Dividend policy research paper

PDF | This research aims to test dividend signaling theory in an Dividend Policy of Public and Private Firms, Working Paper, Cornell.
Table of contents

According to this piece of legislation, preferred nonvoting shares are entitled to either of the following preferences: preference in dividend payouts;. Moreover, its first paragraph went further in restricting the trading of preferred nonvoting shares in case they did not include at least one of the following preferences: a dividend of a least 25 per cent of net earnings or 3 per cent of book equity and equality of treatment to common stocks regarding dividends;.

Therefore, the new legislation aimed to reduce the discretion of majority voting shareholders in the expropriation of minority nonvoting shareholders through the dividend policy. Nonetheless, the legislation is still timid to fully address the agency problem between majority and minority shareholders in Brazil. Article 9 of the Act, incorporating Articles and of the Income Tax Regulation of Brazil, a , limits the deductibility to a maximum of twice the amount of interests paid or received by the firm, as well as to the amount resulting from the computation of the official long-term interest rate on book equity.

Such legislation in effect created a tax incentive to equity capital — however limited — equivalent to the tax benefit of debt that is usual elsewhere in the world. To the best of our knowledge, such legal provision is unique to Brazil.

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Therefore, Brazil offers a peculiar legal frame to test the tax preference theory of dividends. Also, until recently, dividend policies for common voting and preferred nonvoting stocks have been subject to the discretion of controlling shareholders at the expense of minority shareholders. Such legislation allowed shareholders to hold absolute controlling interest in any public firm with as little as one-sixth of its shares plus one share.

Of course, such disparity between voting and cash flows rights increased the agency problem between majority and minority shareholders, where the latter may be subject to wealth expropriation by the former. Moreover, the minimum capital that any shareholder must commit to a public firm to have absolute control over it is still only 25 per cent. Such special segment requires, among other things, one vote—one share rule. In that year, Bovespa also launched two intermediary listing segments for firms wishing to gradually improve its corporate governance standards.

These levels Level I and Level II , however, tolerate the existence of nonvoting shares even though they introduce new disclosure and floating requirements. Despite being an improvement over the previous regulation, the new rules are still timid steps toward the international corporate governance standards. Several empirical studies on dividend policy have been conducted in Brazil. The pioneer study by Brito and Rietti replicated the well-known study by Elton and Gruber , testing the Clientele Effect in the Brazilian market, between years and Their study did not find any evidence of the existence of this effect in the Brazilian stock market.


Procianoy and Poli discussed the possibility of a dividend policy that could simultaneously produce large tax savings to investors and encourage more liquidity in the stock market and, as a consequence, higher share values. The authors concluded that companies that would adopt their suggested policy would get a substantial increase in share prices.

The investors would look for shares that could give them the larger possible net earnings, as a result of tax savings. The clientele effect was central to this new outfit, and, in such case, the dividend policy was relevant and maximized the value of the company. In another study, Procianoy and Snider observed that changes in the tax legislation on dividends and capital gains, in , offered an opportunity to test the maximization of shareholder wealth through dividend payouts.

At the time of the legislation change in , there was an inversion of tax burden: up to that year, dividends were taxed and capital gains were not, and, from on, capital gains were taxed and dividends were tax-free.

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The study tried to determine if an increase in payout ratios by companies listed in Bovespa has really happened after the tax legislation changed. The authors identified that, for the period from to , the average dividend payout ratio was 25 per cent when dividends were taxed. Meanwhile, from to , when the dividends were tax-free, the average payout ratio was 40 per cent.

Therefore, the authors concluded that after the tax legislation has changed the dividend payouts have generally increased. However, the increase has not been verified in all companies, as suggested by the observed decrease of the minimum dividend. The authors also cautioned that their sample was small.

In conclusion, Procianoy and Snider observed that, after the Brazilian tax legislation change, there was an increase of dividend payouts, but they were not increased to the per cent level, which, according to the authors, would be the ideal rate. They also stated that companies that had more controlling shareholders had a more significant increase in dividend payout ratios than the companies that had just a single controlling shareholder.

Another study about dividend policy and taxes in Brazil is the paper of Procianoy , motivated by the change in the Brazilian legislation with respect to dividends that happened in and This change stopped taxing the dividend distribution by the companies 23 per cent on dividend value retained at the source and instead started taxing capital gains in 25 per cent, which should be calculated from the difference between the sale and purchase prices including adjustment for inflation , a tax rule that was effective from to Using data from Bovespa from the years to , Procianoy tested two hypotheses: the changes in dividend policies by the companies listed in Bovespa ; and the maintenance of a new dividend policy, in the period between and In a recent paper, Vancin and Procianoy find that the legislation has an important role in the determinants of dividend policy.

They find that there is strong empirical evidence that companies paying dividends above the legal mandatory level present different determinants from those that only pay the minimum level. Thus, the samples that mix companies that pay both the mandatory minimum dividend and above the minimum influence regression coefficients, resulting in significant biases in dividend determinants in Brazil. As companies that pay above the mandatory levels are the real decision makers of dividend policies given that other companies simply comply with the legislation , this aspect must be taken into account when studying dividend policy in countries where minimum mandatory dividend legislation is in place.

Ramos studied the influence of taxes on dividends in the Brazilian stock market, adjusting the returns for systematic risk levels.

The model states that, in equilibrium, the expected net return of a stock is linearly related to its systematic risk and its dividend—price ratio. His conclusions support the hypotheses that dividend taxation influences the stock returns in Bovespa. The authors found that firms that paid dividends had comparatively increased positive returns in every single year of the sample, while firms that repurchased shares increased their returns only in the years , , and Mota and Eid analyzed the choice of the method of payout policy of companies listed in Bovespa from to Also, share repurchases are usually used as a complement to dividends and IOEC, mainly because of its higher transaction costs and lack of legal obligation.

Decourt et al. Using a sample of listed companies from to , the authors document that an increase of dividend payout does not signal future earnings, but reductions are correlated to the increasing in contemporaneous net earnings and also signal increase in the future earnings. Apparently, earnings retentions signal good investment opportunities. The authors found that dividends affect positively the value of the companies, in accordance with other studies from Brazil and other countries. Forti and Schiozer found a positive relationship between dividends and past earnings, when looking at dividend policy of Brazilian banks.

This evidence reinforces the use of dividends to inform the quality of assets when sending a sign that the bank is capable of making profits with assets that perform well.

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Furthermore, privately held banks pay more dividends than publicly traded banks, which complies with the purpose of dividend signaling. In contrast, Fiorati et al. Using a sample of public firms from to , the authors could not document a significant relationship between earnings payouts and future firm profitability. The authors suggest that such result may be because of market conditions and the legal and institutional politic—economic organization. Futema et al. They aimed to contribute to the joint understanding of capital structure and dividend policy in Brazil.

They concluded that, as predicted in the static trade-off and pecking order theories, the profitability and growth options are the most influential variables on earnings distribution. This was also observed for companies with high debt and low profit taxation. These results support the theory of trade-off regarding the impact of taxation on profit over debt decision, and consequently over the capital structure. Nakamura et al. Their results indicate that companies with better growth opportunities tended to pay lower dividends, and larger companies tended to pay larger dividends, under the hypotheses that they would face less future restrictions to banking loans, as well as lower transaction costs in case of an eventual issue.

Another positive factor for pecking order is the negative relationship observed between leverage and profitability, confirming that companies use retained earnings to finance their investments and only use debt after running out of internal sources. As it has been shown above, the study of dividend policy in Brazil raises interesting questions regarding the relationship among dividends, capital structure, taxation, corporate governance and institutions.

Moreover, Benetti et al. Such is the motivation of this study. Agency problems have a central role in the definition of dividends policy Ferreira et al. The commitment to corporate governance practices can reduce the risk for investors because of a raise in shares value caused by best practices, ultimately increasing the liquidity and trading volume of the shares because of increased demand.

With the increase in the value of a company stock, there may be, consequently, a reduction in their cost of capital. For the company, it means fundraising at lower costs, with the likelihood of higher returns on investments, and for shareholders, higher dividends Rabelo et al. Silva shows that there is a relationship, often statistically significant, between governance structure, market value, leverage and dividend policy of the Brazilian companies. Gonzaga and Da Costa show that there is a relationship between accounting conservatism and conflicts over dividend policies between controllers and minority shareholders in Brazilian companies.

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The financial corporate governance model seems to address the greatest number of features that apply to the Brazilian reality, given the importance it assumes the agency conflict even if not always explicit between controlling and noncontrolling shareholders and the importance attached to returns on investments Bertucci et al. Bellato et al.

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Their study reinforces the arguments of the codes of good governance practices that the distance from the one share—one vote principle is detrimental to minority shareholders. Through these studies, we can see that there may be a relationship between the levels of corporate governance and dividend policy. In companies where governance levels are higher, the tendency is that the dividend policy is more aggressive to distribute more dividends to its shareholders.

We test the hypothesis of the influence of the Brazilian tax changes on the dividend policy of its listed companies. The final sample comprises companies in the period , making up a total of 1, traded stocks of both common and preferred classes. We have also included companies with multiple classes of preferred stock, but kept in the sample only those whose dividend rights are similar, for homogeneity. As we used annual data frequency, the total sample contains 30, observations over the sample period. Firms whose government or governmental bodies have a controlling stake are classified as state-owned.

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