Do managers cut dividends because they “have to”?
Abstract
I conduct an examination of the cross-sectional and time-series evidence on the decision to reduce dividends over the 40-year period of 1965-2004. As my core analysis, I empirically investigate whether the decision to cut dividends is caused by the exhaustion of corporate cash reserves and the capacity to access default-risk-free debt financing – i.e., financial slack – preventing the firm from paying out cash to its shareholders at the existing level. To measure the amount of financial slack for each firm-year observation in my sample, I first estimate optimal cash and target debt levels in annual cross-sectional regressions and then define financial slack as the deviation of the actual cash-to-assets ratio from the optimal level of cash minus the deviation of the actual debt-to-assets ratio from the estimated target debt level (positive cash deviation measures the amount of excess cash, while negative debt deviation measures the magnitude of unused capacity to issue risk-free debt). I document a significantly negative correlation between financial slack and the probability of a dividend reduction; moreover, this negative association has strengthened over time. As an extension of my main analysis, I also record that (i) firms facing higher costs of external finance due to growth options or asymmetric information problems (high market-to-book firms) are more likely to reduce dividends in response to the depletion of financial slack, (ii) the negative association between financial slack and the likelihood of a dividend reduction is concentrated only among firms that have exhausted their unused capacity to issue safe debt, suggesting that managers are concerned with restricting their debt levels as soon as they are above their target debt levels, and (iii) after the emergence of a substitute form of payout, share repurchases, managers have become less hesitant to cut dividends due to the exhaustion of financial slack.
Degree
Ph.D.
Advisors
McConnell, Purdue University.
Subject Area
Management|Finance
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