The Effect of Financial Reporting Quality on Corporate Dividend Policy

• In Event: Determinants of Cash Retention and Payouts

Abstract

This study examines how financial reporting quality affects corporate dividend policy. The agency theory of dividends, combined with the governance role of financial reporting in mitigating overinvestments, suggests that financial reporting quality can affect dividend policy, but the direction of the effect is unclear. While the "outcome" view predicts that higher quality reporting leads to higher dividends, the "substitute" view predicts the opposite. We find that higher quality reporting is associated with higher dividends. This positive association is more pronounced within firms with more severe free cash flow problems and among firms with higher ownership by monitoring-type institutional investors. Further, lead-lag tests yield evidence consistent with the direction of causality going from financial reporting quality to dividends. Overall, our findings are consistent with financial reporting quality acting as a governance mechanism that induces managers to increase dividends. Our findings support the outcome view that dividends are the result of enhanced monitoring (Jensen 1986; La Porta, Lopez-de-Silanes, Shleifer, and Vishny 2000)

Authors

• Santhosh M Ramalingegowda, The University of Georgia

• Yong Yu, The University of Texas at Austin