Dividend Policy In Regulated Firms.pdf

We study the impact of different regulatory and ownership regimes on the dividend policy of regulated firms. Using a panel of 106 publicly traded European electric utilities in the period 1986-2010, we link payout and smoothing decisions to the implementation of different regulatory mechanisms (cost plus vs. incentive regulation) and to firm ownership (state vs. private). After controlling for the potential endogeneity of the regulatory mechanism, our results show that utilities subject to incentive regulation smooth their dividends less than firms subject to cost-based regulation and present higher impact effects and target payout ratios. This suggests that when managers are more sensitive to competition-like efficiency pressures following the adoption of incentive regulation, they adopt a dividend policy more responsive to earnings variability and more consistent with optimal cash management. However, these results apply only to private utilities. If the state still has ultimate control, smoothing of dividends remains irrespective of the regulatory mechanism. It seems that corporate governance (i.e. state control) trumps regulation when it comes to dividend payout policy.

The neoclassical view of Miller and Modigliani (1961) suggests that dividends do not matter, and dividend smoothing is suspect as it is costly. However, Lintner (1956) noticed that managers are concerned with the stability of dividends, and this observation has been explained by various theories including risk aversion, lack of investment opportunities, signalling theories, and agency cost explanations. Agency theory predicts substantial and stable dividends, while Fudenberg and Tirole (1995) explain income and dividend smoothing based on incumbency rents. La Porta et al. (2000) conjecture that minority shareholders press corporate insiders to pay dividends.

Consistent with an agency cost explanation of dividend smoothing, Gugler (2003) finds that target dividend levels, the smoothing of dividends, and the reluctance to cut dividends depend on the identity of the (ultimately) controlling owner. State-controlled firms engage in dividend smoothing and have the highest target payout ratios, while family-controlled firms do not smooth dividends. Michaely and Roberts (2012) find that privately owned firms smooth dividends and payout less than their publicly listed counterparts.

In this paper, we conjecture that regulation also plays a role in shaping firm dividend policy. We compare the dividend policy of firms that are partly owned by the state and subject to regulation with firms that are fully private and subject to regulation. These firms are key for national economies in terms of aggregate investment and market capitalisation, and they are remarkable because of their generous dividend payments. Our results show that utilities subject to incentive regulation smooth their dividends less than firms subject to cost-based regulation and present higher impact effects and target payout ratios. However, these results apply only to private utilities. If the state still has ultimate control, smoothing of dividends remains irrespective of the regulatory mechanism.