THE ASSOCIATION OF MANAGERIAL OWNERSHIP WITH

DIVIDEND POLICY AND LEVERAGE POLICY: INDONESIAN FIRMS *)

Putu Anom Mahadwartha**)

Abstract

The research examines the relationship of financial policy (dividendand leverage) influenced managerial ownership. Managerialownership as dependent variable regressed with dividend andleverage policy that already separate the effect of agents and insiderswealth. Logit Model is use to examine the relationship becausemanagerial ownership proxy by dummy variable. Hosmer-Lemeshowand Andrews Goodness-Of-Fit test used to conclude the model fitted.Result showed a significant relationship that financial policyinfluenced probability firm engages in managerial ownershipprogram. Dividend policy is a substitute for managerial ownership.The lower dividend level will increase the probability of the firmengage in managerial ownership program and still maintain theeffectiveness of reducing agency cost of equity. The lower leveragelevel will increase the probability of the firm engage in managerialownership program to multiply the effect of reduced agency cost ofdebt with the reduction in agency cost of equity.

Keyword: managerial; ownership; leverage; dividend; logit

*) presented on National Seminar Surviving Strategies to Cope with The Future,13 September 2002, Universitas Atmajaya Yogyakarta-Indonesia.**) Doctoral students, Economics Faculty, Gadjah Mada University.

I. OVERVIEW

Shareholders, debtholders and management (managers) are parties that

have different interest and perspective regarding value of the firm. Shareholders

will tend to maximize their shares, forcing managers to act in their interest despite

of debtholders interest. Debtholders on the other side will protect their fund

already placed in firm with covenant and strict monitoring policy. Conflict of

interest between parties in firm is known as agency problems.

Agency theory derives from the conflict of interest between corporate

managers, outside shareholders and bondholders. Managerial ownership, leverage

and dividend policies might be related directly through agency theories. Jensen

and Meckling (1976) provide an analysis of the effect of agency conflicts among

the three groups. Their analysis suggests that the proportion of equity controlled

by insiders should influence the firm’s policies.

Managers choose their stock ownership in the firm, the firm’s mixture of

outside debt and equity financing and dividends to reduce the costs of these

agency conflicts. Leverage is relevant because using debt reduces the conflict of

having outside equity. Managerial ownership and dividend are relevant because

they reduce the conflict of interest between managers and outside shareholders

(Jensen and Meckling, 1976; Crutchley and Hansen, 1989; Jensen, Solberg and

Zorn, 1992; Myers, 1977; Smith and Warner; 1979). Leland and Pyle (1977); and

Ross (1977) present hypotheses that managerial ownership and financial policies

help resolve informational asymmetry between managers and external investors

(outside shareholders).

Mahadwartha (2002); Mahadwartha and Hartono (2002) investigate

interdependency of leverage and dividend policy with managerial ownership, and

find significant result that support agency theory. The two previous papers used

different approach but came with the same conclusion about managerial

ownership. This paper inversely tries to investigate the relationship between

managerial ownership with dividend and leverage policy without any

interdependency relationship between those two policies. The result hopefully

supports the last two papers that managerial ownership does matter controlling

agency problem in Indonesia.

The paper proceeds as follows; Section II reviews the relevant issues and

empirical finding of managerial ownership. Section III describes hypotheses to be

test and a brief theoretical background. Section IV describes methodology used in

the study. Section V describes the results from statistical analysis and summary

and discussion are presented in Section VI.

II. ISSUES

How the self-interest controlled is main issue that tries to explain by

agency theory. Manager’s interest must align with shareholders interest to

minimize the agency cost. Managerial ownership is one issue used to control such

self-interest behavior (Jensen and Meckling, 1976; Crutchley and Hansen, 1989;

Jensen, Solberg and Zorn, 1992; Myers, 1977; Smith and Warner; 1979; Leland

and Pyle, 1977; Ross, 1977; Mahadwartha, 2002; Mahadwartha and Hartono,

2002).

Financial policies such as dividend and leverage will affect managerial

policy and decision of managers to join as owner of the firm. Mahadwartha

(2002); Mahadwartha and Hartono (2002); Crutchley and Hansen (1989); and

Jensen, Solberg and Zorn (1992) tested the issue with different perspectives and

variables. Mahadwartha (2002); Mahadwartha and Hartono (2002) used

Indonesian data and find a significant result and support of managerial ownership

to control agency cost of equity and agency cost of debt. The main differences

between these two studies are in firm specific variables, observation and period of

analysis.

Crutchley and Hansen (1989) find strong support that managerial

ownership will tend to influence firm specifics variables and on the long run

suggest that it will influence dividend and leverage policy. Jensen, Solberg and

Zorn (1992) directly tested relationship between managerial ownership and

financial policies (dividend and leverage). They found that managerial ownership

influenced policies but policies did not influence managerial ownership.

Conclusion of four previous study is high managerial ownership will derive firms

to lower debt and dividend. The study conduct here will test inversely about the

relationship between policies (dividend and leverage) influenced managerial

ownership.

Dividend and leverage policy variables used in the study is the same as

Mahadwartha (2002); Mahadwartha and Hartono (2002). Dividend and leverage

variables already separate the effect of inside shareholders wealth and agents

wealth with outside shareholders wealth. The measurement suggests increasing

predictability power of policy variables.

III. THEORY AND HYPOTHESIS

Agency theory viewed firm as a set of contracts among factors of

production, with each factor motivated by its self-interest (Jensen and Meckling,

1976). The relationship of agency is one of the oldest and commonest codified

modes of social interaction. Examples of agency are universal. Essentially all

contractual arrangements, as between employer and employee or the state and the

governed contains important element of agency.

Agency theory is concerned with resolving two problems that can occur in

agency relationship. The first is the agency problem that arises when the desires or

goals of the principal and agent conflict and it is difficult or expensive for the

principal to verify what the agent is actually doing. The second is the problem of

risk sharing that arises when the principal and agent have different attitudes

toward risk (Fama, 1980; Eisenhardt, 1989). Difference in risk preferences leads

to different policy decisions and disregard the value maximizing activity as the

economics pursued. As Ross (1973) noted:

An agency relationship has arisen between two (or more) partieswhen one, designated as the agents, acts for, on behalf of, or asrepresentative for the other, designated the principal, in aparticular domain of decision problems.

Problems in decision making especially with aligned of interest between

agent and principal will leads to catastrophic decreasing value of the firm.

Decision making policy such as dividend and leverage will increase value of the

firm as long as the policy able to aligned the self-interest behavior between

parties.

Separation between ownership and control arise agency problem.

Managerial ownership on the other side, try to decrease agency problem by

pooling back the ownership structure and control mechanism of the firm. Agrawal

and Knoeber (1996) describe the importance of ownership structure as control

mechanism in agency problem.

In addition, concentrated shareholdings by institutions or by blockholders

can increase managerial monitoring and improve firm performance, as can

outsider representation on corporate bonds. The use of debt financing can improve

performance by inducing monitoring by lenders. Agrawal and Knoeber (1996)

investigated firm performance and mechanism to control agency problems. The

findings support managerial ownership as mechanism of control and affect firm

performance.

III.1. Leverage Policy Influenced Managerial Ownership

Agency cost between managers and shareholders are real, pervasive and

very difficult to effectively reduce. One way to control these cost is for firm to

issue debt. Leverage policy serves as a bonding mechanism for managers to

convey their good intentions to outside shareholders. Because taking on debt

validates that managers are willing to risk losing control of their firm if they fail to

perform effectively. As bonding mechanism, leverage policy will decrease agency

cost of equity but increase the agency cost of debt (Megginson, 1997: 335)

Mahadwartha (2002); Mahadwartha and Hartono (2002); Crutchley and

Hansen (1989); and Jensen, Solberg and Zorn (1992) find a negative relationship

between managerial ownership influenced leverage policies. Firm with managerial

ownership program will tend to lower their debt level to reduce agency cost of

debt and simultaneously reduce agency cost of equity. The result also support by

Friend and Hasbrouck (1987); Friend and Lang (1988).

Is leverage policy attracting firm to involve in managerial ownership

program? This question is not answered from previous study (Mahadwartha,

2002; Mahadwartha and Hartono, 2002). The relationship between leverage policy

influenced managerial ownership programs will negative. Less leverage will

increase the probability a firm to engage in managerial ownership program to

multiply the effect of reduced agency cost of debt with the reduction in agency

cost of equity.

The relationship between leverage policy and managerial ownership isnegative. The lower leverage level, the higher probability of managerialownership happened.

III.2. Dividend Policy Influenced Managerial Ownership

Agency cost or contracting model of dividend assumes that dividend

payments arise as an attempt to overcome the agency problem that result when

there is a separation of corporate ownership and control. As ownership becomes

more atomistic, few investors have the incentive or the ability to monitor and

control corporate managers and agency problems become more important.

As bonding mechanism, dividend policy will decrease agency cost of

equity, reduce the opportunity for managers to use firm cash flow for perquisites

activities but also decrease the ability to pursue new investment opportunity

(Megginson, 1997: 377). Rozeff (1982) used American company data to

investigate dividend policy and ownership structure. The findings showed that

ownership structure affect dividend policy or how firm disbursed their cash in

dividend payment.

Mahadwartha (2002); Mahadwartha and Hartono (2002); Crutchley and

Hansen (1989); Jensen, Solberg and Zorn (1992); and Rozeff (1982) find a

negative relationship between managerial ownership influenced dividend policies.

Firm with managerial ownership program will tend to lower their dividend

payment because the purpose of managerial ownership is the same as dividend

policy that is reduce agency cost of equity. It will be ineffective to use two tools at

the same time for the same problems.

Is dividend policy attracting firm to involve in managerial ownership

program? This question is not answered from previous study (Mahadwartha,

2002; Mahadwartha and Hartono, 2002). The relationship between dividend

policy influence managerial ownership programs will negative. Lower dividend

will increase the probability a firm to engage in managerial ownership program

and still maintain the effectiveness of reducing agency cost of equity.

The relationship between dividend policy and managerial ownership isnegative. The lower dividend level, the higher probability of managerialownership happened.

IV. METHODS

IV.1. Data and Sample

Samples are 81 manufacture firms from Jakarta Stock Exchange (JSX)

with period of observation from 1993 to 2000. All data are available from Market

Directory JSX and Pusat Pengembangan Akuntansi Universitas Gadjah Mada

(PPA-UGM). Pooling data result in 648 observations for 8-year observation

period.

IV.2. Variables Description

1. Leverage (LEV): leverage measurement separates the outside shareholders

wealth with inside shareholders wealth and agents wealth. The measurement

will clarify the effect of outside shareholders to managerial ownership

program.

MvCso = TotShrso * MpriceCs

TotShrso = total common stock outsiders own

MpriceCs = average price per year with weekly data to reduce the seasonality

effects from price changes.

Leveragei = LtDebtit __

LtDebtit + MvCsoit

Dividend = ComDivit_____TotShrsit * MpriceCsit

2. Dividend (DIV): dividend measurement separates the outside shareholders

wealth with inside shareholders wealth and agents wealth.

3. Managerial ownership (DMOWN): dichotomous behaviors of managerial

ownership (binomial data) support the use of dummy variable. D=1 for firm

with managerial ownership and vice versa.

Mahadwartha (2002); Mahadwartha and Hartono (2002); Crutchley and

Hansen (1989); Jensen, Solberg and Zorn (1992); Rozeff (1982); Megginson

(1997: 376); Ang, Chua and McConnell (1982); Gaver and Gaver (1993) find that

size of firm affect the relationship between dividend, leverage and managerial

ownership. This study also includes size as control variable that measure as

dummy variable (DSIZE). Size is measure from total assets, ascend and pick 50%

upper level with value D=0 and 50% lower level with value D=1. The reason is

pooling data can cause cross sectional biased (Murphy, 1985). Crisis period is also

control by dummy variable (DCRS) with cut off data 1993 – 1996 and 1997 –

2000.

IV.3. Statistical Analysis

Model equation is:

DMOWN = +1LEV +2DIV+3DSIZE +4DCRS +1

Logit model will be used to solve the equation because dependent dummy

variable (Gujarati, 1995: 554). The result will employ in term of probability of

dependent variable to happen after independent variables. Linear Probability

Model (LPM) is not use because some limitations such as questionable value of

R2 and heteroscedastic variances on disturbances.

Hosmer-Lemeshow and Andrews Goodness-Of-Fit test is employ to see if

Logit Model fitted. The idea underlying these tests is to compare the fitted

expected values to the actual values by group. If these differences are “large”, we

reject the model as providing an insufficient fit to the data.

V. RESULTS

Descriptive result for independent variables:

LEV Mean Std. Dev. Observation(0, 0.2)

(0.2, 0.4)(0.4, 0.6)(0.6, 0.8)(0.8, 1)

All

0.0477390.2977110.5026110.6963630.8942790.391157

0.0592300.0550230.0585380.0599010.0545910.336113

2638286

105112648

Table 1: Descriptive for Leverage

DIV Mean Std. Dev. Observation(0, 0.5)(0.5, 1)(1, 1.5)(1.5, 2)(2, 2.5)

All

0.0477660.6822611.0908661.8034552.3931620.077072

0.0942070.1738360.0422480.193305

NA0.210596

62813

1648

Table 2: Descriptive for Dividend

DMOWNPredict

Constant

LEV

–0.396933(–2.215737)*

–0.738048(–2.217768)*

DIV

DSIZE

DCRS

McFadden R2

– –2.438077(–2.765506)*

–0.492879(–2.315441)*

–0.760215(–3.639324)*

0.058508() z-statistic* Significant at 5%; ** Significant at 10%Table 3: Logit Model Result

Quantile of Risk Dep=0 Dep=1 Total H-LLow High Actual Expect Actual Expect Obs Value

1 0.0005 0.09252 0.0929 0.11413 0.1148 0.14374 0.1438 0.16115 0.1621 0.18766 0.1882 0.21457 0.2150 0.23928 0.2392 0.28679 0.2871 0.3708

10 0.3710 0.4020Total

59585858514651534537

516

59.615458.429756.562055.000353.670951.163050.039348.204443.762639.5524516.000

5777

141814122028

132

4.384586.570338.437979.9996911.329112.837014.960716.795621.237425.4476132.000

64656565656465656565

648

0.092730.031260.281611.063440.762582.597560.080141.846360.107090.420737.28350

H-L Statistic:Andrews Statistic:

7.28357.9224

Prob[Chi-Sq(8 df)]:Prob[Chi-Sq(10 df)]:

0.50640.6364

Table 4: Hosmer-Lemeshow and Andrews Goodness-Of-Fit Test

The result shows that all variables including control variables significant at

5%. Leverage and dividend variable significantly affect managerial ownership (–

0.738048 and –2.438077) as predicted earlier. The relationships are negative and

significant. Control variables DSIZE and DCRS also significant. Size of the firm

is matter when company engages in managerial ownership program. Before crisis

and within crisis period showed different behavior in financial policy and

managerial ownership.

The columns labeled “Quantiles of Risk” depict the high and low value of

the predicted probability for each decile. Also depicted are the actual and expected

numbers of observations in each group, as well as the contribution of each group

to the overall Hosmer-Lemeshow (H-L) statistic large values indicate large

differences between the actual and predicted values for those deciles. H-L and

Andrews Goodness of Fit test showed that differences between actual and

expected DMOWN variable is not “large” and the H-L statistics and Andrews

statistics exceed the Chi-sq with 8 and 10 degree of freedom. As a whole, the

model is fitted.

VI. DISCUSSION AND CONCLUSION

Mahadwartha (2002); Mahadwartha and Hartono (2002) investigate

interdependency of leverage and dividend policy with managerial ownership, and

find significant result that support agency theory. This paper inversely tries to

investigate the relationship between managerial ownership with dividend and

leverage policy without any interdependency relationship between those two

policies. The result significantly supports the last two papers (Mahadwartha,

2002; Mahadwartha and Hartono, 2002) that managerial ownership does matter

controlling agency problem in Indonesia.

1. Leverage policy variable (LEV) influenced managerial ownership (DMOWN)

with significant result (-0.738048) at 5%. The lower leverage level will leads

to higher probability firms engage in managerial ownership program. Less

leverage will increase the probability a firm to engage in managerial

ownership program to multiply the effect of reduced agency cost of debt with

the reduction in agency cost of equity.

2. Dividend policy variable (DIV) influenced managerial ownership (DMOWN)

with significant result (-2.438077) at 5%. The lower dividend level will leads

to higher probability firms engage in managerial ownership program. Lower

dividend will increase the probability a firm to engage in managerial

ownership program to maintain the effectiveness of reducing agency cost of

equity. Since there is a managerial ownership, the usefulness of dividend

policy to control agency cost of equity will lower.

3. The magnitude of dividend policy parameter (-2.438077) is higher than

leverage policy (-0.738048). this is make sense because dividend policy act as

substitution policy for managerial ownership to control agency cost of equity.

4. Size (DSIZE) and period of crisis(DCRS) as control variables are significant.

The result supported previous empirical studies that include size as firm

specific variable for decision-making in financial policy of the firm. Lower

level of size will increase the probability firm engage in managerial ownership

because management only needs a small portion of their wealth to capture

firm shares. Crisis dummy variable showed differences in behavior of the firm

before and while crisis.

5. Hosmer-Lemeshow and Andrews Goodness-Of-Fit Test showed the research

model fitted to test managerial ownership issue as dependent dummy variable

Research in managerial ownership will lead to broad conclusion that

managerial ownership is important in controlling agency cost of equity, beside the

use of debt and dividend. The robustness of model also supported by previous

empirical study conducted by Mahadwartha (2002); Mahadwartha and Hartono

(2002) for Indonesian capital market.

Future research should expand sample size, not only manufacture firms but

also include other industries cover by Jakarta Stock Exchange and Surabaya Stock

Exchange. Other firm specific variables such as diversification losses, internal

cash flow, etc should also include as variables that influenced managerial

ownership program.

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