Why are firms with entrenched managers more likely to pay dividends?

Abstract

Purpose – The purpose of this paper is to examine the relation between managerial entrenchment and dividend policy for a large number of US industrial firms and examine the relative importance of three competing explanations behind the empirical association between managerial entrenchment and dividend policy, namely, the entrenchment irrelevance hypothesis, the dividend signaling hypothesis, and the optimal entrenchment hypothesis. Design/methodology/approach – Utilizing all firms in the Investor Responsibility Research Center database, Compustat and center for research in security prices (CRSP), this paper investigates firm's propensity to pay dividends based on various logit and Tobit regressions as a function of managerial entrenchment measured by Gompers et al. G index after controlling for known determinants of firms' dividend decisions during the period from 1990 to 2003. Findings – Results show that firms with entrenched managers are more likely to pay dividends. Their high propensity to pay persists over time. A large cash reserve can be used to deter hostile takeovers. Paying dividends reduces cash holdings, leaving the firm more vulnerable to hostile takeovers. In equilibrium, value-maximizing firms with weak investment opportunities provide managers against takeovers to induce them to distribute cash rather than build a warchest against unwanted takeovers. Originality/value – The main finding confirms the belief that firms choose a combination of anti-takeover provisions and dividend policy to maximize shareholder value, evidence in favor of the optimal entrenchment hypothesis.