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Managerial Entrenchment Hypothesis and

Dividend Payout Policy

Raheel Gohar Assistant Professor

National University of Sciences and Technology (NUST) NUST Business School, H-12 Sector,

Islamabad, Pakistan. raheel@nbs.edu.pk. Tel: +92-334-5062345

Ayesha Rashid Lone National University of Sciences and Technology (NUST)

NUST Business School H-12 Sector, Islamabad, Pakistan.

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ABSTRACT

The influence of managerial entrenchment on dividend payout policy is studied for the

period 2006 to 2010. The results of the study indicate that the ratio of sum of shares

owned by the CEO, Chairman and the directors (i.e. insider ownership) is negatively

related to both likelihood and payment of dividend. Even when controlling for firm size

and leverage it is found that the ratio of shares owned by the block holder shows a

negative and significant results (for both the logit and tobit regression). This study proves

the idea that either the block holders are part of the management or they have strong

board representation so they do not consider dividend payout as a disciplining and

monitoring mechanism. Investment opportunities and leverage showed a negative and

significant relationship with both the likelihood and the level of payout.

Keywords: Managerial entrenchment, dividend payout policy, logit and tobit regression,

Pakistan.

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1. INTRODUCTION

In Pakistan families or closed groups run most of the companies and usually they own

more than 50% of the companys paid up share capital. As they are the controlling groups

so they do not care much about the interests of the minority shareholders and other

stakeholders. Their main interest is to have a cordial board that does not cause any

trouble to them. According to a survey conducted by Pakistan Institute of Corporate

Governance (PICG) in 2007, different people have different understanding of what

Corporate Governance (CG) is? It is thought that just compliance is Corporate

Governance, which is wrong. Not many companies are adhering to the Code of Corporate

Governance. Mostly the companies are just following box-ticking approach. For them

the Code of Corporate Governance is just a compulsion, they dont understand its

importance and significance. Hence there is lack of awareness in Pakistan for Corporate

Governance, which results in the entrenchment of managers in most of the companies.

An entrenched manager is the one that has little concern about his being dismissed from

the firm. Managerial Entrenchment hypothesis is defined as the ability of management to

insulate themselves from the reactions of shareholders and other stakeholders in response

to their actions.The entrenched managers (strong managers) as compared to the non-

entrenched (weak managers) feel less need of paying dividends as a disciplinary

mechanism. Because of their value maximizing behavior they are more likely to use the

retained earnings for the investment purposes rather than using it to pay dividends.

Whereas in the presence of good CG and external monitoring by the block holders the

weak mangers are more likely to make a payout decision as compared to the strong type

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of managers. The entrenchment agenda has also proved that the level of payout is higher

for the weak managerial types.

The present study aims to find out the relationship between the managerial entrenchment

and the likelihood and the level of dividend payout. Dividend policy refers to the policy

that a firm adopts regarding the amount of profit that it intends to give to its stockholders

in the form of dividends. When a firm makes profits the main question that it faces is

what to do with that profit? In this regard the firm has two choices either to give the profit

as dividends or to use it as an investment in some project with positive NPV. Dividend

policy is the main component of the firms overall financial policy because it determines

whether to distribute the earnings among the shareholders or to use the retained earnings

for investment purposes. Hence dividend policy forms the basis upon which the other

theories of finance, such as asset pricing, capital structure and capital budgeting rely

(Allen and Michaelay, 1997).

In most countries the payment of dividend is considered to be very important. If the firms

are not able to pay dividends themselves then they are even forced to pay through

external financing (debt). This is not the case in Pakistan; here the payment of dividend is

directly related to the availability of surplus funds and the external finances are not

related with the firms decision to pay dividends (Mehar, 2002). In Pakistan the payment

of dividend is highly correlated with the type of governance and ownership structure.

Many previous studies have used different indexes (G-Index, E-Index) as a proxy for

managerial entrenchment. In this study the managerial entrenchment level is measured by

following four characteristics: CEOs power over the internal governance mechanism,

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investment opportunities, the CEOs incentive compensation and monitoring by large

external shareholders (Hu and Kumar 2004).

Most of the studies done for Pakistan are related to the determinants of dividend policy

and the effect of overall corporate governance on the payout ratio. The present study is

the first attempt up to the authors knowledge to analyze the effect of managerial

entrenchment on both the likelihood of dividend payout and the level of payout

separately. Logit regression is used to study the impact of managerial entrenchment on

the likelihood of dividend payout and Tobit regression is used to study the impact of

managerial entrenchment on the magnitude of payout.

Results of both logit and tobit regressions are almost same and as predicted by the

entrenchment framework. The variables of percentage of shares owned by the CEO,

percentage of shares owned by the Chairman and the percentage of shares owned by the

other directors has not shown any significant results, whereas the variable of total

ownership has a negative and significant impact on both likelihood and the level of

payout. Hence it is concluded that when considering the likelihood or level of dividend

payout it is the total insider ownership that matters. The greater the percentage of equity

ownership by the CEO, Chairman and the directors collectively the lesser is the chance of

a dividend payout and the level of payout.

It is verified that if there are many investment opportunities in the market then the

managers prefer to use the earnings for the investment purposes rather than making a

dividend payout decision. Management has more chances of investing in projects of their

own interests whether they are positive NPV projects or the negative ones. Block holder

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that was used to measure the monitoring by large external shareholders has shown a

negative and significant relationship with both the likelihood and the level of payout.

Most of the companies are family-owned or are owned by groups in Pakistan. Hence we

can say that the dividends are less valuable for the block holders in this country. So we

cannot consider the block holders as a separate monitoring agent for the management

(McConnell and Servaes, 1990).

2. LITERATURE SURVEY

This section provides a brief overview of the researches that have been done on the issue

of managerial entrenchment and the payout policy.

2.1: Review of Existing Literature:

In 1976 two economists Jensen and Meckling pointed out the prospective for significant

agency costs when the ownership and control of a firm are separate. They also proved

that larger managerial equity ownership helps to line up the interest of management and

other shareholders. As the decisions made by the managers affect their wealth too, hence

they try to make decisions keeping in mind the interests of shareholders.

Stulz in 1988 developed a model in which the market value of the firm first increases

then decreases as managerial equity ownership becomes more concentrated. This results

in a curvilinear relationship between the value of the firm and the fraction of shares

owned by the management.

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Morck, Shleifer, and Vishney (1988) suggest that naturally managers try to assign the

firms resources in their own best interest but as the equity ownership of managers in a

firm increases their interests start to correspond with those of outside stakeholders.

According to Leland and Pyle (1977) the percentage of equity under managerial

ownership serves as information for outsiders, which tells them about managers personal

valuation of the firm and his stake/interest in the firm.

Fluck (1999) suggested that the entrenched managers choose the allocation of equity

ownership so as to maximize personal benefits in opposition to the threat of possible take

over/control challenges.

Dividend is considered a disciplinary instrument. By plum meting the amount of free

cash flows by paying dividend, the managers are compelled to surrender to the discipline

of the financial markets (Deventer and Warther, 1998). The payment of dividends helps

in constraining managers from using profits in non-productive projects or for their

personal interests.

Farinha and Foronda (2005) provide an insight about the role of dividend policy as a

disciplining mechanism in countries with different legal systems and distinct agency

problems. Their sample was comprised of the firms from the countries dominated in

Anglo-Saxon tradition and compared it with the firms of the countries that have Civil

Law Legal Systems.

La Porta et al (1999) explained models for the relationship of the dividend policy and the

agency problems. First one is the outcome model which states that the dividend is the

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result of good corporate governance mechanisms. It is because of the effectiveness of

governance that the Shareholders are able to pressurize the managers to hand out the

earnings to the shareholders in the form of dividends. The second model is the substitute

model which states that the firms practicing poor corporate governance mechanisms pay

dividends in order to convince the shareholders that their rights will be protected and in

order to establish a good reputation in the market so that in future if needed it would be

easy to raise the capital from the market.

Fama and French (2001) proved that the apparent benefits of dividends have declined

with time. One of the possibilities can be better corporate governance that has lowered

the benefit of dividend in controlling the agency problems between the managers and the

shareholders.

McConnell and Servaes (1990) found a significant curvilinear relation between tobins Q

and the fraction of common stock owned by the management. Jorge Farinha (2002) also

observed a significant U-shaped relationship between dividend payout ratios and insider

ownership for a large (exceeding 600 firms) sample of UK companies.

Gugler and Yurtoglu (2002) proved that dividends signal the severity of the conflict

between the large controlling owner (management) and small outside shareholders

(minority shareholders). Large shareholders have the ability to expropriate the minority

shareholders and then pull out the rents. An increase in dividends reduces the funds held

by the management and it increases the market value of the firm, whereas a decrease in

dividends results in exploitation of the minority shareholders rights.

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Once a firm starts to pay dividends, managers are extremely reluctant to cut back or stop

paying dividends so the entrenchment of management is irrelevant to dividend policy. It

is commonly reported that if a firm is already paying dividends, the level of managerial

entrenchment does not have any significant impact the dividend policy (Lintner, 1956,

Allen and Michaely, 2003).

Harada and Nguyen (2011) suggested that the firms with concentrated insider ownership

of equity are more reluctant to increase the dividends as the earnings of the firm increase

or the debt decrease.

Jiraporn and Chintrakarn (2009) suggested that firms with staggered boards pay larger

dividends. Dividends help to lessen the conflicts between the management and the other

shareholders. Firms with entrenched managers rely more on dividends in order to

alleviate the agency costs.

Hu and Kumar (2004) find that both the likelihood and the level of payouts are

significantly and positively (negatively) related to factors that increase (decrease)

executive entrenchment levels, even when controlling for size, leverage and proportion of

tangible to total assets.

The behavior and the pattern of dividend policy is the most disputed topic in the

corporate finance literature and is getting the attention because of its importance in the

growth and the development of capital markets in both developed and emerging markets.

There is no one rule or definition for the behavior of the firms regarding their dividend

policies (Black, 1976; Allen and Michaely, 2003 and Brealey and Myers 2001).

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One popular pattern is the relation of dividend with the earnings and the growth of the

firm. But researches have proved that the dividend policies not only vary from country to

country but even among the firms of the same country. Pakistan capital market and

economy is still in its development stages. Studies have shown that the firms in Pakistan

are paying stable dividends in the times of growth. But Pakistani firms are plagued by

dominant shareholders and cross holdings and as a result the dominant shareholders have

the power and the right to manipulate the dividend policy of the firm to get maximum

benefits. Thus the problem of agency cost arises because the dominant shareholders are

confiscating the rights of the minority shareholders by influencing the dividend policy of

the firm.

The main problem that Pakistani market is facing is that the payment of the dividends by

the firm is voluntary. In fact, in Pakistan dominant shareholders often disagreed with the

payments of the dividends and consider increase in the prices of the share as the main

element of stock returns therefore, it is understood that investor attitude towards

dividends is expected to have an impact not only on the dividend policy but also on the

dividend pay out ratio in Pakistani firms.

The Tax environment in the country is also affecting the dividend policy adopted by the

firm. Right now no capital gain is charged on the appreciation of stock price but 10% is

charged on the dividend income, which makes the dividends less attractive. This adverse

treatment of dividend income through tax is also affecting the dividend policies adopted

by the firms in Pakistan.

Mehar (2003) found that in Pakistan only 23% of the increase in earnings after tax is

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transformed into dividend while most of the earnings are used for the investment

purposes. And large insider ownership is an important factor in dividend payout policy.

Javed and Iqbal (2010) proved that the firms with more investment opportunities and

larger in size practice good corporate governance practices and these type of firms are in

more need of external financing. As the investment opportunities increase the percentage

of insider ownership also increases but this ownership concentration is gradually diluted

as the size of the company increases. The results also show that the practice of good

corporate governance is important in Pakistan.According to Afza (2010) Managerial

ownership, individual ownership, operating cash flow and size are the most significant

determinants of dividend behavior.

Chaudary, Goergen and Syed (2006) did a survey of Pakistani banks. They report that

many major steps are taken in Pakistan in order to improve the corporate governance

practices in the firms but considering the importance of good governance in the growth of

the economy, a lot more needs to be done.

3. DATA AND MATHODOLOGY

3.1: Measurement of managerial entrenchment:

Managerial entrenchment is defined as the power possessed by managers. The managers

who are more powerful are known as entrenched managers. In order to measure

managerial entrenchment one has to include all the variables directly or indirectly related

to power of managers.

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Many previous studies have used G-Index as a proxy for managerial entrenchment. G-

Index was developed by Gompers, Ishii, and Metrick (2003). The data is obtained from

the Investor Responsibility Research Center (IRRC) and it consists of 24 Anti-takeover

provisions that Gompers et al. (2003) have used in the construction of the index. The

value of G-Index ranges from 0-24 and a higher value of indexindicate stronger

managerial power. The G-Index is available from 1990 onwards and is usually revised

after every 2 to 3 years. One of the limitations of using this index is that it limits the

analysis to only large firms.

Another index used in the previous studies as an alternative measure of entrenchment is

Entrenchment Index (the E Index) developed by Bebchuk, Cohen, and Ferrell (2009).

The difference between G-Index and E-Index is that in the later only 6 Anti-takeover

provisions are used out of the 24 used in the G-Index. E-Index ranges from 0-6 with a

higher value signifying stronger managerial power.

The present study is following the study of ( Hu and Kumar 2004). Instead of using any

index as a proxy for the managerial entrenchment they have measured the managerial

entrenchment level by four characteristics i.e. CEOs power over the internal governance

mechanism, investment opportunities, the CEOs incentive compensation and monitoring

by large external shareholders.

3.2: Hypothesis

Many previous studies have proved that the dividend payout decision made by the

managers is divided into two steps. In the first step they decide whether they should pay

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or not i.e. the likelihood of dividend payout. In the second step the quantity of payout is

decided (Kumar and Lee 2001).

H1: Strong managers (Entrenched managers) are less likely to make a dividend payout as

compared to the Weak managers, Ceteris paribus.

H2: Strong managers (Entrenched managers) opt for the lower magnitude of payouts as

compared to the weak managers, Ceteris paribus.

3.3: Framework of Study

Managerial Entrenchment

CEOs Power over internal Gov

mechanism

Investment Opportunities

CEOs incentive compensation

Monitoring by Block holder

Dividend Payout Policy

Likelihood of dividend payout

(Logit Regression)

Level of dividend payout

(Tobit Regression)

Corporate Governance

(The Code of Corporate

Governance)

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3.4: Data

In Pakistan SECP issued a code of corporate governance in 2002, which was

subsequently revised in 2005 that is why our study period is 2006 onwards. Focus of this

study is the companies listed in KSE-100 index list of 2006. In the beginning our data set

consisted of all non-financial firms listed in the list of KSE-100 index i.e. equal to 71

firms but due to the limitation of non-availability of data, the final data set consist of 38

companies for period of five years from 2006 to 2010.

The data is mostly collected from the annual reports of the companies. The annual reports

are downloaded from the companys websites. The 5 years stock prices of the firms are

collected from the database of Business Recorder.

3.5: Methodology

3.5.1: Description of Variables

Following Hu and Kumar (2004), the managerial entrenchment level is measured by

following four characteristics: CEOs power over the internal governance mechanism,

investment opportunities, the CEOs incentive compensation and monitoring by large

external shareholders.

3.5.1: Dependent Variable

The effect of managerial entrenchment on the likelihood of payout is measured by the

logit regression. In this case the dependent variable i.e. the likelihood of payout is a

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dichotomous variable which equals 1 if the dividend is paid in a given year and zero

otherwise.

The effect of managerial entrenchment on the level of payout is measured by the tobit

regression. In this case the dependent variable is dividend yield (D/P) which is calculated

as the amount of ordinary cash dividend (D) paid at the end of year t divided by the year

end closing share price (P).

3.5.2: Independent Variables

Here is the detailed description of how the independent variables are constructed.

CEO compensation

Sal_bon (+) is the compensation variable, which is calculated as the Log (1+value of cash

salary and bonus given to a CEO in a certain year). It is predicted that this variable has a

positive impact on the dividend payout.

Insider Ownership

The larger managerial equity ownership helps to line up the interest of management and

other shareholders (Jensen and Meckling, 1976; Morck, Shleifer, and Vishney, 1988). To

study the effect of insider ownership on payout, three separate ownership ratios are

calculated for CEO, Chairman and other directors. All three ratios are predicted to have a

negative relationship with the payout.

CEO ownership Ratio (-) is the ratio of ordinary shares owned by a CEO to total

number of common shares for a sample firm at the end of a given year.

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Chairman ownership Ratio (-) is the ratio of ordinary shares owned by a Chairman to

total number of common shares for a sample firm at the end of a given year.

Director ownership Ratio (-) is the ratio of sum of ordinary shares owned by all the

directors (except CEO and the Chairman) to total number of common shares for a sample

firm at the end of a given year.

As most of the companies are family owned in Pakistan hence here it is necessary to

study the effect of the sum of shares owned by CEO, Chairman and directors. A dummy

variable Total large ownership (-) is included that equals 1 if the percentage of shares

owned by the directors (including CEO and Chairman) is more than 1% of the total

common shares of a firm in a given year.

CEO/Chairman (-)

Many previous studies have proved that if the CEO and Chairman in a firm are same than

one person cannot perform the duty of two efficiently hence it effect the performance of

the company. A dummy Variable CEO/Chairman is included that equals 1 if the CEO

and the Chairman are same and zero otherwise.

Block holder (-)

In Pakistan families or groups run most of the companies. So there isnt any major

agency conflict between the management and the shareholders as they are the same. In

this case dividends are less valuable for the shareholders and the managers. The

management and owners are more likely to cut dividends when necessary. Unlike

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developed countries, in Pakistan the percentage of shares owned by the block holder has

a negative impact on payout.

This variable is defined as the ratio of shares owned by the largest block holder to total

number of common shares for a sample firm at the end of a given year. Block holder is

the one who owns more than or equal to 10% of common shares of a firm.

3.5.3: Control Variables

The control variables used in the regression are as follows.

Investment Opportunities (-) The more the availability of investment opportunities for a firm then it is less likely for

the firm to use its earnings to pay dividends. The firms with good investment

opportunities pay significantly less dividends. (Fama and French 2001). Investment

opportunity is calculated by dividing firms Market value of assets to book value of firm's

assets. The market value of firms assets is calculated by adding the book value of

liabilities and market value of equity.

Firm Size (+)

The greater the size of the firm it is more likely to make a dividend payout. Large size

firms pay more dividends. Firm size is calculated by taking Log of (1+market value of

assets).

Leverage (-)

Leverage and dividend payout have an inverse relationship. If a firm has more debts then

it is more likely for a firm to use its earnings to make debt payments instead of paying it

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as dividend. It is calculated by this formula (Debt/ (Debt + Equity)). For the calculation

the book value of debt and the market value of equity are used.

4. RESULTS AND DISCUSSION

4.1: Descriptive Statistics

Table 1 reports the descriptive statistics for the main variables.

Table 1: Descriptive statistics of variables

Variables N Mean Median Std.Dev Min Max

Sal/Bon 184 6.9 6.96 0.56 4.06 4.06

CEO Own 179 1.55 0 4.2 0 20.38

Chair Own 174 2.23 0 6.01 0 41.19

Dir Own 179 3.12 0.01 9.34 0 51.35

Block holder 185 46.51 40 27.75 0 95.02

Invest 186 1.53 1.18 1.02 0.34 6.32

Firm Size 187 10.36 10.42 0.56 8.44 11.91

Leverage 186 0.44 0.4 0.25 0.04 0.97

As shown in table 1 the ratio of shares owned by the chairman is greater than the ratio of

shares owned by the CEO in a good number of companies. The mean of the shares owned

by directors is 3.12%, the mean of shares owned by chairman is 2.23% and the mean of

shares owned by the CEO is 1.55% in sample firms.

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The mean of ratio of shares owned by the largest block holder is 46.51% that is very

high. The main reason for this high percentage is that majority of the companies are

family owned or owned by groups, who control a large number of common shares.

4.2: Correlation Table 2 represents the correlation amongst all main variables.

All three ownership ratios i.e. CEO, Chairman and directors share ownership show

positive and significant correlation with each other and leverage, and a negative

correlation with the block holder, investment opportunities, firm size and sal_bon (Table

2).

The ratio of shares owned by the Block holder has a negative correlation with all the

insider ownership variables (CEO, chairman, and directors) and leverage, and a positive

correlation with investment opportunities and firm size.

Investment opportunities and size are significantly and positively correlated to the firm

size, where as leverage is negatively correlated to both Investment opportunity and size

of firm.

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Table 2: Correlation Matrix

4.3: Results

In this section logit and tobit regression results for the relationship of managerial

entrenchment and dividend payout are presented.

4.3.1: Results of logit regression

This study has estimated logit regression for each year t of the 2006-2010 periods. The

dependent variable (the likelihood of making a payout) is 1 in year t if the firm pays

dividend and zero otherwise. Table 3 reports the results of the likelihood of dividend

payout. As predicted the results show that managerial type significant effect on the

decision of payment of dividend.

SAL_BON C_OWN D_OWN CH_OWN TOT_OWN BLOCK INVEST FIRMSIZE LEVER

SAL_BON 1.000 -0.305 -0.271 -0.140 -0.215 0.154 0.216 0.377 -0.110

C_OWN -0.305 1.000 0.762 0.179 0.373 -0.339 -0.062 -0.311 0.156

D_OWN -0.271 0.762 1.000 0.086 0.335 -0.393 -0.048 -0.206 0.124

CH_OWN -0.140 0.179 0.086 1.000 0.412 -0.417 -0.155 -0.283 0.005

TOT_OWN -0.215 0.373 0.335 0.412 1.000 -0.524 -0.158 -0.338 0.191

BLOCK 0.154 -0.339 -0.393 -0.417 -0.524 1.000 0.229 0.305 -0.107

INVEST 0.216 -0.062 -0.048 -0.155 -0.158 0.229 1.000 0.387 -0.569

FIRMSIZE 0.377 -0.311 -0.206 -0.283 -0.338 0.305 0.387 1.000 -0.238

LEVER -0.110 0.156 0.124 0.005 0.191 -0.107 -0.569 -0.238 1.000

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The variable sal_bon (log of salary and bonus) that is based on CEOs compensation has

a positive (b= 3.98) and significant (p=0.05) impact on the likelihood of payout as

predicted.

All the variables related to insider ownership were predicted to have a negative impact on

the payout decision. The Chairman ownership (b = -0.081) and Director ownership (b = -

0.069) shows negative coefficients as predicted but the results are not significant. Total

ownership is the only ownership variable that shows a negative (b = -3.878) and

significant (p = 0.042) result. So greater the percentage of insider equity ownership the

less likely it is for the management to make a payout decision.

The ratio of shares owned by the block holder shows a negative (b= -0.092) and

significant (p = 0.002) results which proves the idea that if the Block holders are part of

the management or they have strong board representation then they dont consider

dividend payout as a disciplining and monitoring mechanism.

As expected Investment opportunity shows a negative (b = -1.383) and significant (p =

0.02) results. So more the investment opportunities for a firm the less likely it is to use its

earnings to pay dividends.

Firm size shows a positive coefficient (b = 0.97) as predicted but the results are not

significant. Leverage has a significantly (p = 0.00) negative (b = - 11.092) impact on the

likelihood of payout. As greater debt ratio decrease the firms liquidity and limits the

dividend payments to the shareholders.

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Table 3: Results of Logit Regression

Variable

Predicted

Sign Coefficient Std. Error z-Statistic Prob.

C - -17.584 12.743 -1.380 0.168

SAL_BON Positive 3.98** 2.031 1.960 0.050

CEO OWN Negative 0.087 0.224 0.391 0.696

CHAIR OWN Negative -0.081 0.069 -1.180 0.238

DIR OWN Negative -0.069 0.093 -0.737 0.461

TOTAL OWN Negative -3.878** 1.911 -2.029 0.042

BLOCKHOLDER Negative -0.092* 0.030 -3.039 0.002

INVEST Negative -1.383** 0.594 -2.327 0.020

FIRM SIZE Positive 0.97 1.220 0.795 0.427

LEVERAGE Negative -11.092* 3.181 -3.487 0.000

Table 3 presents the results of the logit regression for the likelihood of dividend payments. The dependent variable is equal to 1 if a firm pays dividend in a given year t and 0 otherwise. The positive (negative) coefficient sign indicates that the variable is positively associated to the likelihood of dividend payout. The * indicates significance of t-stat at 1%, ** at 5% and *** at 10%.

4.3.2: Results of tobit regression

The tobit regression is used for analyzing censored regression problems. In this type of

regression the zero values of the dependent variable correspond to the censored

observations whereas the positive values correspond to actual transactions.

Table 4 reports the results of the level of dividend payout. As predicted the results show

that managerial type significantly effect on the level dividend payout.

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Table 4: Results of Tobit Regression

Variable

Predicted

Sign Coefficient Std. Error z-Statistic Prob.

C - -0.267* 0.097 -2.763 0.006

SAL_BON Positive 0.034* 0.008 4.038 0.000

CEO OWN Negative 0.001 0.002 0.387 0.699

CHAIR OWN Negative -0.0003 0.001 -0.497 0.619

DIR OWN Negative -0.001 0.001 -0.961 0.336

TOTAL OWN Negative -0.03* 0.010 -2.900 0.004

BLOCKHOLDER Negative -0.0003** 0.000 -2.189 0.029

INVEST Negative -0.014* 0.004 -3.207 0.001

FIRM SIZE Positive 0.02** 0.008 2.511 0.012

LEVERAGE Negative -0.069* 0.018 -3.884 0.000

Table 4 presents the results of the tobit regression for the magnitude of dividend payouts. The dependent variable is cash dividend yield in year t and for non-paying firms the yield is set to zero. The positive (negative) coefficient sign indicates that the variable is positively associated to the level of dividend payout. The * indicates significance of t-stat at 1%, ** at 5% and *** at 10%.

The results of tobit regression are almost same as predicted by the logit regression.

Sal_bon has a positive (b = 0.034) and significant impact on the magnitude of payout.

Chairman ownership and director ownership shows a negative impact on the level of

payout but as shown in the logit regression the results are not significant. Total ownership

has a negative (-0.03) and significant (0.004) impact on the level of payout. Hence

greater the percentage of insider ownership the less likely it is to make payout decisions

and the magnitude of payout is also less.

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As shown in table 4 the ratio of shares owned by the block holder has a negative (-

0.0003) and significant (0.029) relationship with the level of payout. So for block holder

the level of payout is not important. In most of the companies the block holder is a

subsidiary company of the controlling group so the block holder doesnt feel any need of

using dividend payout as a monitoring mechanism.

The greater the investment opportunities for a firm the less is the level of payout. A large

part of the earnings are used in the additional projects so the level of dividend payout is

very low. Tobit regression shows a negative (-0.014) and significant (0.001) relationship

between the investment opportunities and the level of payout.

Firm size showed a positive but insignificant relationship with the likelihood of payout in

the logit regression. In the tobit regression the result is positive (0.02) and significant

(0.012). Hence greater the size of the firm the greater is the magnitude of dividend

payout. Leverage has a negative (-0.069) and significant impact on the level of payout.

5. CONCLUSION

In this study the impact of managerial entrenchment on both the likelihood of dividend

payout and the level of payout is examined with the help of the logit and the tobit

regression. It is evident from the results that both the hypotheses are proved true i.e. the

entrenched managers are less likely to make a dividend payout and opt for lower level of

payouts as compared to the weak managers.

25

Sal_bon (log of salary and bonus) is the variable used to measure the CEOs incentive

compensation in this studyand it showed a positive and significant result. Hence greater

the salary and bonus (compensation ratio) of the executives the more likely is the

payment of dividends (Gaver and Gaver 1993).

It is found that the percentage of shares owned by the chairman is greater than the

percentage of shares owned by the CEO in most of the firms in our sample. The variables

of CEO ownership, Chairmans ownership and directors ownership showed insignificant

results. The variable of total ownership has a negative and significant impact on both

likelihood and the level of payout. Hence it is concluded that when considering the

decision of dividend payout it is the total insider ownership that matters. The greater the

percentage of equity ownership by the CEO, Chairman and the directors the lesser is the

chance of a dividend payout and the level of payout. There is a negative relationship

between the executive stock ownership and the dividend payout (Fenn and Liang 1997).

As predicted, the investment opportunity has shown a negative significant relationship

with both the probability and the level of dividend payout. It is proved that if there are

many investment opportunities in the market then the managers prefer to use the earnings

for the investment purposes rather than making a dividend payout decision. Management

has more chances of investing in projects of their own interests whether they are positive

NPV projects or the negative ones. In the presence of high growth and investment

opportunities firms are reluctant to pay higher dividends their main concern is to utilize

the investment opportunities present in the market on time (Afza and Mirza 2010).

26

Firm size has shown a positive relationship in both the logit and tobit regressions but the

result is significant only in the tobit regression (level of dividend payout), which proves

that the large size firms pay higher dividends (Stacescu 2006).

As expected, leverage has a negative relationship withboth the likelihood and the level of

dividend payouts in Pakistan (Afza and Mirza 2010). The firms that are highly leveraged,

their main priority is to pay the interests on the debt so for these types of firms the

payment of dividend is not a good choice. Highly leveraged firms are less likely to pay

dividends and the amount of dividend paid is also less as compared to the non-leveraged

companies.

Block holder that was used to measure the monitoring by large external shareholders has

shown a negative and significant relationship with both the likelihood and the level of

payout. Most of the companies are family-owned or are owned by groups in Pakistan.

Block holders are usually the subsidiary companies that have other interests in the

company rather than the collection of dividends. Hence we can say that the dividends are

less valuable for the block holders in this case. They are usually directly involved in the

management of the company so they dont need to use dividend as a monitoring or profit

making mechanism. So we cannot consider the block holders as a separate monitoring

agent for the management in this case and the relationship between the block holders and

the dividend payout is negative (McConnell and Servaes, 1990).

27

Limitations of Study

Study period in this study is just five years, which do not provide us with more authentic

results. So period of study should be expanded.

The sample size is small i.e. 38 firms because only the firms listed in the KSE 100 index

list of 2006 was used. In future study the companies listed in 2007 and onwards lists

should also be included.

There are many other important variables that are excluded from the study due to their

unavailability e.g. CEOs service length, CEOs age, Number/Percentage of executive

directors in the board and executive stock options. These variables should be included in

the future studies if available.

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