0.244***
(-9.38)
0.008**
(2.39)
0.000
(1.47)
0.019
(1.47)
0.119***
(4.34)

-0.282***
(-6.01)
0.009
(1.48)
0.006*
(1.78)
-0.010
(-0.66)
0.141***
(2.71)

-0.284***
(-6.21)
0.009
(1.48)
0.006*
(1.79)
-0.009
(-0.63)
0.141***
(2.70)

0.020
582
1,725
10,624

0.021
582
1,725
10,624

0.028
220
753
3,523

0.028
220
753
3,523

0.037
891
1,725
9,170

0.037
891
1,725
9,170

0.051
355
753
3,069

0.051
355
753
3,069

47

Table 9: Takeover counts, offer premiums and hostile acquisitions

Panel A presents statistics on takeovers. # of takeover attempts are the total number of firm-announcements over the
sample period 1990-2003. # of Takeover attempts is total takeover counts, where a takeover is defined as a merger or an
acquisition that seeks to acquire a majority interest. % of takeover attempts is the number of attempts expressed as a
percentage of total firm-year observations. %Hostile (Unconditional) is the total number of hostile offers divided by the
total number of firm-year observations, and %Hostile (Conditional) is the total number of hostile offers divided by the
total number of offers. Premium is defined as the percentage premium of offer price to target trading price one week
prior to the announcement date. Panel B reports results from logit regressions estimating the likelihood of hostile
takeovers. Cash/NCAssets is the ratio of cash to total non-cash assets, where cash is defined as cash and short-term
investments. MLEV, SGR and MB are the ratio of total debt to firm value, annual asset sales growth rate and Market-toBook ratio, measured in the prior fiscal year. SIZE is the market value of equity deflated into 2004 dollars using the CPI.
Prior returns are compounded raw returns over the previous calendar year. ROE is net income over book value of equity.
Marginal effects are reported, and t-values calculated using robust standard errors (clustering at the firm level) are
reported in parenthesis. *, ** and *** represents 10%, 5% and 1% significant level, respectively.

Panel A: Takeover counts and offer premiums.

# of Takeover
% Takeover
attempts
attempts
G1
105
3.71
G2
105
3.17
G3
115
3.18
G4
83
2.83
G5
56
3.07
Difference
G5-G1
-49
-0.636

% Hostile
(Unconditional)
0.07
0.18
0.17
0.24
0.38

% Hostile
(Conditional)
1.90
5.71
5.22
8.43
12.50

Premium
(Mean)
0.38
0.31
0.40
0.26
0.49

Premium
(Median)
0.33
0.27
0.34
0.3
0.43

0.313**

10.60**

0.107*

0.092*

48

Panel B: Logit regressions to estimate the likelihood of hostile takeovers.

1
2
3
Cash/NCAssets
-0.007**
-0.009**
-0.009**
(-2.56)
(-2.33)
(-2.28)
GINDEX

4
-0.007**
(-2.00)
0.000*
(1.94)

G2
G3
G4
G5
Intercept
MLEV
M/B
SGR
SIZE
Prior Returns
ROE
PseudoR2
# of Hostile takeovers
# of Firms
# of obs

-0.010***
(-8.60)
-0.004
(-1.45)
0.000
(-0.55)
0.000
(0.21)
0.000
(0.50)
0.000
(-0.73)
0.005
(0.68)
0.002
27
2,116
14,123

-0.015***
(-7.66)
-0.005
(-1.17)
0.000
(-0.54)
0.000
(-0.24)
0.000
(1.17)
-0.001
(-0.91)
0.006
(0.57)
0.002
27
1,788
9,004

-0.018***
(-5.08)
-0.005
(-1.09)
0.000
(-0.55)
0.000
(-0.34)
0.000
(0.77)
-0.001
(-0.59)
0.006
(0.53)
0.003
27
1,788
9,004

49

-0.022***
(-6.22)
-0.005
(-1.06)
0.000
(-0.54)
0.000
(-0.04)
0.000
(0.92)
-0.001
(-0.63)
0.006
(0.50)
0.004
27
1,788
9,004

5
-0.008**
(-2.02)

0.003
(1.25)
0.003
(1.04)
0.003
(1.16)
0.005*
(1.88)
-0.021***
(-5.13)
-0.005
(-1.07)
0.000
(-0.53)
0.000
(-0.05)
0.000
(0.85)
-0.001
(-0.66)
0.006
(0.51)
0.004
27
1,788
9,004

Table 10: Logit regression using alternative proxy for entrenchment

Dependent variable is Payert, which equals 1 if a firm pays dividends in year t, 0 if it does not. INDDIR is the fraction of
top executives who joined the company before the current CEO was appointed (Landier, Sraer and Thesmar (2005)). G
index is Gompers, Ishii and Metrick (2003) governance index. NYPCTL is a firms size percentile ranked using NYSE
ME break points; EBIAT/A is the ratio of earnings before interest but after tax to total assets; RE/TA is the ratio of
retained earnings over total assets; V/A is the ratio of total firm value (book value of total debts + market value of equity)
to total assets. LAGMLEV is market leverage ratio at the beginning of the year. IHPCT, IBPCT and IPPCT are the
percentage of common shares outstanding held by institutions, block institutions (holding >= 5% shares), and the 18
largest public pension funds, respectively, calculated using holding information reported in the quarter immediately
before the end of fiscal year t. Firmage is the number of years elapsed since a firm first appears in Compustat. Marginal
effects are reported. t-values calculated using robust standard errors (clustering at the firm level) are in parenthesis. *, **,
and *** represents 10%, 5% and 1% significant level, respectively.

INDDIR

1
-0.037**
(-2.24)

2
-0.037**
(-2.26)

3
-0.037**
(-2.30)

4
-0.037**
(-2.27)

-0.115***
(-3.10)
0.003***
(9.08)
0.203***
(4.42)
-0.169***
(-3.97)
-0.010***
(-4.68)

-0.102***
(-2.73)
0.003***
(8.33)
0.189***
(3.80)
-0.174***
(-4.21)

-0.125***
(-3.54)
0.003***
(8.53)
0.204***
(4.47)
-0.177***
(-4.20)
-0.010***
(-4.69)

-0.146***
(-4.13)
0.003***
(8.78)
0.203***
(4.41)
-0.174***
(-4.14)
-0.010***
(-4.74)

-0.029
(-0.77)

-0.038
(-0.99)

GINDEX
Intercept
NYPCTL
RE/TA
EBIAT/A
V/A
dA/A
LAGMLEV
IHPCT

-0.034
(-0.89)
-0.057**
(-1.99)

-0.008
(-0.68)
-0.042
(-1.02)
-0.061**
(-2.09)

IBPCT

5
-0.032**
(-1.98)
0.019***
(6.46)
-0.264***
(-5.75)
0.003***
(8.85)
0.204***
(4.24)
-0.168***
(-3.89)
-0.009***
(-4.27)

-0.244***
(-6.89)
0.002***
(7.31)
0.168***
(3.80)
-0.136***
(-3.35)
-0.007***
(-3.06)

7
-0.024
(-1.53)
0.008***
(2.88)
-0.296***
(-6.97)
0.002***
(7.22)
0.168***
(3.69)
-0.136***
(-3.31)
-0.006***
(-2.90)

-0.042
(-1.09)
-0.057**
(-2.01)

-0.063*
(-1.77)
-0.048*
(-1.82)

-0.064*
(-1.80)
-0.049*
(-1.87)

0.012***
(14.11)

0.011***
(13.24)

0.729
1,768
7,238

0.730
1,768
7,238

-0.061**
(-2.16)

IPPCT

0.312**
(2.39)

Firmage

PseudoR2
# of firms
# of obs

6
-0.025
(-1.61)

0.700
1,768
7,238

0.693
1,768
7,238

0.699
1,768
7,238

50

0.697
1,768
7,238

0.708
1,768
7,238

Table 11: Sub-sample analysis firms existed in 1982 or earlier

This table uses a subset of firms that had a G score reported in 1990 and first appeared in Compustat no later than 1982.
Panel A reports results from Poisson regression to estimate the governance index levels in 1990. The explanatory
variables are measured in 1982 and 1989, respectively. Panel B presents the changes in the propensity to pay estimated
using the base period 1973-1989. The number of firms for each G quintile is reported in square bracket. G index is the
governance index from Gompers, Ishii and Metrick (2003). E index is the entrenchment index from Bebchuk, Cohen and
Ferrell (2004). Payer is a binary variable that equals 1 if a firm pays dividends in the year, 0 if it does not. LogA is the
logarithm of total assets (in millions). EBIAT/A is the ratio of earnings before interest but after tax to total assets. SGR is
the annual sales growth rate. V/A is the ratio of total firm value (book value of total debts + market value of equity) to
total assets. MLEV is the market leverage ratio, calculated as total debts divided by total firm value. Firmage is the
number of years elapsed since a firm first appears in Compustat. *, **, and *** represents 10%, 5% and 1% significant
level, respectively.
Panel A: Regressions to estimate the governance indices in 1990.
G index in 1990
1982
1989
ParaEst
SE
ParaEst
SE
Intercept
1.870***
0.111
1.814*** 0.115
Log A
0.017*
0.010
0.018*
0.010
EBIAT / A
-0.1821
0.270
-0.3981
0.292
SGR
-0.0461
0.056
-0.0221
0.057
V/A
0.0137
0.024
-0.003
0.027
MLEV
0.0378
0.102
-0.0039
0.106
Firmage
0.006*
0.003
0.007**
0.003
Payer
0.109**
0.045
0.116*** 0.042
Log Likelihood
8425.6
8261.5

E index in 1990
1982
ParaEst
0.264
-0.028
-0.189
-0.166
0.019
0.319
0.012*
0.255***
-309.0

SE
0.238
0.022
0.563
0.126
0.051
0.212
0.007
0.097

1989
ParaEst
SE
0.135
0.249
-0.024
0.022
-0.963
0.596
-0.014
0.119
0.044
0.057
0.390*
0.218
0.013**
0.006
0.223**
0.090
-311.4

Panel B: Changes in propensity to pay over the period 1990-2003. Number of firms for each group is in brackets.
G2
G3
G4
G5
G1
1990
0.090** [105]
0.050
[138]
0.051* [171]
0.011
[163]
-0.041**
1991
0.040
[101]
0.006
[131]
0.056** [158]
0.016
[157]
-0.039*
-0.004
[131]
0.062** [153]
0.015
[154]
-0.034
1992
0.067*
[100]
1993
0.096**
[83]
0.020
[108]
0.044
[144]
0.017
[157]
-0.040*
0.065** [104]
0.032
[140]
0.009
[153]
-0.025
1994
0.122*** [82]
1995
0.126**
[64]
0.080** [101]
-0.005 [144]
0.039
[145]
-0.013
0.061*
[97]
0.014
[143]
0.044*
[145]
0.010
1996
0.058
[61]
1997
0.037
[58]
0.084**
[89]
0.011
[134]
0.040
[135]
0.000
0.051
[79]
0.053* [130]
0.035
[129]
-0.032
1998
0.058
[45]
1999
0.042
[41]
0.059
[77]
0.047
[120]
0.043
[119]
-0.015
0.098**
[66]
0.065* [111]
0.029
[120]
-0.019
2000
0.067
[34]
2001
0.054
[29]
0.081
[65]
0.054
[102]
0.073** [101]
0.017
0.173*** [64]
0.064*
[93]
0.112*** [103]
0.018
2002
-0.019
[19]
2003
-0.016
[20]
0.213*** [63]
0.074** [91]
0.098** [101]
0.008

51

[109]
[106]
[100]
[112]
[111]
[107]
[109]
[100]
[96]
[90]
[89]
[89]
[90]
[88]

Table 12: Share repurchases and total payouts

This table reports the average of annual median across firms over the period 1990-2003. Following Fama and French (2001), I define share repurchase as
max{0, change in treasury stock from the year before}. A firm engages in share repurchases if the change in treasury stock is strictly positive. For any year t,
the amount of share repurchases is the number of shares repurchased multiplied by the price per share at the end of fiscal year, the amount of dividends is
calculated as dividend per share times the number of shares outstanding, and total payout is the sum of the two. *, **, and *** represents 10%, 5% and 1%
significant level, respectively.
Normalized by Earnings After Interest Exp and Taxes
G1
G2
G3
G4
G5
Diff G5-G1

G1

G2

Normalized by ME
G3
G4
G5

Diff G5-G1

Panel A: % of firms repurchase shares

All
0.403
0.418
0.430
Non-Payer
0.322
0.360
0.355
Payer
0.484
0.476
0.505

0.450
0.387
0.512

0.404
0.311
0.496

0.001
-0.011
0.012

Panel B: Amount of share repurchases

All
0.010
0.020
0.021
Non-Payer
0.001
0.003
0.010
Payer
0.020
0.037
0.033

0.028
0.013
0.042

0.023
0.002
0.043

0.012
0.001
0.023

0.000
0.000
0.001

0.001
0.000
0.002

0.001
0.000
0.001

0.001
0.000
0.002

0.001
0.000
0.002

0.001**
0.000
0.001

0.159

0.163

0.175

0.046***

0.007

0.008

0.010

0.010

0.011

0.004***

0.318

0.325

0.350

0.091***

0.015

0.016

0.019

0.021

0.023

0.008***

0.246
0.010
0.482

0.251
0.013
0.490

0.258
0.002
0.515

0.060***
0.001
0.119***

0.012
0.000
0.023

0.012
0.000
0.024

0.014
0.000
0.029

0.014
0.000
0.029

0.015
0.000
0.031

0.004***
0.000
0.008***

Panel C: Amount of dividends

All
0.129
0.127
Non-Payer
Payer
0.258
0.253
Panel D: Total payout
All
0.198
Non-Payer
0.001
Payer
0.395

0.206
0.003
0.409

52