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Asian Review of Financial Research Vol.22 No.3 pp.35-72
The Effect of Ownership Structure on Payout Policy
Young Kyung Ko Ph.D. candidate, Business School, Korea University
Sung Wook Joh* Associate Professor, College of Business Administration, Seoul National University
Key Words : Share Repurchase,Cash Dividends,Payout Policy,Ownership Structure


In this paper, we investigate how the ownership structure of a firm is related to its corporate policy on payouts. Previous literature has identified several goals that may guide firms' payout policies such as signaling firm value or lowering agency costs. Some of these studies argue that firms may distribute their cash or engage in share repurchase programs in order to send a signal to the market that either they are undervalued or their future value will be higher. Other researches claim that firms might lower their agency costs by adopting a payout policy to lower free cash flows. The focus of our study is to investigate whether the ownership and the control rights of controlling shareholders are linked to corporate payout decisions. It has been widely recognized that there can be a discrepancy between the ownership rights (also known as cash flow rights) and the control rights of controlling shareholders. In the case of Korea, ownership by affiliated firms can contribute to such differences. Many Korean firms have subsidiaries that are interconnected through interlocking ownership and internal capital markets. Considering the corporate ownership structure, we measure control rights through all the cash flow rights of controlling shareholders and the voting rights of all subsidiaries. Thus, the control rights include all the shares under the influence of the controlling shareholders. First, we examine payout policies for all publicly traded firms in the Korean Stock Exchange between 1998 and 2005. For share repurchases, we collected information on corporate decisions to engage in open market share repurchases as well as to allocate resources to trust funds that specialize in treasury stocks. Since all publicly traded firms are required to disclose their decisions on share repurchases, we collect information on the announcement dates, the amounts, and the methods of share repurchases. In addition, for corporate decisions to distribute cash to shareholders, we use the annual information of cash dividends reported in their financial statements. We empirically test the determinants and effects of payout policy using the announcement information and the financial data of publicly traded firms. Based on empirical results from previous studies, we have controlled for other explanatory factors such as firm size, capital structure, volatility, market to book ratio, cash holding, free cash flow, and chaebol dummy. In addition to these explanatory factors, we also examine how ownership and control rights affect payout decisions. Overall empirical results in this paper can be summarized in three parts. First, we find that firms of which controlling shareholders have greater ownership and control rights are more likely to choose to pay cash dividends to their shareholders controlling for other factors. In contrast, firms with lower ownership and control rights are more likely to adopt share repurchase programs. These results are strong and statistically significant. Thus, our findings support the hypothesis that ownership structure affects corporate decisions to adopt payout policy. Second, we test whether firms with weak ownership rights are engaged in larger scale share repurchase programs. Specifically, we examine factors affecting the number of shares that a firm buys back or the proportion of firm resources allocated buying back shares. After controlling for the aforementioned explanatory factors, we find that firms with weaker ownership and control rights are more likely to both buy more shares and spend proportionately more resources, compared to firms with stronger ownership and control rights. Third, we examine the effects of payout policy on firm value. In particular, we investigate how announcements by firms to buy shares affect their stock returns. Under the efficient market hypothesis, investor decisions in the market are believed to reflect all information available in stock prices. Thus, the changes in stock prices reflect how the market evaluates the payout decisions of firms. We find that stock prices decline after the announcement of share repurchases by firms whose controlling shareholders have weaker ownership. This result is different from the positive stock returns shown in many earlier studies of share repurchases that did not examine ownership structure. Our result suggests that investors in the market perceive a negative consequence of share repurchases by firms with weak ownership structure and consequently, firm value declines. Taking into account all the results in this study, we conclude that a firm's payout policy depends on ownership structure. Moreover, firms with weak ownership structures tend to adopt share repurchase programs at the cost of other shareholders.
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