Recent studies have examined the relationship between managerial incentives and firm dividend payout. Executive Share Options (ESOs) have attracted a great deal of attention from financial economists... The objective of my study is to investigate how corporate dividend policy is affected by managerial stock incentives. In particular, I develop a model based on agency theory whereby managerial quality and effort are unobservable to shareholder. Using Tobit regression tested on data [1] from Toronto stock exchange during 2002-2003, I find that Executive stock options are negatively associated with payout ratio and the distinction between CEO stock options to Exercisable and Unexercisable options gives more available picture about the dominant compensation instrument for top management. This result is similar as predicted by Lambert, Lannen and Larker (1989), Fenn and Liang (2001), Aboody and Kasznik (2001), Bahattacharyya et al. (2003).
1- Introduction
Explaining dividend policy has been considered as one of the most difficult controversial of the three issues of long term financial decisions making. Despite of the numerous published theoretical and empirical studies, we have yet to understand completely the factors that explain the firm payout policy. Fisher Black (1976) wrote that ". . . the harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don't fit together" (p. 5). A number of researches provide theoretical as well as empirical evidence on different aspects of dividend policy but a lot of issues are still unresolved [2] . The one of the most important trends in corporate finance during the two decades is the dramatic growth of open market share repurchases as substitute of distributing cash to Shareholders. These events suggest a crucial change in the study of factors that explain corporate payout decision that might be related to growing use of managerial and employee stock options. Executive stock option plans have become the dominant instrument for top management in recent years. Many studies have documented an association between managerial compensation and firm dividend policy. Recent studies have documented an association between managerial compensation and firm dividend policy. Executive Share Options (ESOs) have attracted much controversy in recent years. During the early 1990s they were hailed as the most effective tool for relating executive pay to corporate performance and aligning the interests of managers and shareholders.
Many studies link firms' payouts to managerial incentives related to stock option compensation; Lambert, Lanen, and Larcker (1989), examine changes in firms' cash dividends after the adoption managerial stock option plans. They find that firms decrease the level of dividends relative to the level of expected dividend after the adoption of such plans. The fact that stock option has been suggested as a reason for managers preferring share repurchase to cash dividend is also examined by many authors like Jolls (19998), Weisbenner (2000). Fenn and Liang (2001) find a significant negative association between CEOs' option holding and the propensity to pay dividends. The Bhattacharyya (2003) tests confirm the existence of positive effect of executive compensation on the earning retention.
Based on the theoretical consideration and empirical evidence, I propose many arguments to build the problematic of this paper:
1- Explaining dividend policy has been one of the most complex decisions facing financial research. In market with asymmetric information, Managers may use firm resources to activities that benefit them, but they are not in the shareholder's best wealth. In this context, Dividend policy can be used as a bonding mechanism reducing management's scope for making unprofitable investment out of internal funds
2- Many authors report that dividend payouts are negatively related to insider stock holdings. Others argue that the insider stock ownership provides direct incentive alignment between managers and shareholders.
3- Managerial stock option has the potential to help align the incentives of managers and shareholders. Observation shows that executive stock options generally are not dividend protected and hence the expected value of these options decreases with the payment of a cash dividend. On the other hand, few practitioners doubt the optimality of managers' compensation contracts. According to this view, managers have some discretionary latitude to set their own pay, i.e. they can manipulate the pay process, or their contract-setting principal more generally, to their advantage.
4-From above arguments, and according to many authors, it that the distinction between CEO stock options to Exercisable and Unexrecisable options gives more available information about the dominant compensation instrument for top management.
In addition to standard factors explaining dividend policy (free cash flow, size, ownership structure), executive stock option [3] is it a consistent variable that may help to understand the behaviour of firm dividend ratio. The remainder of this paper is organised as follows; in section 2, I present the related literature on the association dividend policy and managerial stock option compensation. Section 3 presents the empirical study by analysing the data used, methods and results are also reported in this section. Section 4 contains a summary of the paper.
2- Related Researches on Relationship between Dividend Policy and managerial stock option compensation.
The payout literature sine MiMo (1961) theorem have looked at various factors related to Taxes, asymmetric information and others possible variables explaining firm's payout policy. There is however few studies have looked on the effect of managerial stocks incentives on firm's cash dividend. The principal finding of these studies: (1) Controlling for FCF, stock option holdings are strongly correlated with the composition of payout. (2) Negative relationship with dividends and positive relationship with repurchases. (3) Distinctions between exercisable and unexercisable stock option and between lagged and contemporaneous changes in stock options are important to understand how SOP can influence Payout ratio. Jensen (1986) suggested that agency costs are attached to free cash flow. The starting point for author's is based on conflicts of interest between shareholders and managers over payout policies are severe when the firm generates important free cash flow, and this may be to invested in negative NPV projects or lost through organizational inefficiencies. In this context increasing dividends by firm constitutes, an important control mechanism that reduce the management access to abuse of discretionary funds. A complementary method of motivating managers to optimally utilize free cash flow in order to maximise shareholders and managers wealth is to provide greater amounts of equity related compensation.
The first study that links firm's dividend policy to managerial incentives is advanced by Lambert, Lanen and Larcker (1989) who examine the effect of the introduction of stock option for CEO on the change un corporate payout ratio. The basic hypothesis tested by the authors is that the adoption of a stock plan will provides manager more arguments to alter dividend policy. The evidence and research design is follows from institutional and financial market practices that Executive stock options are not dividend protected. Subject to this reality the distribution of dividend will decline the value of all option and thus give managers more pretexts to avoid dividend distribution in order o increase the value of their stock option. The sample used in the empirical study, consist of 222 companies selected from the Fortune 500 and Fortun 50 merchandising firms. Based on the Marsh-Merton model the results tests suggest: (1) following the initial adoption of top management stock option plan, the dividends are reduced relative their expected level. (2) The higher the proportion of stock options in the CEO's compensation, the lower level a firm's distribution ratio.
Smith and Watts (1992) examine the relation between growth options and compensation policy, between regulation and leverage, dividend and compensation policies. Using a models of the cross-sectional variation in corporate policies and an industry level data from 1965 to 1985; the authors find: (i) contracting theories are more important in explaining corporate financing, dividend and compensation policy than either tax-base or signalling theories. (ii) Firms with more investment opportunities have lower dividend yields, higher executive compensation, lower leverage and greater use of stock options plans. (iii) The regulatory process provides incentives to regulated firms to have less frequent use of stock option plans, lower executive compensation, higher leverage, and higher dividend yields. Yermack (1995) analyzes the determinants of CEO option of 792 US public corporations between 1984 and 1991. In other words the author study whether the mix of compensation between stock options and cash pay can be explained by explanatory variables related to agency costs reduction. Results showed: (1) firms in highly regulated industries tend to provide greater incentives from stock options when accounting earnings contain large amount of "noise" (2) companies with financial constraints and zero dividend use CEO stock option as a substitute for lower level or capacity of cash compensation.
The purpose of the paper of White (1996) is to focus on the use of dividend provisions in executive compensation contracts to influence dividend changes. The idea of the author is to propose a model that links firm compensation incentives to dividend policy in order to reduce conflicts between shareholders and management. The study is based on data for 62 largest US companies in oil and gas, defense/acropace and food processing industries. In line with previous evidence, White (1996) finds (i) a significant positive relationship between Executive compensation and dividend payouts and yields. (ii) the results show also that larger firms (those facing more monitoring costs on dividend decision), are more allowed to link managerial rewards to dividend distribution, (iii) firms with higher manager ownership are less likely to use incentives in their compensation plan. Jolls (1998) introduces the form of executive compensation as explanation for share repurchase. The author highlights the role and importance of stock options in the choice between repurchases stock and increase dividends. To give more explanation of the substitution hypothesis Jolls (1998) considers the following methodology and data: (i) she uses a discrete choice model based on a multinomial Logit approach; (ii) she supposes constant the relationship between executive stock options and the above choice decisions. (iii) She collects two types of data: firms (n=324) announcing repurchase or dividend increase during the fiscal year 1993, and firms neither announce these decisions. The finding show that firms with executive stock option are more likely to substitute stock repurchase than to increase dividends.
Lippert et al (1999) document the impact of incentive compensation on the price response to dividend increase announcements. The study is based on sample collected from proxies filed, with Securities and Exchange Commission by the 1000 largest US firms. Overall, the tests show that the price response decreases with pay-performance sensitivity. This relationship is more robust for firms with lower quality projects (as defined par authors: market to book values less than the sample median). For firms with higher quality projects, an alternative explanation (positive relationship) is not empirically validated.
The study of Weisbenner (2000) analyzes the interaction between the growth of stock options and corporate payout policy. Using a discrete choice framework based on a Tobit model, the author estimate a cross-sectional and panel data on stock option programs for a sample of 800 U.S largest firms at the end 1994. according to the Weisbenner (2000): (i) the use on both total options and those held by top executives give more information and distinguish between dilution hypothesis and the agency hypothesis, (ii) in order to enhance the value of their own stock options, managers prefer repurchasing shares or retaining earning than to increase cash dividend. The empirical estimation reports many results and suggestions: (a) Employee's stock options are not as an expense against earning, there is a positive and significant association between SOPs for non executive employees and stock repurchases. (b) Stock option granted to top manager affect corporate payout policy differently than do stock option granted to employees (c) Consistent with Joll (1998), Fenn and Liang (2000), and others study, the author finds that the probability of repurchasing stock is positively related to stock option.
Fenn and Liang (2001) provide evidence that the use of managerial stock incentives help to explain the rise in repurchases at the expense of dividends. The authors examine how firm dividend policy is influenced by managerial stock incentives. The study uses data and information on more than 1100 non financial firms during 1993-97, obtained from Standard & Poor's Execucom database. Fenn and Liang (2001) show several results: (1) giving more evidence on the substitution hypothesis, the test find that manager stock options are positively related to share repurchases and negatively to dividend payments, (2) another analysis examine how managerial stock incentives help to mitigate free cash flow problems by inducing a higher total cash payout. The empirical test give no relationship between the level of stock ownership and payout by firms with relatively high management ownership, more investment opportunities and more limited free cash flow (3) in addition to stock option, a further set of results concerns the factors, that influence the choice between dividends and repurchases. They found that firms with larger numbers of investment opportunities and less predictable cash flow require greater financial flexibility, and hence rely more on share repurchases rather than more obligatory dividends to disgorge cash flow.
Aboody D and Kasznik R. (2001), empirically explore the association between CEO stock option compensation and firms' cash payout policies. In other words, they focus on the relation between CEO option holding and the ratio of share repurchases to total cash payout. They use information for 1354 firms with positive cash distributions to shareholders over the period (1992-1998). they report a significant negative and robust association between CEOs' stock options and firms' cash payout policies as evidence consistent with stock option compensation motivating CEOs' to favour share repurchases over dividends as a cash distribution mechanism. To confirm this result, the authors present several tests: (1) they investigate relationship between share repurchases and CEOs' restricted stock [4] . They show that the association between the extent of CEOs' restricted stock and the composition of their firms' cash payout is the opposite direction to that they identify for CEOs' stock options. (2) They examine the cross-sectional variation with respect to CEOs' option induced incentives to substitute share repurchases for cash dividends. They show no evidence that CEOs with mostly exercisable options substitute repurchase for dividends. The substitution of share repurchase for cash dividend is fully attributable to unexercisable options. (3) They also analyze the relationship between the firm's dividend payout and lagged changes in the CEO's stock option. They conclude that firms' cash payout policies are significantly associated with two and three year lag changes in number of CEO's unexercisable option, but are not significantly associated with contemporaneous in number of unexercisable options. (4) They consider that the relationship between firms' cash payout and CEOs' stock options is significantly different from one between firms' payout policies and option held by other top executives.
Liljeblom and Pasternack (2002) examine the impact of employee/executive option in the choice of the distribution method (share repurchase, and cash dividend). The study is based on a sample consists of companies listed on the Helsinki stock Exchange over 1996-2001: consistent with prior research on incentives effects; the authors find a significant difference between firms with or without dividend protected options: (i) for firms with stock options are dividend protected, the tests show a significant positive relationship between dividend payout and the options program. (ii) This association is negative and insignificant in firms with stock options that are not dividend protected.
The paper of Arnold et al (2002), applies arguments from principal agent theory and from the theory of finance to analyze different forms of dividend protection and to address the relevance of dividend protection in SOPs. It has two main purposes: (i) first, to examine how SOPs should be designed to provide incentives for dividend decisions in the best interest of shareholders. (ii) Second, to show that neither financial investment opportunities, nor share repurchases can substitute for dividend protection. To emphasize the relationship between SOPs and payout policy, they assume:
Under the principal-agent paradigm Bhattacharyya N, Mawani A, and Morril (2003), develop a model of dividend whereby managerial characteristic and effort are unobservable to shareholders. This reflects many aspects: (i) consist with asymmetric information, the shareholder propose two type of contracts according to productivity level: higher quality managers who have access to positive net present value projects are more likely to reinvest firm liquidity rather than paying dividend to shareholder. On the other hand, lower quality manager do not have the same access to positive NPV projects, prefer distribute dividends rather invest cash in negative project value. (i) When we consider a context of market equilibrium, the model assumes a negative association between dividend and managerial compensation. To test this hypothesis, the authors consider a Tobit regression analysis and data of U.S firms over the period 1992-2001. The results show many determinants and relationships: first as predicted by Bhattacharyya et al (2003) executive compensation have a negative effect on dividend payout, second many control variables like debt equity ratio, firm's beta and capital expenditure are also negatively associated with dividend policy.
Table1: Fundamental research on the relationship between Dividend and stock option
Authors
Model
Variables
Sample
Results
Lambert, Lanen and Larcker 1989
Marsh-Merton dividen model + cross section régression
Divi, stock price,
221 firms from CRSP
Negative relation div- SOP
Yermack (1995)
Merton model + Tobit model
CEO SOP, Financial constraints,
792 Public US firms
Few agency theories explain CEO stock options
White (1996)
Logistic regression model
Payout yield, compensation, and other variables.
310 firms-years
Positive relationship between dividend and Executive compensation
Jolls 1998
Discret choice framework (logit model)
Employee and manag stock option, div, repurchase, ownership
1400 firms USA
Prob of repurcha stock is positiv related to SOP
Lippert (1999)
Abnormal return + regression panal
Managerial stock incentives+ other explanatory variables
1000 largest US firms
Dividend increase with PPS(pay performance sensitivity)
Weisbenner (2000)
Tobit model
Employee and manag stock option, div, repurchase, ownership
800 largest US firms
Executive and employee SOP have different effect on dividend
Fenn and Liang (1997, 2000, 2001)
Tobit estimation
Managerial stock incentives+ other explanatory variables
1100 firms
Negative relation div- SOP
Aboody et al (2001)
Tobit model
Stock option Exer and Unexer and other explanatory variables
1727 US firms
Negative relationship div- SOP
Liljeblom et al (2002)
Probit and Tobit models
Employee and executive incentives + other variables
217 firms in Helsinki stock exchange
Positive relationship when options are dividend protected
Arnold et al (2002)
Stochastic model
SOP, share repurchase , forms of dividends protection
-
Link between share repurchase and SOP
Bhattacharyya et al (2003)
Tobit model
Total compensation and other variables
2263 firm-years (US)
Negative association between compensation and dividend
3- Empirical analysis:
My most important forecast is that stock option compensation motivates CEO to reduce dividend payout. To test this prediction, I investigate the relationship between the number of shares underlying the stock options held by the firm's CEO deflated by number of shares outstanding and firm's dividend payout ratio. In this case I distinguish global, Exercisable and unexercisable stock option. Before conducting many statistical and econometric tests for this goal, I propose in the following section the model that will be used in the empirical tests.
3-1 Tobit Model:
All the qualitative choice problems, concern dependent variables that are discrete, usually taking on only two or three values. There are occasions, however, in which the dependent variable has been constructed on the basis of an underlying continuous variable for which there are number of observations about which we do not have information. In other words information is missing for dependent variable, but the corresponding information for the independent variables is present. In this case, the dependent variable is only incompletely observed due to censoring (truncated). In his survey of the econometrics of Tobit models, Amemiya (1984) provides a likelihood-based classification of different types of Tobit model. The standard Tobit model (type I Tobit Model or Canonical Censored regression Model) is the most widely used, can be written as:
(1)
Where the disturbances are assumed to be . We can write the above system in the form: . In other words, all negative [5] values if are coded as single value 0. The dimensional vectors are constants, with only the former vector being known. Unfortunately, ordinary least-squares (OLS) of the Tobit model will yield biased and inconsistent estimates of. These parameters can be estimated by maximizing the Logliklihood function. If we pose N0 the number of observation where, and N1 number of observation where . We can write for N0 observations with :
(2)
And for N1 observations with
(3)
The Log Likelihood function of the sample will be written if we combine this two probabilities:
(4)
Where f, F are the density and cumulative distribution function of . When we estimate the Tobit model, we can select one of the three distributions for error term. Eviews allows us three possible choices for distribution of:
Table 2: different hypothesis of Tobit model
Standard normal
Logistic distribution
Extreme value (type I)
3-2 Sample selection:
I collect data and information about financial reporting and stock options awarded to CEOs between 2002-2003 from Canadian firms, listed on Toronto Stock Exchange. The initial sample contains 400 firms-year observations; I excluded firms in the financial service, government sectors, as well as firms' years with negative or missing financial information. Finally, I only retain those firms for which payout ratio that are non negative because of difficulty in interpreting a negative payout ratio. The final sample consisted of 176 firm-year observations. These data are used in the subsequent analysis to assess the association between dividend policy and characteristic of stock option awarded to CEOs.
3-3 Measures and significances of the Variables:
* Dividend payout ratio (DIV): Our measure of dividend payout is regular cash dividends on earning.
Stock options variables:
CEOs Stock option: in order to decrease the conflicts of interests between managers and shareholders, stock options are used as executive compensation and motivations given to management to maximise shareholders wealth. I rely on a Tobit model to estimate the possibility relationship between payout policy and executive stock options. My primary testable prediction is that CEOs with stock options have more incentives to reduce dividends. In other words payments of dividends will reduce the stock price and the value of outstanding options. In this paper I use three proxies of executive stock options: (1) RMO: ratio of CEO stock option measured by number of stock options to total outstanding shares. (2) RMEO: ratio of CEO exercisable stock option to total outstanding shares; (3) RMNEO ratio of CEO unexercisable stock options to total outstanding shares. The use of these variables as explanatory variables of dividend payout ratio must respect the correlation in the equality: RMO = RMEO + RMNEO.
Hypothesis1: Following results of prior studies, I expect a negative association between stock option and dividend payout ratio.
Agency costs variables
* Free cash flow (RFCF): Free cash flow is defined as cash flow in excess of that required finance all projects that have positive net present values. In other words, is the cash flow available to managers before discretionary capital investment decisions. The proxy used in this paper is the total of net income, depreciation, interests' expense deflated by the total assets. Following Jensen's (1986), FCF hypothesis means that dividends may limit management's opportunity to use liquidity in perquisites and negative net present value that benefit them at shareholders and debtholders expense. According to this conceptual framework, managers facing the obligation to disgorge the FCF may use dividend payout in order to maximise the stakeholder wealth.
Hypothesis2: In line with the theory of FCF; I suppose a positive relationship between free cash flow and dividend payout ratio.
* Ownership structure (OWC): It is not entirely clear whether ownership structure determines payout policy or if payout policy determines corporate ownership. Ownership structure can affect dividend payout through shareholders' monitoring qualities and the possibility of investing additional resources into the firm. Active monitoring by large shareholders is expected to reduce managerial discretion and information asymmetry thereby lowering firm's dividend policy. At the same time, large shareholders can help in reducing financing constraints. Under concentrated ownership structure, the hypothesis of convergence of interests (Jensen and Meckling, 1976) predicts that positive incentive effects are driven by high ownership of the controlling shareholder (Claessens, et al, 2002). On the other hand, Shleifer and Vishny (1997), La Porta et al. (1999) argue that conflicts of interests may exist between the controlling shareholder and small investors, which results in wealth expropriation. This leads to the hypothesis of negative entrenchment effects. The higher the concentration of ownership, the higher are thus the motivations for the shareholders to monitor the manager. I use a dummy variable to measure ownership concentration, which equal 1 if owner is over 10% and 0 if not.
Hypothesis 3: I expect a positive relation between ownership and dividend payout. I consider that the higher the concentration of share among shareholders correspond a higher level of dividend payout and a lower stock option granted to management.
* Manager ownership (MOW): I use the percentage of equity holds by manager as proxy of insider ownership. Many studies have documented a significant effect of manager ownership on firm value and financial decisions (for example: Morck et al 1988, McConnell and Servaes 1995, Berger et al, Denis et al 1997, Mehran et al 1998…). The link between dividend policy and manager ownership is recognized in some empirical studies: Leland and Pyle 1977 argue that higher equity ownership by management will support the search of objectives that maximize shareholder wealth, Rozeff document that dividend policy and manager ownership are alternative tools to decrease agency costs.
Hypothesis 4: Based on the previous results, I suppose a negative association between manager share holding and dividend payout.
Control variables: (standard characteristics)
* Firm size (Size): I use the Logarithm of the book value of total assets to measure the firm size [6] . The effect firm size on dividend payout is ambiguous: Jensen and Meckling (1976) document that large firms are mostly to monitor, Weisbenner (2000) note that this measure serves as a proxy for financing costs, asymmetric information, variance in cash flow.
Hypothesis 5: I suppose a positive relation between size and dividend payments. This association means that larger firms with better market access should be able to pay higher dividends.
* Leverage (Lev): this variable is measured by Book value of long term debt dividend by book value of total assets. Conflicts of interest between shareholder and debtholders can be more severe when firm has higher leverage. Many authors document that debt and dividend are substitutes; higher leverage ratio will be associated with lower need for dividends. Jensen (1986), Berger et al (1997), Fenn and Liang (2001) suggest that debt is considered as an alternative method of disgorging free cash flow and firms will rely less on dividend.
Hypothesis 6: the predicted relation between leverage and dividend payout is negative. This means that firm with more debt will distribute less dividends.
* Profitability (Prof): this paper utilizes earning to total assets to measure profitability of the firm [7] . Miller and Rock (1985) conclude in the context of signalling theory, that higher profitability may be positively associated to dividend payout. Following agency framework, Farinha (2003) note that firms with high profitability may support less agency costs of equity and therefore using dividend as method of monitoring manager is less needed. Fama and French (2001), document that the probability that firm pay more dividends is positively associated to profitability.
Hypothesis 7: Following earlier empirical studies, I suppose a positive effect of profitability on the payout ratio of Canadian firms.
Table 7: Measures of explanatory variables
Name of the variables
Proxies of
Variables
Calculations
Lev
Leverage
Long term debt to total asset
Prof
Profitability
Earning to total asset
Size
Size
Log of total assets
MOW
Manager ownership
% of equity holds by manager
RMEO
Ratio of CEO EXER SOP
Number of Stock option exercisable to total outstanding shares
RMNEO
Ratio of CEO Non exerçable SOP
Number of Stock option unexercisable to total outstanding shares
RMO
Ratio CEO SOP
Number of Stock option to total outstanding shares
OWC
Ownership concentration
Dummy variable which equal 1 if owner is over 10% and 0 if not
RFCF
Ratio of FCF
[Net income + depreciation +interests expense]/ Total Asset
3-4 Descriptive statistics
Table 8 reports descriptive statistics of the explanatory variables. Since we want to analyse the dividend - CEOs stock option relationship, we have divided the full sample in three panel groups: panel A for firms' characteristics variables, panel B for stock option variables, and panel c for agency variables. The table shows there are significant level in firm characteristics and agency variables such. The mean of Leverage is about 19%, Profitability is low than 3% and all firms have similar size (Std Dev is low). For agency variables, we find that the mean percentage of managerial ownership is 4% (Min 1% and Max 72%). On the other hand RFCF is higher (15%). Table 8 provides descriptive statistics for stock and option holding for CEOs, and shows the difference between means and median for RMEO and RMNEO. The average value for the stock option is more than 0,9%. In this context we note that levels of Exercisable CEO stock option are greater than those of Non Exercisable. A correlation matrix of the sample variables used in our analysis is presented in table 9. By virtue of the low sample size, almost all of the correlations are statistically significant at conventional levels. For example, we observe high positive correlation between RMO and RMEO (this is true also between RMO and RMNEO).
Table2: Scheme of the most correlations between explanatory variables
Positive relationship (+)
Negative relationship (-)
Higer correlation
1) RMO andRMEO
2) RMO and RMNEO
No one
Lower correlation
All other variables
It is noteworthy that the agency variable MOW and OWC (except RFCF), are positively correlated with all stock option and all of its components. In other side, profitability and size are negatively associated with all stock option variables, Leverage is negatively with RMEO and RMO, and positively correlated with RMNEO.
4-4 Estimations results: I consider two empirical models:
Model1:Pooled least squares(fixed effect, random effect,)
PR = F(intercept, Lev, SIZE, MOW, RMEO, RMNEO, RMO, OWC, RFCF)
Model 2: Standard Tobit régression analyses.
(5)
To examine the forecast made by hypothesis 1, I estimate the association between stock option and dividend in two cases: In the first case I use all Executive stock options in explaining firm's dividend policy. Because information on the age of executive stock options is not available, and given that most options are exercised before they reach the end of their contractual life, stock options are substituted in the second case, by stock option exercisable and stock options unexercisable. Using this distinction table presents results of the estimations Tobit and pooled regressions:
4-4-1 Estimations with Pooled least squared method:
I estimate for sets of pooled least squared: (1) fixed effect, (2) random effect, and for each model we distinguish two cases of variables: (i) case 1: I use two variables related to CEOs' stock options: Exercisable and Unexercisable. (ii) In case 2 I compute all CEOs' stock options in a unique variable. The above table shows adjusted R² squared for four models ranges between 1% and 12%. The results show (see tables 3 and 10-14) that all the regression coefficients except for Leverage (Fixed effect case and case 2) and Size are not significantly different from Zero. All The CEOs' stock option variables are not significant. As predicted by many authors( Lambert et alii (1989), Fenn and Liang (2000), Bhattacharaya (2003)…) CEOs' stock options as measured by RMO is negatively associated with dividend payout in the case of the random effect, in the other cases this variable is not conform as the predictions theories.
Table3: Panel-data linear Regression results
Fixed effect
Case 1
Fixed effect
Case 2
Random effect
Case 1
Random effect
Case 2
Intercept
(-) NS
(-) NS
(-) Sign 1%
(-) Sign 1%
Lev
(+) NS
(+) NS
(+) NS
(+) NS
Prof
(-) NS
(-) NS
(+) NS
(+) NS
Size
(+) NS
(+) NS
(+) Sig 1%
(+) Sig 1%
MOW
(+) NS
(+) NS
(+) NS
(+) NS
RMEO
(+) NS
//////////
(-) NS
/////////
RMNEO
(+) NS
/////////
(+) NS
/////////
RMO
//////////
(+) NS
///////////
(+) NS
OWC
(+) NS
(+) NS
(+) NS
(+) NS
RFCF
(+) NS
(+) NS
(-) NS
(-) NS
R squared
Prob>F(Prob>chi2
0,0095
0,9845
0,0097
0,9866
0,1279
0,0112
0,1278
0,0061
Interpretations : (a) low R2 : 1% for fixed effect, 12% for random effect, (b) fixed effect not significant, random effect significant at 5%, (c) none variable is significant in fixed effect, (d) intercept and size are significant ( 1%, 1%)in random effect, (e) conclusion: panel data regression biased and inconsistent results.
NS : not significant, Sig :significant
4-4-2: Estimations with Tobit regression:
When I use a Tobit regression, results demonstrate (see tables 4 and 15-20) that the almost of the all variables (stock options, agency and control variables) appears to have pronounced effects on dividend payout. As shown in table 4, stock options (RMO) and stock option exercisable (RMEO) are significantly and negatively associated with dividend payout.
Table 4: Tobit results
Extreme values
Case 1
Extrem values
Case 2
Normal hypothesis
Case 1
Normal hypo
Case 2
Intercept
(-)Sig 1%
(-)Sig 1%
(-)Sig 1%
(-)Sig 1%
Lev
(+)NS
(+)NS
(+)NS
(+)NS
Prof
(+)NS
(+)NS
(+)NS
(+)NS
Size
(+) Sig 1%
(+) Sig 1%
(+) Sig 1%
(+) Sig 1%
MOW
(+)Sig 10%
(+)NS
(+)NS
(+)NS
RMEO
(-) Sig 1%
///////////
(-) NS
///////////
RMNEO
(-)NS
///////////////
(-)NS
///////////////
RMO
//////////////////
(-) Sig 1%
//////////////////
(-) NS
OWC
(+)Sig 5%
(+)Sig 5%
(+)NS
(+)NS
RFCF
(-)Sig10%
(-)NS
(-)NS
(-)NS
LogLikelihood
Av Log Likhd
-120,645
-0,685253
-121,89
-0,688649
-59,93119
-0,34518
-60,04253
-0,339223
Tobit results (interpretations) : a) Hypothesis extreme values> hypothesis normal distribution, b) Case 1>case 2, c) Intercept and size are significant in all tests (1%), d) MOW and RFCF are significant in one case (10%), e) OWC is significant in extreme value (case 1, case 2), f) relationship stock option and dividend (-) conform to the hypothesis, g) RMNEO non significant in all tests, h) RMEO is significant only in case 1 (extreme values), i) RMO is significant only in case 2 (extremes values).
NS: not significant, Sig : significant
4-4-3 Overall interpretations:
Results of Stock options variables: Contrary to Aboody and Kasznik (2001), who find that the coefficient estimate on unexercisable is significantly positive, while the coefficient estimate on Exercisable is statistically insignificant, my estimation show the opposite results (see table 5). These findings (only executive stock option RMO) are similar as predicted by prior studies (Lambert et el 1989, Bhattacharyya et al (2003). Fenn and Liang (2001), interpret the potential influence of managerial stock incentives in one of two ways: (i) first stock options given to managers can align the interests of management and shareholders, these incentives can also mitigate the free cash flow problems. (ii) A second potential explication is through the incentives to influence the choice between share repurchase and dividend payments. Liljeblom and Pasternack (2002) suggested that this negative relationship can be avoided by dividend protection. When options are dividend protected, it is possible to show a positive association between stock incentives and dividend payout.
Table 5: Comparison Pooled and Tobit tests of CEOs' stock options variables
Pooled Least square
Tobit Model
Fixed effect
Random effect
Extreme Value
Normal Hypothesis
Case 1
Case 2
Case 1
Case 2
Case 1
Case 2
Case 1
Case 2
RMEO
(+) NS
//////
(-)NS
//////
(-)Sig1%
/////
(-)NS
/////
RMNEO
(+)NS
//////
(+)NS
//////
(-)NS
//////
(-)NS
//////
RMO
//////
(+)NS
//////
(-)NS
//////
(-) Sig1%
//////
(-)NS
RMEO is significant 1% in one case (Tobit model , extreme value)
RMNEO not significant in all Tests
RMO is significant 1% in one case (Tobit model, extreme value)
Results of the control variables : Results are consistent across Tobit model:
Firm Size: Dividend payout is positively associated with firm size in all regression results. This variable is significant at 1% in Pooled regression (random effect) and Tobit estimation. The positive relation between size and the likelihood of dividend initiation indicates that large firms are more likely to pay dividends. Fama and French (2001) propose that firm size, profitability, current growth, and growth opportunities all help explain the probability that a firm is a dividend payer. These firms have a tendency to be the larger size, more profitable with slower growth opportunities. In the other hand, firm size may control for unobserved heterogeneity across firms, since big firms and small firms may different maturity, market power, asset in place, management strategies, level of free cash flow, or borrowing capacity, all of which may affect the dividend payout.
Leverage: The validation results of our study indicates that leverage is significant (at 10 % and 5% levels) in two estimations of pooled regression (fixed effect case 1 and case 2) and affects positively dividend payout (not conform to our prediction). Debt used here as a measure of firm leverage and proxy for closeness to debt covenants restrictions. High leverage, with its financial risk and debt servicing requirements should be associated with lower dividend payout in the case of small firm and higher dividend payout in the case of big firm. According to Jensen and Meckling (1976), Jensen (1986) and Stulz (1988) financial leverage has an important role in monitoring managers thus reducing agency costs arising from the shareholder-manger conflict. Moreover, some debt contracts include protective covenants limiting the payout. Therefore, we expect a negative relationship between payout ratio and leverage.
Profitability: this variable is not significant in all tests .The sign of this variable is confusing [8] : Positive effect signifies that firms with more profitable investment must signal to the market this good news. While, negative effect means that firm with growth opportunity should not pay dividend. Fama and French (2001) suggest a systematic divergence between set of paying and non paying firms with respect to features such as Leverage, investment opportunities, growth, firm size and profitability.
The results of estimating agency variables : Results allow us to deduce :
Free cash flow: The results show a negative and a significant effect of this variable in the case of Tobit model (extreme value) and insignificance in all others tests. This result is contrary to the free cash flow hypothesis in the line with Easterbrook, 1984; Jensen, 1986 which suppose that an increase in dividends is positively received by investors because it reflects that managers will have less cash to spend in negative net present value projects. An inverse relationship between FCF and dividends could follow if higher cash flow signifies higher agency problems related to inefficient and improper uses. A higher level of dividend payments will reduce the FCF and in turn reducing agency conflicts.
Manager Ownership: The results indicate a positive effect of manager ownership in all regression. Only extreme value case show a significant (at 10 % level) coefficient of this variable, however the results of the others estimations are not significant at conventional level. Following Jensen and Meckling (1976) there is a theoretically optimal quantity of shares that managers should hold that will link their interest to the wealth of the other shareholders while at the same time minimizing their personal benefits and the possibility of outside takeovers. More specifically Miller and Rock (1985), Leland and Pyle (1977), consider that Manager Ownership can be used as a signal. If manager owner signal an increase in dividend payout, they will benefits from this through the share price appreciation. Farinha (2002) finds a U-shaped relationship between insider ownership and dividend payout.
- Ownership structure:
The results indicate a positive effect of ownership structure in all regression. Only extreme value case show a significant (at 5 % level) coefficient of this variable, however the results of the others estimations are not significant. The association between ownership structure and dividend payout is a focal point of many empirical studies: Jensen and Meckling (1976), suggested that concentrated ownership is beneficial for corporate valuation, because controlling shareholders are better at monitoring managers. La Porta (2000) present empirical results in favour of the outcome agency model of dividend. The suggest that firms with higher legal protection to shareholders pay higher dividend, compared to firms with low shareholder protection distribute less amount of dividend due to the more agency conflicts between controlling shareholders and the minority shareholders. Maury and Pajuste (2002) examine the influence of ownership and control structure on dividend payout strategies. They show that dominant shareholders in control may collude in generating private benefits of control that are not shared with minority shareholders as indicated by lower dividend payout levels.
Table6: Comparison Pooled and Tobit tests control and agency variables
Variables
Significance
Observed sign
Predicted sign
A) Control variables
Leverage
Substitution hypothesis
(+) in all tests
(-)
Profitability
Signalling approach
(-) in fixed effect and (+) in random and Tobit estimations
(+)
Size
Market access
(+) in all tests
(+)
B) Agency variables
MOW
Alignment of interests
(+) in all tests
(-)
OWC
Separation ownership and control
(+) in all tests
(+)
RFCF
Management opportunity
(-) in fixed effect and (+) in random and Tobit estimations
(+)
4- Conclusion:
This paper on stock options and dividend policy in Canadian listed firms provides valuables results and insight on the determinant of variables explaining dividend payout. Executive compensation has been the subject of extensive prior research, and excellent general reviews already exist for the interested reader. In this context, we have investigated whether stock-based compensation particularly stock options, motivate CEOs to reduce cash dividend. This testable hypothesis is derived from the observation that the payment of a dividend, ceteris paribus, reduces the value of the option, and thus increases the cost to the manager of paying a dividend. Using data for a sample of 89 companies the results of Tobit analyses of dividends payout of Canadian firms over the period 2002-2003 are consistent with the prediction of many authors. That, there is a negative association between CEOs' stock option holding and the ratio of dividend.
From above arguments I have also estimated this relationship using Exercisable and Unexercisable options as explanatory variables. The results reveal that these variables are not significant in all estimation except the case of Tobit regression (hypothesis of extreme value) where the variable RMEO is significant at 1%.. These results offer the following pictures of dividend payout: (i) the characteristics of a manager's compensation contract are potentially important determinants of the corporate dividend payout ratio . in this context, stock option exercisable can be as a factor explaining dividend policy. The addition of a stock option to a manager's compensation package provides an incentive for executive to reduce corporate dividends. (ii) Regarding the agency problem and payout policy, dividends are seen as a mechanism to disgorge the firm of free cash flow that could otherwise be used by managers in their own interests (Rozeff (1982), Easterbrook (1984), and Jensen (1986)). Managerial stock incentives might mitigate agency costs at companies with the most serious excess cash flows problems. (iii) The effect of Leverage is bit puzzling: following Jensen (1986) debt is considered as an substitute method of disgorging free cash flow. Apparently, the tests show an opposite conclusion: more levered firms maintain higher payout ratios than less levered firm do.
