Effect of family control on corporate dividend policy of firms in Pakistan

Yousaf, Imran; Ali, Shoaib; Hassan, Arshad Article Effect of family control on corporate dividend policy of firms in Pakistan Financial Innovation Provided in Cooperation with: Springer Nature Suggested Citation: Yousaf, Imran; Ali, Shoaib; Hassan, Arshad (2019) : Effect of family control on corporate dividend policy of firms in Pakistan, Financial Innovation, ISSN 2199-4730, Springer, Heidelberg, Vol. 5, Iss. 1, pp. 1-13, https://doi.org/10.1186/s40854-019-0158-9 This Version is available at: https://hdl.handle.net/10419/237184 Standard-Nutzungsbedingungen: Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden. Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen. 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If the documents have been made available under an Open Content Licence (especially Creative Commons Licences), you may exercise further usage rights as specified in the indicated licence. https://creativecommons.org/licenses/by/4.0/ RESEARCH Open Access Effect of family control on corporate dividend policy of firms in Pakistan Imran Yousaf 1* , Shoaib Ali 1 and Arshad Hassan 2 * Correspondence: [email protected] 1 Faculty Member, Air University School of Management, Air University, Islamabad, Pakistan Full list of author information is available at the end of the article Abstract This study examines the impact of family control on the dividend policy of firms in Pakistan, covering the period from 2009 to 2016. It also investigates whether family control moderates the impact of firm-specific factors on the dividend policy. The GMM model for panel data estimation is used. The mean difference univariate analysis shows that family firms differ from nonfamily firms based on financial characteristics. The multivariate analysis shows that family firms pay lower dividends than nonfamily firms. Besides, firm size inversely affects the dividend policy, whereas tangibility positively affects it. Moreover, family control does not moderate the impact of all firm-specific factors on the dividend policy. Overall, family control, size, and tangibility are found to be the main determinants of the dividend policy in Pakistan. Keywords: Family firm, Family ownership, Dividend, Minority shareholder, Expropriation, Agency conflicts Introduction “Corporate governance is a philosophy and mechanism that entails processes and structure which facilitate the creation of shareholder value through management of the corporate affairs in such a way that ensures the protection of the individual and collective interest of all the stakeholders”(Hasan & Butt, 2009, p.50). Corporate governance only modestly provides a mechanism through which outside investors can protect themselves against expropriation by insiders. It is mostly associated with the presence of agency problems, which can arise when there is a separation of control and ownership in a firm. The agency issues may exist between managers and owners or between controlling owners and minority shareholders. Notably, owner–manager problems are fewer in family firms, but more prominent between a controlling shareholder and minority shareholders (Jensen & Meckling, 1976). The latter case can be attributed to scenarios wherein controlling shareholders expropriate the wealth of minority shareholders. Extant research on finance also contends that family firms often expropriate the wealth of minority shareholders (De Cesari, 2012). Such firms should then pay more dividends compared with nonfamily firms to overcome agency problems and reduce agency © The Author(s). 2019 Open Access This article is distributed under the terms of the Creative Commons Attribution 4.0 International License (http://creativecommons.org/licenses/by/4.0/), which permits unrestricted use, distribution, and reproduction in any medium, provided you give appropriate credit to the original author(s) and the source, provide a link to the Creative Commons license, and indicate if changes were made. Financia l Innovation Yousaf et al. Financial Innovation (2019) 5:42 https://doi.org/10.1186/s40854-019-0158-9 costs. Bozec and Laurin (2008) argue that dividends can be a controlling mechanism in governance to reduce agency costs. The Pakistan business landscape is dominated by family-owned firms. Around 59% of nonfinancial listed firms can be classified as family-owned firms (Shahab and Attiya, 2012). These family firms are indispensable to the economic growth of Pakistan. Owners of family firms control firms through direct ownership, a pyramid structure, or a cross-holding ownership structure. These firms conventionally offer more benefit to family members (majority shareholders). Some studies find that family firms pay less dividends than nonfamily firms do (Attig et al., 2016; Lukas, 2017; Duygun et al., 2018). Contrariwise, evidence also suggests that family firms pay higher dividends to overcome agency conflicts (Lukas, 2010). So far, there is no conclusive substantiation that resolves these contradictory findings. Our objective herein is to examine the effect of family control on the dividend policy of firms in Pakistan. Further, previous studies focus on determining the determinants of the dividend policy of firm (Baker and Powell, 2000; Ben et al., 2006; Denis and Osobov, 2008; Ahmed and Javid, 2009; Mehta, 2012; Yousaf and Ismail, 2016; Baker et al. 2019) without segregating the family and non-family firms. Thus, this paper contributes to the strand of literature on the determinants of corporate dividend policy in two ways: first, by accounting for family control; second, by examining the moderating role of family control on ‘the impact of firm-specific factors on the dividend policy’. Some investors give preference to dividend yield over capital gain while designing their portfolios. This study will be helpful for dividend demanding investors in the selection of stocks for portfolios, because this study also explores whether family firms pay more dividends or non-family firms. It will also be helpful for policymakers of the family businesses’ dominant country while designing or restructuring the corporate governance code for family dominant firms to protect the rights of minority shareholders. Our study is novel for three factors: First, scholars have rarely, if not ever, studied the stated objective in the context of Pakistan. Second, this study contributes to the corpus of literature on dividend policy in firms by focusing on an emerging economy, thus making it relevant to a large group of fast-developing countries in Asia and Africa. Third, it is particularly important to study firm policy dynamics in countries where most firms are family-run. To examine the impact of family control on the dividend policy of firms in Pakistan, we collect sample data of 103 nonfinancial firms ranging from 2009 to 2016 and subject them to panel data analysis using the generalized method of moments (GMM). The remaining paper is structured as follows: After providing an overview of the extant literature in section 2, we explain the data, variables, and empirical methodology in section 3. In section 4, we present and discuss our findings, and then conclude in section 5. Literature review Decisions on corporate dividends are the main strategic decisions of firms. In such decisions, firm characteristics are considered highly influential. These characteristics include family ownership, size, profitability, growth, leverage, tangibility, and turnover. Yousaf et al. Financial Innovation (2019) 5:42 Page 2 of 13 This section explains the theoretical and empirical relationship between dividend policy and its determinants (including family ownership). Family ownership According to the agency cost theory, agency conflicts can exist between firm managers and shareholders (Jensen and Meckling, 1976). Under family ownership, the interests of shareholders and managers might align. Such mutual interests reduce agency conflicts (La Porta et al., 2000), especially given that family owners would likely monitor their managers more strictly (Anderson and Reeb, 2003). When firms distribute dividends, family owners serve as efficient monitoring mechanisms to ensure that managers do not waste free cash flow on unprofitable projects. Hence, distribution of dividends reduces agency conflicts of free cash flow between controlling and minority shareholders (Jensen, 1986). Through this strategy, firms can establish better corporate governance systems. Thus, based on the outcome model of dividends, higher dividends should be associated with better corporate governance practices. The dividends can reduce the conflict between family and nonfamily owners. However, DeAngelo and DeAngelo (2000) argue that income and wealth preservation might reflect the preferences of family-owned firms in lieu of wealth maximization for outside shareholders through a dividend payout. Faccio et al. (2001) argue that a controlling family might expropriate the wealth of minority shareholders when its cash flow rights dwarf over minority shareholders. Gugler and Yurtoglu (2003) argue that free cash flow reduces if family firms pay higher dividends. High dividends might then decrease the tendency of family firms to expropriate wealth from minority shareholders. Moreover, De Cesari (2012) claims that family firms pay fewer dividends to preserve their cash flow for expropriation. Thus, lesser dividends indicate the possibility of wealth expropriation by family owners. Ultimately, it leads to the high agency costs (La Porta et al., 2000). Family firms have a lower dividend payout ratio compared with state-controlled firms (Gugler et al., 2003; Duygun et al., 2018) and often use funds for own benefits. Evidently, families expropriate shareholder wealth by paying lower dividends, and minority shareholders resultingly face a loss. Villalongs and Amit (2006) maintain that conflicts arise between a large controlling shareholder and minority shareholders when the former uses firm resources for own benefits and, thus, pays fewer dividends to minority shareholders (i.e., agency problem). Li et al. (2006) find that family firms do not pay dividends smoothly and also pay fewer dividends compared with nonfamily firms (Gugler and Yuroglu, 2003); their dividends are, in fact, more volatile. Further, Jensen et al. (1992) find a negative association between insider ownership and dividend payout. According to Baron and Kenny (1986) and Dawson (2014), testing for moderation is crucial when a contradictory relationship between the independent and dependent variable exists. That is, a relationship between two variables may be affected by a third variable. Novi and Pontoh (2018) state that a family firm with higher profitability moderates the relationship between the ownership structure and dividend. However, their results are insignificant. Similarly, they also tested for the moderating role of other firm-specific variables such as return on equity and earning per share. Saerang and Pontoh (2016) study the sample of Indonesian firms. They empirically prove that the larger the size of the family firm, the higher the dividends for shareholders. Yousaf et al. Financial Innovation (2019) 5:42 Page 3 of 13 Size Chang and Rhee (1990) point out that larger firms have more convenient access to capital markets at lower costs when a financing need arises. Thus, such firms can afford a higher dividend payout than smaller firms. Gaver et al. (1993), Holders et al. (1998), Fama et al. (2001), and Jones et al. (2001) similarly find an empirically positive relationship between size and dividend payout. On the other hand, Ahmed and Attiya (2009) find a negative relationship for the emerging economy of Pakistan. Profitability A firm pays dividends from its profits. Thus, profits indicate a firm’s capacity to pay dividends. Baker et al. (1985) report that anticipated future earnings constitute the “impact determinant”of the dividend payout. Pruitt and Gitman (1991) find that past and current returns are important factors in influencing the dividend payout. The pecking order hypothesis explains this relationship between profitability and dividends. Less profitable firms would not find it optimal to pay dividends, because they consider the cost of issuing equity and debt financing. Contrariwise, highly profitable firms are better able to pay dividends. It concludes that profitability directly affects the dividend payout (Fama and French (2002). Growth Firms with high growth require more capital than those with lower growth because the former logically have higher investment expenditures. Such firms are expected to implement a policy of low dividend payout because they retain their profits to finance investments; they also seek to avoid the high costs of external finance (Rozeff, 1982). According to the agency theory, low-growth firms should pay higher dividends to reduce agency costs between shareholders and managers because they have lower investments expenditures and, thus, higher retained earnings. Otherwise, managers may use their firm’s retained earnings or cash flow to invest in unprofitable projects if the firm is characterized by low growth opportunities. In this scenario, the best option is to distribute dividends among shareholders to reduce agency costs in lieu of wasting funds (Jensen, 1986). Hence, the agency theory predicts a negative relationship between growth and dividend payout. In the literature, both Lang et al. (1989) and Denis et al. (1994) also confirm this negative relationship. Leverage Based on the agency theory, Jensen (1986) argues that debt is an alternative for dividends in reducing agency conflicts. Debt repayment on higher debts reduces the cash flow available to a firm. Inevitably, the likelihood of managers investing free cash flow in unprofitable projects decreases, whereas monitoring by the capital market also increases. The agency theory also explains the negative relationship between debt and dividend payout. Kalay (1982) argues that debt covenants can force firms to limit the dividend payout. Jensen et al. (1992) and Faccio et al. (2001) empirically determine a negative relationship between leverage and dividend payout. Finding the same result, Gugler et al. (2003) argue that highly leveraged firms pay fewer dividends to shareholders because the high amount of interest and principal payments reduce firms’ Yousaf et al. Financial Innovation (2019) 5:42 Page 4 of 13 capacity to pay dividends to shareholders. Thus, highly leveraged firms pay fewer dividends to maintain their liquidity position and, thus, fulfill their current and future debt obligation. Such firms become bankrupt if a failure of debt repayment occurs (Chao et al., 2019; Chao et al., 2019) or liquidation arises. Leuz et al. (1998), Thornton (1992), and Niskanen and Niskanen (2004) suggest that debt covenants restrict dividend policy, indicating a negative relationship between leverage and dividend payout. Tangibility The tangibility of assets may affect the dividend policy because firms can use tangible assets as collateral against debt (Booth et al., 2001). Bradley et al. (1984) argue that firms with a higher proportion of tangible assets can fulfill their financing needs more easily and with cheaper cost through debt because they can use more tangible assets as backup or collateral against large debts. In such scenarios, there is decreased pressure on internal funds to fulfill financing needs, and firms can easily declare dividends from internal funds. Hence, these tangible assets, when taken as collateral, positively affect the dividend policy. Research methodology Data description This study examines all nonfinancial listed firms on the Karachi Stock Exchange. There are 559 companies listed in Pakistan. First, we focus on 390 nonfinancial firms and exclude financial firms because the financial sector is highly controlled by regulators. Second, we exclude 287 firms due to nonavailability of data on variables for consecutive years. Third, we select 54 family and 49 nonfamily firms from the 103 remaining firms. These sample firms are chosen from 19 nonfinancial sectors in Pakistan. Table 1 reports the distribution of the full sample by industry. Our analysis uses annual data and the sample period is from 2009 to 2016. The Balance sheet analysis of stock exchange-listed firms published by State Bank of Pakistan provides us with the accounting data of firms, whereas annual financial reports of selected companies provide the family ownership-related data. Model The panel data framework helps us analyze the effect of family ownership on corporate strategic financial policies of firms. We use the balanced panel data of 103 crosssectional firms over 8 yrs and study a sample of 824 observations. The panel data analysis assists in investigating time-series as well as cross-sectional data simultaneously. Notably, Pindado, Requeio, and Torre (2012) and Bostanci et al., 2018) empirically prove that previous dividends affect current year dividends. We thus use the GMM model because it is an efficient analytical method that can handle econometric problems of endogeneity and the omitted variable bias. As suggested by Roodman (2009), the lag dependent and explanatory variables are used as instruments following Arellano and Bond (1991). The functional form of our models is as follows: Yousaf et al. Financial Innovation (2019) 5:42 Page 5 of 13 Divit ¼α0þα1Family OwnershipðÞ it þα2SizeðÞ it þα3ProfitibilityðÞ it þα4GrowthðÞ it þα5LeverageðÞ it þα6TangabilityðÞ it þα7TurnoverðÞ it þuit There are many definitions of “family firm”in the literature. Perez-Gonzalez (2006) define one as a firm that has two or more biologically related individuals as directors, officers, or shareholders, where an individual has at least 5% ownership. Barth et al. (2005) state that if at least 33% of the shares of a firm are owned by one person or one family, then it is a family firm. This study defines a family firm as one that fulfills conditions (a) and (b), or only condition (c), as outlined hereafter: (a) at least two individual with a biological or connubial relationship are directors (or CEOs) of the firm; (b) individuals from a family that owns at least 20% of the shareholdings; and (c) if at least 33% of the firms’shares are owned by one person or one family. The firm is categorized as a family firm which fulfills both (a) and (b) conditions or solely (c) Condition. All other firms are categorized as nonfamily firms. The family dummy (FD) variable is 1 for family firms and 0 otherwise. We use three dimensions to define a family firm: governance, management, and ownership. A family can influence the firm through its degree of involvement in these dimensions (Astrachan, Klein and Smyrnios, 2002). In this definition, the extent of governance is measured by directorship, management involvement by the CEO, and ownership by at least 20% of the shareholdings. Table 1 Distribution of the full sample by industry Industry description Family firms Nonfamily firms Percentage family firms in industry Personal Goods (Textile) 18 02 90.0 Construction and Materials (Cement) 04 05 44.4 Electricity 01 04 20.0 Travel and Leisure 02 01 66.6 General Industrials 04 01 80.0 Automobile and Parts 05 01 83.3 Food Producers 07 03 70.0 Engineering 01 01 50.0 Forestry (Paper and Board) 02 01 66.6 Chemicals 05 04 55.5 Pharma and Bio Tech 02 04 33.3 Household Goods 02 01 66.6 Fixed Line Telecommunication 01 03 25.0 Tobacco 00 02 0.00 Industrial Transportation 00 01 0.00 Oil and Gas 00 11 0.00 Multiutilities (Gas and water) 00 02 0.00 Electronic and Electrical Goods 00 01 0.00 Software and Computer Services 00 01 0.00 Total 54 49 Yousaf et al. Financial Innovation (2019) 5:42 Page 6 of 13 We use two proxies of dividends: total dividends scaled by total equity as the first proxy and total dividends scaled by total assets as the second proxy. The natural logarithm of assets is a measure of the firm size. The net income scaled by total assets is a proxy for profitability and denoted by ROA. The market-to-book value of equity is a proxy for growth and denoted by M/B. The long-term debt to total assets is a proxy for firm leverage. The fixed assets scaled by total assets is a proxy for tangibility. Finally, the value of stock traded scaled by stock market capitalization is a proxy for turnover. Empirical results Descriptive statistics and analysis Summary statistics and correlation matrix Table 2reports the summary statistics of the full, family, and nonfamily firms’sample. For the comparison of family and nonfamily firms, we find that: 1) The mean value of both dividend proxies is much higher for nonfamily firms. Thus, family firms pay fewer dividends in Pakistan. 2) The mean value of profitability (ROA) is much higher for family firms. 3) The market-to-book value of equity is higher for nonfamily firms, which, thus, have higher growth opportunities. 4) The leverage and tangibility of family Table 2 Summary Statistics DIV/TA DIV/E SIZE ROA M/B LEV TANG TURN Panel A: Summary statistics for the full sample Mean 0.073 0.034 15.563 9.665 19.017 0.136 0.476 0.001 Median 0.012 0.006 15.559 6.380 8.447 0.077 0.474 0.000 Maximum 3.807 1.964 19.666 266.050 151.024 1.073 0.973 0.027 Minimum −0.070 0.000 8.536 −46.730 −146.26 0.000 0.001 0.000 Std. Dev. 0.229 0.099 1.744 18.173 94.917 0.168 0.228 0.002 Obs. 824 824 824 824 824 824 824 824 Panel B: Summary statistics for the family firm’s sample Mean 0.013 0.028 14.907 6.712 6.087 0.151 0.514 0.000 Median 0.000 0.000 14.852 4.260 5.234 0.102 0.516 0.000 Maximum 0.484 1.641 17.852 266.050 98.113 0.988 0.965 0.002 Minimum 0.000 −0.070 8.536 −46.730 −653.01 0.000 0.007 0.000 Std. Dev. 0.033 0.097 1.469 18.248 41.716 0.150 0.195 0.000 Obs. 432 432 432 432 432 432 432 432 Panel C: Summary statistics for the non-family firm’s sample Mean 0.057 0.124 16.284 12.913 33.240 0.120 0.434 0.001 Median 0.020 0.051 16.576 10.760 14.964 0.037 0.412 0.000 Maximum 1.964 3.807 19.666 63.720 1501.020 1.073 0.973 0.027 Minimum 0.000 0.000 11.372 −40.910 −1456.26 0.000 0.001 0.000 Std. Dev. 0.136 0.308 1.739 17.547 129.007 0.185 0.253 0.003 Obs. 392 392 392 392 392 392 392 392 Note: DIV/TA denotes to Dividends/Total Assets; DIV/E denotes to Dividends/Total Equity; ROA denotes to Return on Assets; M/B denotes to market-to-book value of equity; Lev denotes to leverage; Tang denotes to tangibility; and Turn denotes to Turnover Yousaf et al. Financial Innovation (2019) 5:42 Page 7 of 13 firms are higher. 4) Finally, the standard deviation of the family firm’s dividends is lesser. The correlation matrix of different variables in Table 3shows that leverage negatively correlates with dividends, profitability, M/Bratio, and turnover. Tangibility also negatively correlates with dividends, profitability, and M/Bratio. However, there is a positive relationship between dividends and profitability. This result is particularly consistent with the residual cash flows theory. Dividends are also positively correlated with firm size because larger firms have easier access to capital markets at a lower cost when financing needs arise. Hence, such firms can afford to pay higher dividends, whereas smaller firms cannot (Chang and Rhee, 1990). Mean difference univariate analysis Table 4reports the results of the mean difference univariate analysis. We find that the difference between the dividends of family and nonfamily firms is statistically significant at the 1% level. Thus, family firms pay significantly smaller amounts of dividends. These results are consistent with the findings of De Cesari (2009), who states that this strategy allows family firms to preserve cash flow for expropriating the wealth of minority shareholders. Further, such firms, unlike nonfamily firms, often use their resources for own benefits (Villalonga and Amit, 2006). The size, profitability, M/B, leverage, and tangibility of family and nonfamily firms significantly differ. Thus, the characteristics of family firms are different from nonfamily firms in Pakistan. Tables 5and 6report the regression results for the effect of family control on the dividend policy. “Dividends/total equity”is the first proxy of the dividend policy; it is a dependent variable in Table 5.“Dividends/total assets”is the proxy of the dividend policy; it is a dependent variable in Table 6. We find that family ownership negatively affects both proxies of the dividend policy. This coefficient shows that family firms in Pakistan pay lower dividends to shareholders, which is consistent with the findings of Villalonga and Amit, 2006), Hu et al. (2007), and De Cesari (2009). That is, family firms use funds for own benefits and Table 3 Correlation Matrix DIV/TA DIV/E SIZE ROA M/B LEV TANG TURN DIV/TA 1 DIV/E 0.867*** 1 SIZE 0.055 0.056 1 ROA 0.303*** 0.266*** −0.014 1 M/B 0.125*** 0.179*** −0.003 0.141*** 1 LEV −0.135*** −0.096*** 0.127*** −0.324*** −0.108*** 1 TANG −0.079** −0.090*** 0.159*** −0.248*** −0.080** 0.568*** 1 TURN 0.188*** 0.127*** 0.361*** 0.296*** 0.064* −0.052 −0.020 1 Note: DIV/TA denotes to Dividends/Total Assets; DIV/E denotes to Dividends/Total Equity; ROA denotes to Return on Assets; M/B denotes to market-to-book value of equity; Lev denotes to leverage; Tang denotes to tangibility; and Turn denotes to Turnover * Significance at the 10% level ** Significance at the 5% level *** Significance at the 1% level Yousaf et al. Financial Innovation (2019) 5:42 Page 8 of 13