2017-78 5/1/17 Exogenous Information Shock and Dividend Payout Policies: Evidence from IFRS Adoption Nishant Agarwal 1 , Arkaja Chakraverty 2 This Draft: 25 th April, 2017 Abstract We study changes in firms’ dividend policies in response to improved information environment between investors and firms, enabled by IFRS adoption. We document that the relation between information asymmetry reduction and dividend payout policy is not monotonic, and in fact depends on firm’s underlying growth opportunities. Following mandatory adoption of IFRS, firms with low growth opportunities exhibit higher propensity of paying dividends. On the other hand, those with high-growth opportunities exhibit reduced propensity of paying dividends. These results are consistent for dividend payout ratio as well. These, in conjunction, suggest owing to improved information environment, investors are better able to assess firm’s growth opportunities and demand dividends accordingly. Key words: Information asymmetry, dividend, growth opportunities, IFRS 1 Indian School of Business. Email: nishant_agarwal@isb.edu 2 Indian School of Business. Email: arkaja_chakraverty@isb.edu We are immensely grateful to Sanjay Kallapur, K R Subramanyam, Hariom Manchiraju and Ranjani Krishnan for their guidance and numerous discussions to improve the paper. We would also like to extend our gratitude to the participants at American Accounting Association Conference, 2016 for their valuable inputs. 1
1. Introduction A plethora of work has gone into studying the determinants of a firm’s dividend decision since Miller and Modigliani (1961) proposed dividend irrelevance theory. Information asymmetry between managers and shareholders is one of the primary reasons behind dividend payouts. For instance, Jensen (1986) highlights agency cost arising out of the information asymmetry between the firm and the shareholders as the main motivation for a firm to pay dividend. In addition, prior studies also find support for the role of information asymmetry as an incentive to managers to signal private information (Bhattacharya, 1979; John and Williams, 1985; etc.). In this paper, we study changes in firm’s dividend payout policy when information asymmetry is reduced through an exogenous shock to the information environment of a firm. A recent study by Hail, Tahoun, and Wang (2014) (HTW hereafter) documents the influence of reduction in information asymmetry on a firm’s payout policies. They find that following reduction in information asymmetry between firms and investors, propensity of a firm’s paying dividends reduces, which is consistent with prior literature that highlights information asymmetry as a key driver for dividend payouts. However, literature also suggests firm ’ s dividend payout policies are linked to its growth opportunities (Jensen, 1986; DeAngelo, DeAngelo, and Skinner, 2004). F irm’s characteristics , such as investment opportunities, substantially effects its dividend policies as well – dividends are less likely for firms with high investment opportunities (Fama and French 2001). On the contrary, firms with low growth opportunities have more free cash flow available that leads to potentially higher agency conflicts (Jensen 1986). Therefore, such firms are likely to pay more dividends on an average in comparison with high growth firms. Building on this, we investigate whether growth opportunities available to a firm shape its payout policies post an exogenous shock to its information environment. Specifically, we determine the influence of the interaction between growth opportunities and information asymmetry reduction on dividend payout policy. 2
We first focus on the changes in propensity of paying dividends post the information shock. The influence of the interaction between growth opportunities and information asymmetry reduction on propensity is not clear ex-ante. HTW (2014) find since information asymmetry reduces across the board for all firms post the exogenous shock, the propensity of firms’ paying dividends reduces, in line with FCF theory (Jensen, 1986) as well as signalling theory (Bhattacharya, 1979; etc.) of dividends. Nonetheless, reduced information asymmetry between a firm and its shareholders facilitates better evaluation of firms’ gr owth opportunities by investors. Investors, once better able to assess growth opportunities, demand these cash flows as dividends from low growth firms that were not paying dividends at all. Improved informed environment could also improve minority investors’ monitoring capabilities and enable them to more successfully alleviate overinvestment issues and extract higher cash dividends from firms (La Porta et al. 2000; Kalay 2014), especially if firms have limited investment opportunities. Similarly, investors are more willing to let go off dividends from firms with high growth opportunities. They are likely to accept a lower propensity of dividends from high growth firms in expectation of future capital appreciation from such firms. Therefore, we predict that information asymmetry reduction leads to an increase in propensity of paying dividends by low growth firms and a reduction in propensity of paying dividends by high growth firms. We further argue that an exogenous information shock impacts not only the propensity of paying dividends, but also their levels. As shown in Figure 1, while propensity to pay dividends has reduced over the years, the aggregate amount of dividend paid has increased over time. This suggests that dividend payout could increase post the information shock despite a reduction in propensity to pay dividends. However, since reduction in information asymmetry 3
reduces propensity of firm’s paying dividends (HTW, 2014), this effect should also hold true for payout levels of firms. Consequently, we argue that if growth opportunities moderate the relation between information asymmetry reduction and propensity to pay dividends, they also influence the relation between the former and dividend levels. We therefore examine the changes in payout ratios of firms post the exogenous information shock. As argued for the case of propensity of paying dividends, improved information asymmetry might result in either increase or decrease of payout levels. However, if improved information environment helps investors better assess growth opportunities, they can force low growth firms to disgorge more cash as payouts. We therefore predict that information asymmetry reduction leads to an increase in payout ratio by low growth firms. Also, if investors are willing to let go off dividends in case of high growth firms, leading to a lower propensity of paying dividend post the information shock, the same trend should hold for payout level also. We therefore predict that information asymmetry reduction leads to a decrease in payout ratio by high growth firms. To test these predictions, we use mandatory adoption of International Financial Reporting Standard (IFRS) as an exogenous information shock. Researchers document improved information environment, and hence increased transparency between managers and shareholders following IFRS adoption (Barth et al., 2008, Landsman et al., 2012, Horton et al., 2013). To formally analyse the causal impact of mandatory IFRS adoption on dividend policies, we use difference-in-difference (DID) method. We use linear and non-linear models to estimate change in dividend payouts and propensity of paying dividends, respectively. We collect firm- level annual data from 49 countries over a span of 8 years – ranging from 2001 to 2008 from WorldScope and Datastream. Countries that enacted IFRS accounting standards are in the treatment group, whereas the others are used as control group. We take 2005 as benchmark year for IFRS for control groups. 4
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