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dividends. In contrast, shareholders of firms with few growth opportunities may want to
press corporate insiders to release cash so that earnings cannot be used to benefit corporate
insiders. Better corporate governance therefore increases the cost of expropriation for
controlling shareholders, and forces them to pay higher dividends when the firm has few
growth opportunities.
The two important findings of a positive relationship between dividend payouts and
legal protection (La Porta et al., 2000) on the one hand and a large control divergence of
controlling shareholders (Faccio et al., 2001) on the other raises the issue of the
governance role that legal institutions play in determining the dividend payout policy of
the ultimate owners of a firm when control divergence is present and when shareholder
power is not aligned with the “divergence” force. Our study attempts to answer several
questions in relation to this issue. The first is whether in countries with better legal
shareholder protection, controlling shareholders have more (less) need to mask
expropriation, and thus pay higher (lower) dividends. The second is whether the
investment opportunities of a firm are important determinants of the dividend decision of
its controlling shareholder in countries with strong or weak legal institutions. This study
complements and extends the work of Faccio et al. (2001) and La Porta et al. (2000) by
focusing on the interactions among control divergence, legal institutions, and investment
opportunities.
In countries in which shareholders’ rights are well protected, there is a negative
relationship between dividends and investment opportunities, which indicates that
shareholders exercise their “power” rationally. In contrast, firms with controlling
shareholders who have a large control divergence pay a consistent stream of dividends,
irrespective of the firm’s need for investment funds, which suggests that the “divergence”
force dominates (Faccio et al., 2001). If shareholder power and the “divergence” force
mitigate each other, then we predict that in countries with good legal investor protection,
the negative relationship between dividends and investment opportunities will be stronger
for firms that are controlled by controlling shareholders with a large control divergence
than in those that are controlled by shareholders with a small control divergence. Thus, we
argue that the positive relationship between dividends and control divergence that is
documented by Faccio et al. (2001) is likely to be less pronounced in countries with strong
legal investor protection, especially when firms have good investment opportunities.
Using a broad firm-level ownership dataset from nine East Asian and thirteen West
European countries for the period 1990 to 2000, this study shows that dividend payout