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5. Summary and Conclusion
This study examines how legal institutions affect the relationship between dividend
payouts and the separation of the controlling shareholder’s control from ownership.
Controlling shareholders with a large control divergence have an incentive to extract
private benefits. However, extraction or expropriation for private benefit is not without
cost. As outside investors are alert to potential expropriation by controlling shareholders,
controlling shareholders with a large control divergence have an incentive to mask their
expropriation activities by paying higher dividends (Faccio et al., 2001), or else, the firm’s
cost of capital will be too high. Outside investors perceive dividend payouts to be a signal
of a low level of expropriation, as dividend payouts reduce the amount of retained wealth
that is available for controlling shareholders to expropriate. Furthermore, La Porta et al.
(2000) show that better investor protection at the country level increases the cost of
expropriation, which forces controlling shareholders to pay higher dividends, especially
when a firm has poor growth potential. This study complements and extends the work of
La Porta et al. (2000) and Faccio et al. (2001) by focusing on the joint effects on dividend
policies of legal institutions, the control divergence of controlling shareholders, and
investment opportunities.
Using a comprehensive sample of firms from nine East Asian and thirteen European
countries, the regression results show that in countries with good investor protection,
faster growing firms pay lower dividends, which is consistent with the findings of Fama
and French (2001) and La Porta et al. (2000). Our results also indicate that controlling
shareholders with a large control divergence pay higher dividends, which is consistent
with the findings of Faccio et al. (2001), who posit that ultimate owners mask extractions
that are made for their own private benefit by paying higher dividends. Interestingly,
however, our results explain that in countries in which the rights of investors are well
protected, controlling shareholders with a large control divergence make smaller dividend
payouts, especially when investment opportunities are good. This suggests that controlling
shareholders in this situation have less need to mask their expropriation activities, as
minority shareholders become less alert to expropriations as a result of their reliance on
strong legal investor protection.
Our results imply that good legal investor protection plays an effective monitoring
role in determining the dividend policies of controlling shareholders with a large control
divergence. The enhancement of legal institutions, especially in emerging markets in
which governance systems are weak, can therefore mitigate the efforts of controlling