Rent Extraction by Large Shareholders: Evidence Using Dividend Policy in the Czech Republic
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Transcript of Rent Extraction by Large Shareholders: Evidence Using Dividend Policy in the Czech Republic
Rent Extraction by Large Shareholders:Evidence Using Dividend Policy in the
Czech Republic
Jan Bena, Jan HanousekRound Table Seminar
CERGE-EI, PragueMay, 2006
Intro – Ownership, Corporate Governance and Firm Performance
Early surveys created a general presumption that the effect of privatization on firm performance is positive
Most recent studies used larger data sets and controlled for endogeneity/selection of ownership
Domestic private ownership has much less definite impact on performance
Foreign ownership (especially concentrated) has a positive effect on many performance indicators
For more details: Hanousek, Kočenda, Svejnar (2006), also a survey Estrin, Hanousek, Kočenda, Svejnar (invited to JEL, 2006).
Intro – Ownership, Corporate Governance and Firm Performance
New evidence: Privatization to domestic owners has only
limited effects on performance Only privatization to (certain types) of
foreign owners appears to have improved efficiency of firms
effect of the state not only negative
Motivation: State of the Literature
Empirical tests do not point out single main driving force behind corporate payout policy in cross-section
Empirical tests of corporate dividend behavior carried out almost exclusively using data from the most developed countries
Existing theoretical literature addresses predominantly the U.S. experience
Motivation: Questions
Does ownership structure affect dividend policy? Concentration, Type, and Nationality
How are benefits from firms distributed among shareholders Do majority shareholders steal profits from
minority shareholders? Are dispersed shareholders able to extract
dividends from firms run by managers?
Contribution
Evidence that ownership structure determines corporate payout policy
Dividend policy in the Czech Republic reflects the conflict among shareholders how to distribute benefits from firms
The first empirical study of dividend behavior in the Central and Eastern Europe
Important robustness check to established theories since we are using data from country with unique recent economic history and institutional setting
Outline
Stylized Facts about Corporate Dividend Policy Survey of Dividend Theories Dividend and Capital Gains Income Taxation Closest Papers Review Specific Features of the Czech Economy Ownership Structures Model & Data Estimation Technique Endogeneity of Ownership Results
Stylized Facts about Corporate Dividend Policy
Long-term target dividend payout ratio Changes in dividends rather than absolute levels:
initiations, omissions, increase/decrease announcements
Dividend smoothing Changes in dividends reflect changes in long-term
ability of firms to generate earnings Managers increase dividends only when they are
confident that increased earnings are permanent Managers decrease dividends only in financial
distress
Survey of Dividend Theories
Lintner (1956): partial adjustment process towards a target payout ratio
Free Cash Flow TheoryDivert free funds managers have power over within corporations away from them
Theory: Easterbrook (1984); Jensen (1986); Zwiebel (1996)Empirics: Gugler (2003); DeAngelo, DeAngelo, and Stulz (2004); Desai, Foley, and Hines (2002); Dewenter and Warther (1998); Laporta, Lopez-de-Silanes, Shleifer, and Vishny (2000)
Survey of Dividend Theories, cont.
Signaling TheoryCommunicate the level and growth of earnings or future prospects of the company to investors Theory: Bhattacharya (1979); Miller and Rock
(1985) Empirics YES: Bernheim and Wantz (1995);
Amihud and Murgia (1997) Empirics NO: Benartzi, Michaely, and Thaler
(1997)
Survey of Dividend Theories, cont.
(Tax) Clientele Theory Some investors benefit from special treatment
in the tax law Summary: Allen, Bernardo and Welch (2000)
Dividend and Capital Gains Income Taxation
Companies distribute dividends from after-tax-profits Same income dividend tax treatment applied to individuals and
corporations Flat tax rate 25 %; in 1999 lowered to 15 % Foreign owners: tax treaty between Czech Republic and the
country of the receiver Double taxation of dividends prevented Marginal tax rate on cash dividends is the same for all types
of shareholders Tax considerations or tax clientele effects cannot drive
cross-sectional differences in dividend policies
Closest paper: Gugler (2003)
Estimates the effect of ownership on dividend policy using data from Austria
Ownership and control structure of a firm is a significant determinant of its dividend policy
State-controlled firms Engage in dividend smoothing, have the
highest target payout ratios, are the most reluctant to cut dividends
Family-controlled firms Do not smooth dividends, are the least reluctant
to cut dividends
Closest paper: Gugler and Yurtoglu (2003)
Analyze dividend announcements and pay-out ratios in Germany -- Look at the conflict between large controlling shareholder and minority shareholders arising from private benefits of control
Dividends are device for small shareholders to limit rent extraction by controlling owners
"Majority-controlled and unchecked" firms have the smallest target pay-out ratio
"Majority-controlled and checked" firms have the largest target pay-out ratio
Major differences from previous papers
Czech economic environment and institutional setting is very different from the one in Austria (Germany)
We benefit from a large sample We use a different estimation technique to
account for specifics of an emerging market environment (including privatization)
Specific Features of the Czech Economy
Privatization Ownership structure of Czech companies was
primarily set (exogenously) by government bureaucrats
Economy was privatized and deregulated fairly quickly
Market forces drove majority of economic activity very early during transition
Ownership structure stabilized after 1996
Specific Features of the Czech Economy, cont.
Legal Uncertainty Evolution of institutional and legal framework
was considerably slower Lawmakers were well behind the economic
activity Corporate law incomplete and kept changing
literally every year Slow / weak law enforcement
Number of Phrases "with exception of" and Total Number of words in the Czech Income Tax Law (1993 - 2004)
30
50
70
90
110
130
150
170
190
210
230
250
Date when Came into Force (Total number of updates is 52)
Num
ber o
f exc
eptio
ns
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
80,000
90,000
Num
ber
of w
ords
Ownership Structures: Concentration
Large shareholding is the most important control device in the Czech Republic
Only highly concentrated owners are able to control managers effectively
Because of underdeveloped legal system and financial market, dispersed ownership structures cannot enjoy benefits from Greater market liquidity and Better risk diversification
Ownership Structures:Variables Definition
Domicile -- Czech, Foreign Type -- State, Private individual, Industrial firm,
Financial institution Concentration - Czech corporate law assigns control
rights to different ownership levels: Majority > 50.0% Blocking minority > 33.3% and ≤ 50.0% Legal minority > 10.0% and ≤ 33.3% Minority ≤ 10.0%
We define concentration of ownership variables:majority, monitored majority, minority, dispersed
Starting Model
Benartzi, Michaely, and Thaler (1997): "... conclusion we draw from [our] analysis is that Lintner's model of dividends remains the best description of the dividend setting process available."
Lintner's Model
Ownership Structure Determines Dividend Payments
Di,t i i i,t 1 iDi,t 1 i,t
Di,t j
j j j i,t 1 jDi,t 1 OWNj i,t i,t
Model: Control Variables
Firm Size (Total assets)
Leverage (Total liabilities / Total assets)
Bank Power (Bank loans / Total liabilities)
Cash Holdings (Cash / Total Assets)
Growth Opportunities (Industry level sales growth rate)
Year dummies
Data
Medium and large non-financial companies traded on the Prague Stock Exchange
Fix the population by choosing 1,664 companies privatized in 1991-1995
Financial and ownership data from database ASPEKT To estimate dividend equations we use data from 1996-2003
(post-privatization market economy period) Data from 1991-1994 (privatization period) are used as
instrumental variables that allow us to control for the endogeneity of ownership
Privatization period data come from the Ministry of Privatization
Descriptive Statistics: Dividend Payments
Year NOB
Number of companies paying dividends in a given year
1996 711997 861998 751999 612000 632001 582002 54
Total 468
Problems with direct application of the Lintner's model
Fewer firms paying dividends (<10% of sample) hence OLS estimation leads to biased results
Missing financial data (weak market supervision), more pronounced for those not paying dividends (about 50%)
Our study follows privatization when the ownership is potentially endogenous with respect to corporate performance (e.g., state versus private, domestic versus foreign).
2 Stage Estimation Procedure
STAGE 1: Decision to pay dividends Estimated as binary 0/1 regression, ownership and control variables
Options: probit, logit, linear probability, tobit..
STAGE 2: Conditional decision about the size of dividend paid.
Classical regression model on a subset of firms decided to pay dividends
Options: OLS, IV, GMM, or use Heckman selection procedure (combination Stage 1)
How to Fix for Missing Financial Data?
STAGE 0: Heckman selection procedure (“Heckit”), inverse Mills ratio included in the first stage.
variables related to not reporting and optimally not used laterSize -- Total number of Shares (TNS) and NS offered under the voucher privatization (NSVP)
Previously having problems with reporting: set of 0/1 indicators of missing financial data (profit,sales, debt, and the number of employees) in priv. projects (91-93)
VP characteristics -- average price, total holdings (in %) of the investment privatization funds and individual investors.
How to Fix for Endogeneity of Ownership?
Hanousek, Kočenda, and Švejnar (2004): ownership is endogenous with respect to corporate performance
Expect bidirectional link between ownership structure and the decision to pay dividends
Therefore we should account for possible endogeneity of ownership: A) Use a reduced form equation (PROBIT) to
predict the type of the single largest owner B) Use linear probability model in STAGE 1 and
use standard IV techniques here
LPM is Optimal Choice for the First Stage
See Angrist and Krueger (2001) for a deep discussion.. The linear probability model allows to instrument
ownership and provides consistent estimates under standard assumptions, while probit regression with plugged predicted values of ownership "do not generate consistent estimates unless the nonlinear model happens to be exactly right, a result which makes the dangers of misspecification high" (ibid).
Also, the linear probability model can be corrected for sample selection. (We redo the first stage using probit as a robustness check.)
Estimation Technique: STAGE 0
STAGE 0: Heckman regression for missing financial data
Regression using I[missing] as a binary response
),,),93/91(,,,(][ IIIPFAPMissFNSVPTNSconstfMissFI
Estimation Technique: STAGE 1
STAGE 1: Decision to pay dividends (0-1 variable) Regression using I[Di,t > 0] as a binary response
We also included a set of control (financial) variables and efficiency measures..
)),.1(,.),(,(][ 9896, MILLStDIVTjOWNconstfDI ti
Additional Variables in STAGE 1:
Control variables: total assets, total liabilities to total assets, bank loans to total liabilities, cash holdings to total assets, and the growth rate of average sales in the industry the firm is part of excluding the firm itself.
Efficiency measures: profit (or total sales) to total assets and total sales to total labor costs.
Estimation Technique: STAGE 2
STAGE 2: Conditional decision about the size of dividend paid
OLS regression on a sub-set of firms paying dividends (Di,t > 0)
Di,t j
j j j i,t 1 jDi,t 1 OWNj i,t
1TA i,t 2TLTA i,t
3BLTL i,t
4CHTA i,t
5grSA i, t1t
MILLSi,t i,t
#
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Results Summary: Main Specification
Marginal Contribution to Probability
To Pay Dividends
Target Payout Ratio
Weight Placed on Current Earnings
% % %Czech 11 49 13
Foreign 35 60 46Industrial 14 47 56
(Cz) Financial(F) Financial
24100
9999
5454
Results Summary: Main Specification, cont.
Marginal Contribution to Probability
To Pay Dividends
Target Payout Ratio
Weight Placed on Current Earnings
CZ Majority 10 47 13CZ Monitored
Majority 16 45 82
F Majority 26 72 61F Monitored
Majority 58 85 86
Results (Domicile & Concentration)
A dominant majority owner pay dividends less often and their target payout ratio is small.
Checked majority owners pay dividends more often and the target payout ratio is large.
Dominant owners extract rents from firms and that strong minority shareholders can prevent this behavior.
Interference with institutional framework
Robustness Checks
LOGIT/PROBIT in Decision to Pay Dividends Eq. Earnings Measures: Operating profit, Profit after/before
income tax, Including/excluding extraordinary items Control Variables: Industry dummies for growth
opportunities Earned Equity
Retained earnings / Total equity Dividends before they are paid out Coefficients in front of ownership dummies remain
significant and almost unchanged
Descriptive Statistics: Ownership Concentration
Mean Std. Dev. NOBTotal Assets Majority 1,0E+06 7,9E+06 1 775
Monitored 1,4E+06 8,2E+06 2 235Dispersed 1,9E+06 9,0E+06 1 866
Dividend / Profit Majority 0,040 0,68 1 775Monitored 0,026 0,29 2 235
Dispersed 0,032 0,16 1 866Profit / Total Assets Majority 0,02 0,16 1 719
Monitored 0,04 0,24 2 204Dispersed -0,01 0,12 1 853
Liabilities / Total Assets Majority 0,40 0,28 1 719Monitored 0,63 0,36 2 204
Dispersed 0,35 0,24 1 853Sales / Staff Costs Majority 8,00 37,29 1 719
Monitored 15,91 38,51 2 204 Dispersed 6,31 7,72 1 853
Descriptive Statistics: Nationality of SLO
Mean Std. Dev. NOBTotal Assets Czech 1,0E+06 7,4E+06 5 786
Foreign 1,8E+06 7,6E+06 844Dividend / Profit Czech 0,012 1,25 5 786
Foreign 0,068 0,27 844Profit / Total Assets Czech -0,01 0,29 5 688
Foreign 0,05 0,15 827Liabilities / Total Assets Czech 0,48 0,35 5 688
Foreign 0,43 0,34 827Sales / Staff Costs Czech 11,42 46,78 5 688
Foreign 9,62 19,13 827