Managerial social capital and dividend smoothing

https://doi.org/10.1016/j.jcorpfin.2020.101811Get rights and content

Highlights

  • Managerial social capital is positively associated with dividend smoothing.

  • The effect of social capital is stronger for financially constrained firms.

  • Social capital is positively associated with passive institutional ownership.

  • The findings are consistent with agency-based models of dividend smoothing.

Abstract

We investigate the influence of a previously unexamined managerial personal attribute, social capital, on a firm's propensity to smooth dividends. We document that greater managerial social capital is associated with a statistically and economically significant increase in dividend smoothing. The effect of social capital on dividend smoothing is stronger for financially constrained firms. We also find that social connections are positively associated with passive institutional ownership. Our results are robust to alternative model specifications, different variable measurement, and endogeneity tests. Overall, the findings are consistent with agency-based explanations for corporate dividend smoothing.

Introduction

Explaining dividend stickiness is a long-lasting research question in corporate finance. Since Lintner's (1956) seminal observation that dividend stability is a company's primary concern, a large body of literature has investigated the pervasive phenomenon of dividend smoothing. Recent theoretical literature (e.g., Lambrecht and Myers, 2012: Baker et al., 2016) has proposed that investor loss-aversion as well as managerial characteristics, such as habit formation and risk-aversion, have important implications for dividend smoothing. However, while recent empirical research (e.g., Leary and Michaely, 2011; Michaely and Roberts, 2012) has focused on market-wide socio-economic indicators, as well as location, industry, and firm characteristics, little is known regarding the impact of managerial attributes on a firm's propensity to smooth dividends.

We conjecture that a previously overlooked managerial personal attribute, social capital, could have implications for dividend smoothing. Social capital can be broadly defined as the value of informal obligations and social contracts. This definition emphasizes understanding of social capital from two distinct perspectives: a micro and a macro. In this paper, we take a micro approach and consider social capital as a personal asset that benefits a single individual or firm.1 As Bourdieu (1986) points out “the volume of social capital possessed by a given agent … depends on the size of the network of connections that he can effectively mobilize.” Studies, such as Cohen et al. (2008), Engelberg et al., 2012, Engelberg et al., 2013, Faleye et al. (2014), and El-Khatib et al. (2015), provide convincing evidence that network participation, or social capital,2 has important implications for corporate policies and for a firm's information environment.

Despite the overwhelming empirical evidence on the prevalence of dividend smoothing, no existing theory appears capable of simultaneously explaining all of the observed aspects of smoothing behavior. Consequently, we rely on a number of theoretical models and on well-established empirical findings to derive testable predictions. Following Leary and Michaely (2011), we classify existing theories relevant to our research into those based on information asymmetry, principal-agent, external financial constraints (from precautionary savings perspective), and agency-based models. These theories lead to competing predictions of the potential role of social capital.

Specifically, standard asymmetric information models (e.g., Fudenberg and Tirole, 1995; Kumar and Lee, 2001; Guttman et al., 2010) imply that signaling through dividend smoothing should be more prevalent among firms that face a high degree of information asymmetry. In principal-agent models, dividend smoothing is the result of information asymmetry between shareholders and managers (e.g., Fudenberg and Tirole, 1995; DeMarzo and Sannikov, 2008). Wu (2017) concludes that dividend smoothing is largely driven by managers' own career concerns. Additionally, from a precautionary savings perspective, financial constraints can also lead to more smoothing if firms with limited access to external financing are reluctant to increase dividends after experiencing earnings growth (e.g., Almeida et al., 2004; Bates et al., 2009). Thus, dividend smoothing should be more pronounced among firms that are more concerned with maintaining financial slack, that is, financially constrained firms.

From these theories, we expect that extensive social ties could reduce a firm's propensity to smooth dividends, for at least three reasons. First, social networks open new channels for information propagation, which can alleviate information asymmetry problems and the need to signal quality through dividend smoothing. Kuhnen (2009) provides supportive evidence that social ties are an efficient channel of information exchange. Cai and Sevilir (2012) find that social connections in the form of a common board membership on acquirer and target companies reduce information asymmetry in merger deals. Similarly, Schmidt (2015) documents that information about mergers efficiently spreads across personal networks. In an international setting, Ferris et al. (2017) show that social networks reduce analyst forecast error and the cost of equity financing. Thus, within the context of asymmetric information models, because social connections positively affect information flows, they should reduce information asymmetry and hence the need for dividend smoothing.

Second, the social capital literature provides overwhelming evidence that social connections alleviate managerial career concerns, which would then reduce managerial incentives for smoothing. Nguyen (2012) shows that socially connected CEOs are more likely to find reemployment, even after a forced departure. Faleye et al. (2014) find that CEO personal connections mitigate career concerns by enhancing the prospect for re-employment. Other studies (e.g., Zhou, 1992; Granovetter, 1995) find that social capital is associated with more successful employment outcomes. Therefore, within the context of principal-agent models, there should be a negative association between social capital and dividend smoothing because social ties provide labor market insurance.

Third, prior research (e.g., Engelberg et al., 2012) shows that social connections offer low-cost access to external finance, effectively alleviating financial constraints. Because, based on precautionary savings models, smoothing should be more prevalent among firms that have limited access to external capital, we would expect an inverse relation between social capital and a firm's propensity to smooth dividends.

However, in influential work examining empirically the validity of dividend smoothing theories, Leary and Michaely (2011) conclude the results present a challenge for theories based on information asymmetry, principal-agent problems, and financial constraints. For example, they find that dividend smoothing is prevalent among firms with low information asymmetry, low financial constraints, and greater institutional holdings, all of which is inconsistent with the proposed theories. Overall, Leary and Michaely (2011) indicate their main findings are more consistent with agency-based models, for the following two reasons. First, Easterbrook (1984) and Jensen (1986) show that firms with access to external finance could alleviate agency problems by paying out a steady stream of dividends, which would force them to regularly approach capital markets to support growth. Thus, easy access to outside financing should be associated with more dividend smoothing, consistent with what Leary and Michaely (2011) find. Second, in line with Allen et al. (2000), institutional investors play an important monitoring function and impose severe penalties for dividend cuts. Consequently, firms with high institutional ownership must commit to smoother dividend payouts, also consistent with the findings of Leary and Michaely (2011).

Therefore, agency-based models on the other hand would predict a positive association between managerial social capital and dividend smoothing. This is because the firm characteristics that Leary and Michaely (2011) find are positively associated with dividend smoothing, namely low information asymmetry, low financial constraints, and greater institutional holdings, are also firm characteristics that are theoretically and empirically positively related to social capital. Specifically, research on social networks between firm managers and financiers shows that social ties mitigate information asymmetry, reduce lending costs, lead to more favorable financing terms, and improve access to outside financing (Engelberg et al., 2012; Karolyi, 2018). Cohen et al. (2008) find that information is efficiently disseminated via educational networks between mutual fund managers and corporate boards. They show that these networks have significant implications for external financing access, with mutual funds investing in more connected firms. Javakhadze and Rajkovic (2018) document that social connections reduce the cash flow sensitivity of cash, effectively alleviating financial constraints. Thus, social connectedness alleviates information frictions and financial constraints, and it is positively associated with institutional holdings. Consequently, consistent with agency-based theories and the empirical findings of Leary and Michaely (2011), social capital could lead to higher dividend smoothing.

In sum, agency-based models, on the one hand, and information asymmetry, principal-agent, and financial constrains (precautionary savings), on the other, make opposite predictions for the type of firms that would engage in dividend smoothing. These opposite predictions extend to the impact of social connections on dividend smoothing, which is the focus of our empirical investigation.

We test the competing hypotheses on a sample of US firms using the BoardEx database as a source for biographical information on managerial teams. BoardEx data, provided by Management Diagnostics Limited, contains social networks information as well as educational employment, and social history of senior executives and board members. Recent research on managerial social connections has used BoardEx (e.g., El-Khatib et al., 2015; Fracassi, 2016).

In OLS regressions, we find that managerial social capital is positively associated with dividend smoothing. Using a traditional measure of smoothing following Fama and Babiak (1968), we find that a one standard deviation increase in social connections results in a 12%–15% (depending on model specification) reduction in the speed of adjustment relative to the cross-sectional mean. We also find evidence consistent with the notion that social capital alleviates financial constraints, which increases a firm's propensity to smooth dividends.

We address potential endogeneity concerns in several ways. First, the primary concern is that managerial social capital could be endogenously correlated with an omitted variable such as experience or skill. To address this issue, we orthogonalize our connectedness measure with respect to a human capital index. More specifically, we measure “excess connectedness” as the residual in a regression of social capital on a human capital index. Second, we estimate instrumental variable two-stage least squares (2SLS) regressions using the number of financiers within the three-digit zip code of corporate headquarters as an instrument. Our findings remain qualitatively the same.

Third, we exploit a quasi-natural experiment following Almeida et al. (2012). We argue that the 2007–2008 financial crisis represents a large exogenous shock to the availability of external financing for firms with high levels of debt maturing in 2008 (compared to firms with less debt maturing in 2008). This shock is exogenous because it is unlikely the crisis was anticipated when setting debt maturity in the preceding years. We find the impact of social capital on dividend smoothing is stronger for firms with high levels of debt maturing during the crisis, implying that social capital effectively alleviates financial constraints, and as a result affects dividend smoothing. Fourth, reverse causality could also be a concern. That is, firms could try to alleviate possible information asymmetry issues by hiring socially well-connected managers. We mitigate this reverse causality concern by splitting the sample into low and high information asymmetry subsamples and examining changes in social capital as well as executive/board turnover in each one. We document that, inconsistent with a reverse causality explanation, firms with low information asymmetry exhibit greater executive turnover as well as greater changes in social capital.

Finally, we also find that social connections are positively associated with passive institutional ownership, establishing one possible direct channel through which social capital could affect dividend smoothing. In this analysis, we alleviate endogeneity concerns using a regression discontinuity design.

Our study contributes to the existing literature in several ways. First, our paper complements prior empirical research examining the determinants of dividend smoothing. Leary and Michaely (2011) test the empirical implications of existing theoretical models, including asymmetric information (e.g., DeMarzo and Sannikov, 2008; Guttman et al., 2010), agency (Allen et al., 2000; DeAngelo and DeAngelo, 2009), and clientele and tax considerations (e.g., Miller and Scholes, 1978). They find that firms that face low levels of asymmetric information and are not financially constrained, engage in greater dividend smoothing. They interpret their overall findings as supportive of agency conflict explanations of dividend smoothing, although they also admit that their evidence provide challenges for the theoretical literature. Michaely and Roberts (2012), using data from the UK firms, document that private firms smooth dividends less than public firms, suggesting that the scrutiny of public capital markets leads to smoothing. Javakhadze et al. (2014) show that dividend smoothing occurs internationally, but with cross-sectional differences. Our results reveal that an attribute previously unaccounted for, managerial social capital, positively affects a firm's propensity to smooth dividend payouts.

Second, our research also adds to recent literature that investigates the effects of social networks on corporate outcomes. Recent studies, such as Faleye et al. (2014), El-Khatib et al. (2015), Fracassi (2016), Fogel et al. (2018), and Goergen et al. (2019) find that social networks have important implications for IPO performance, cash ratios, leverage, M&A activities, corporate innovation, debt contracting, and for insider trading. Extending these studies in an important way, we document that managerial social networks also matter for dividend smoothing.

Section snippets

Data and sample selection

The data come from a variety of sources. We collect financial and accounting variables from Compustat and stock returns from CRSP. Institutional ownership data is obtained from Thomson Financial 13F. We generate our social capital measures from BoardEx, which contains records on bilateral networks as well as biographical information of firm executives and board members starting in 1999. To limit the sample to firms for which we can calculate dividend smoothing measures, we apply the Leary and

Summary statistics and univariate analysis

Table 1, Panel A depicts descriptive statistics of the main variables. Managers of capital accessing firms have on average 207 connections with financiers, with median of 124 and interquartile range of 224. On average, our sample firms are large, with moderately volatile earnings (median earnings volatility is 0.03) and returns (median volatility is 0.08). Sample firms possess important growth opportunities as implied by an average Market-to-book ratio of 1.69.

We first examine the relation

Panel setting

In our main analysis, we estimate the dividend smoothing proxies cross-sectionally. In this subsection, we follow Larkin et al. (2016) and examine the effects of social capital on dividend smoothing in a panel setting. More specifically, we use dividend cuts and/or increases as a dependent variable.

Table 5 presents the results. We estimate linear probability models in Panel A, and probit regressions in Panel B. The dependent variables are indicator variables for dividend changes that equal 1 if

Conclusions

This paper introduces the managerial social capital construct into the corporate payout literature by examining its implications for dividend smoothing. Prior theoretical literature suggests that firms subject to a higher degree of information asymmetry are more likely to smooth dividends as a signaling mechanism. In addition, principal-agent models would predict that managers have an incentive to commit to smoother dividend payouts because of career concerns. Furthermore, from a precautionary

References (58)

  • D. Javakhadze et al.

    An international analysis of dividend smoothing

    J. Corp. Finan.

    (2014)
  • D. Javakhadze et al.

    Social capital, investments, and external financing

    J. Corp. Finan.

    (2016)
  • M. Miller et al.

    Dividends and taxes

    J. Financ. Econ.

    (1978)
  • B. Schmidt

    Costs and benefits of friendly boards during mergers and acquisitions

    Journal of Financial Economics

    (2015)
  • V. Aivazian et al.

    Dividend smoothing and debt ratings

    J. Financ. Quant. Anal.

    (2006)
  • F. Allen et al.

    A theory of dividends based on tax clienteles

    J. Financ.

    (2000)
  • H. Almeida et al.

    The cash flow sensitivity of cash

    J. Financ.

    (2004)
  • H. Almeida et al.

    Corporate debt maturity and the real effects of the 2007 credit crisis

    Crit. Financ. Rev.

    (2012)
  • M. Baker et al.

    Dividends as reference points: a Behavioral Signaling approach

    Rev. Financ. Stud.

    (2016)
  • T. Bates et al.

    Why do U.S. firms hold so much more cash than they used to?

    J. Financ.

    (2009)
  • P. Bourdieu

    The Forms of Capital, Handbook of Theory and Research for the Sociology of Education 241

    (1986)
  • B. Bushee

    The influence of institutional investors on Myopic R&D Investment Behavior

    Account. Rev.

    (1998)
  • B. Bushee

    Do institutional investors prefer near-term earnings over long-run value?

    Contemp. Account. Res.

    (2001)
  • L. Cohen et al.

    The small world of investing: board connections and mutual fund returns

    J. Polit. Econ.

    (2008)
  • H. DeAngelo et al.

    Capital Structure, Payout Policy, and Financial Flexibility

    (2009)
  • P. DeMarzo et al.

    Learning in Dynamic Incentive Contracts

    (2008)
  • K. Dewenter et al.

    Dividends, asymmetric information, and agency conflicts: evidence from a comparison of the dividend policies of Japanese and U.S. firms

    J. Financ.

    (1998)
  • F. Easterbrook

    Two agency-cost explanations of dividends

    Am. Econ. Rev.

    (1984)
  • J. Engelberg et al.

    The Price of a CEO’s rolodex

    Rev. Financ. Stud.

    (2013)
  • Cited by (10)

    • Dividend smoothing and financial transparency

      2024, Finance Research Letters
    • The effect of dividend smoothing on bond spreads: Evidence from Japan

      2023, International Review of Economics and Finance
    View all citing articles on Scopus
    View full text