FOR Prof.Dan only

FOR OFFICE USE ONLY
SCRIPT NO.
LATE DAYS

Leeds University Business School

Assessed Coursework Coversheet

For use with individual assessed work

2

0

0

8

8

1

7

1

4

Student Identification Number:

Module Code: LUBS5018M_______________

Module Title: Accounting and Finance Dissertation _______________________________________

Module Leader: Dr Konstantinos Bozos

Declared Word Count: ___3190______________

Corporate Governance and Dividend Policy

In the Listed Firms of Northern Europe Pre- and Post-crisis

Introduction

My research is aim to study the relationship between corporate governance and dividend policy during emergency period-financial crisis2007-2008 in Northern Europe. The article make an exploitation of the theme on the foundation of other's research accomplishment which studied the Northern Asian within the impacts of 1997 Asian Financial crisis (Sawicki, 2009). The mainly literature is substitutes and outcome models of La Porta et al. (2000). Similar with Sawicki, I predict the pre-and post-crisis have different models indicate the positive or negative relationship between Dividend payout and governance quality. The issue is: When changing into a new research background and the ranges of financial crisis, will the dividends act as substitutes or outcomes of governance mechanisms pre-and post-crisis period. The sample data of firms will be collected from five Northern Europe countries (Iceland, Finland, Norway, Sweden and Denmark) over the period 2004–2013 according to each country’s stock exchanges. Through the “scene reconstruction” of southern Asian research, the new study in Northern Europe and the recent experiences of 2007-2008 financial crisis have valuable meanings for we after 90's" students.

Literature review and research questions

On the sudden financial crisis of 2007-2008, huge ranges of firms collapse and bankrupt swept across the globe. The crisis was caused by an overheating of the world economy, which led, among other things, to the build-up and subsequent burst of several assets bubbles (Marek 2009). A large number of financial institutions have bailed out by governments. For example, Lehman Brothers fail as the beginning of bankruptcy protection from government. The situations relate to the poor corporate governance. The failure of corporate governance became the main cause of such declines of firms which is well established and acknowledged by many observers. Grant Kirkpatrick indicates that the financial crisis can be an important extent attributed to failures and weakness in corporate governance arrangement (Grant, 2009). The role of corporate governance is significance especially when facing the risk management and financial monitoring as well as internal governance. Kashyap also identify the crash of shareholders monitoring as one of the essential reasons for this crisis (Kashyap et al, 2008). The transformation of corporate governance derives from the crisis of public trust due to the information asymmetric and agency problems as well as complicity of broad environment. Claessens and Fan confirm the lack of disclosure and neglect of the rights of minority (Claessens, et al, 2002). Combine with the development of corporate governance, the recent popular theory is multilateral management of corporations which basic on the stakeholders' theory. Freeman and Evan point out the stakeholders of interest should be considered because they have invested specific assets (Freeman, et al, 1990). This reflects the relatively lower protection level of small interest groups.

Since the late 20th century, there were several financial or economic crisis happened worldwide. In the process of this area’s studies, many studies provide evidence of the role in financial crisis. Those evidences make senses when dealing with the future possible crisis in the atmosphere of changing international political and economic patterns. For example, the Asian financial crisis swept southern of Asian. There have some studies basic on the Asian financial crisis. However, 10 years later, a new and deeper financial disaster occurred in worldwide ranges. This situation tell people every studies need to be tested in different periods in order to enrich and extent relevant academic and empirical researches. Johnson et al. (2000) provides a clear explanation for the currency and equity declines by using the measures of governance. Lemmon and Lins find a positive relation between the ratio and value erosion during the crisis, confirming the weakness of minority shareholders to expropriation (Lemmon, et al, 2003).

Dividends are important for corporate governance as Rozeff (1982) constructs dividends as a function of growth, beta and agency costs. Jensen and show an evidence of negative relationship between governance and dividend policy and make sure the payout of dividend is significant. Solberg and Zorn (1992) further confirm the correct of Rozeff’s evidence. The agency problem arising by the information asymmetric and will directly effect on the choices of corporate financial policy. There are many powerful evidences to support this in the theoretical aspect (Black, 1976. Bhattacharya, 1979. Myers & Majluf, 1984). The problem of agency reflects the uncertainty of agency cost. Ownership concentration is used by Rozeff as a proxy of agency cost which justified the difficulties of monitoring and controlling mangers is large for highly dispersed owners. Jensen states that the primary interest of shareholders is to obtain what they deserve by means of dividend payments. The excess cash flow distribute to shareholders could alleviates conflicts between corporate insiders and stockholders if lack of attractive investment opportunities (Jensen, M. 1989). Kose and Knyazeva (2006) find that firms with weak governance pay higher dividends and vice versa (John, 2006).

La Porta (2000) points out the dividends policy can solve the problem of agency. Two models can explain the relationship between governance and dividend payout: In outcome model, minority shareholders use dividends as a result of the effective pressure to force insiders to pay out profits. According to the substitute model, insiders use dividends as a tool to establish a reputation for decent treatment of minority shareholders and thus a negative relationship is expected between governance quality and payout of dividends. .

La Porta raises the question of what determine the minority shareholders’ right and power and then delves in the legal regime. The legal protection can able to make sure the rights of shareholders if the protection is strong. LA Porta et al demonstrates that dividends as an outcomes of legal Protection of shareholders (La Porta, 2000). Protections come from both country-level and firm-level. La Porta just control for governance differences at country level and then leave some spaces of the firm level research. The next will introduce the follow-up study around the specific range of academic study.

The most recent continue study in a particular relationship between dividend and governance quality during the 1997-1998 failing economy has been studied: Sawicki (2009) offer an comprehensive research in analysis the corporate governance and dividend policy during 97-98 Asian financial crisis and he find pre- and post-crisis have different relationship between corporate governance and dividend policy by analyzing the southern Asian firms in ten year period. Moreover, Sawicki illustrate the dividend pay-out as an important tool for governance quality. Sawicki considers both country and firm level which is the extension and development of La Porta.

According to the research orientation of Sawicki, now back to the theme of dividends and corporate governance which practiced in the real world. After the decade since Asian financial crisis 1997, the speed of globalization was extremely fast and finally broke out financial crisis 07-08. The worldwide financial crisis impacted on Europe unquestionably. However the negative influences of crisis was slower and less than the United States because the existing of EU membership and its specific regulations. Basic on this view, the corporate governance acts as a stage of adoption process in order to prevent future financial crisis by setting a range of regulations to enhance shareholders rights (Walter, 2010).

Europe is as an important area which attracts researchers to deal with its achievements and challenges. The crisis showed the issues of corporate governances which require the reformations in order to recovery. The transparency of disclosure and auditing independence contribute to the corporate governance. For such advanced western countries, like Europe firms always have the same theme of corporate governance.

In the field of studies, there are even less empirical researches on the Northern Europe. Northern Europe is famous for their high welfare policy also suffers from the global crisis. The financial crisis 2007-2008 present a new but more valuable opportunity for studying the relationship between dividend and governance quality as solving the problem of agency and their influences.

The article disinterred Sawicki’s research concepts and methods by setting a new framework in the recent crisis with the less studied object-Northern Europe. The attractive of observing the Northern Europe is because firms of North Europe have suffered from economic and bank industry crisis in the 1880's. The continuity of influences never ended until the coming of 2008 global financial crisis. Most noteworthy is as the typical representative of Nordic model underlying the global financial crisis 2007-2008; Norway had a better performance against the disaster. However, Iceland lost heavily and the government applied bankruptcy protection. Such different situations among the five major countries of Northern Europe increases the valuable level of this research (Zhang, 2011).

Overall, the study aim to apply the findings of Sawicki (2004) in a new environment of 2007-2008 global financial crises with and providing important time series evidence of the relationship pre- and post-crisis. I am concerned to justify the findings in southern Europe as new evidence with a new period to illustrate: Pre-crisis relationship is negative between dividends and governance shows that dividends act as a substitute governance tools during the crisis to rebuild the reputation. Post-crisis is positive relationship and shows the dividends are act as an outcomes of governances which crucial to shareholders protections.

Basic on above literature reviews, the hypothesis are as following:

In the substitute model:

H1a: In pre-crisis periods, dividends payout increase as governance becomes stronger.

H1b: In pre-crisis periods, dividends payout increase as governance becomes weaker.

If H1b are correct and reject H1a, the result of testing will prove the dividends act as substitutes if the company lack of governance mechanism (poor governance level) in pre-crisis periods.

In the outcome model:

H2a: In post-crisis periods, dividends payout increase as governance becomes weaker.

H2b: In post-crisis periods, dividends payout increase as governance becomes stronger.

The same method used in the outcome model which showed in following: If the H2b is correct and reject H2a. The negative governance coefficient with dividend increasing will be admitted. The detailed tests are described in the following section.

Methods

Five countries of Northern Europe are represented in this study: Iceland, Finland, Norway, Sweden and Denmark. The countries were exposed to various levels of financial crisis and differ in organizational culture, national conditions and developing features. Except Iceland, the other data from 4 countries have been collected from the top 20 publicity list companies on stock exchanges within each of the countries. (Basic on current stock market) There are 8 firms collect from Iceland because there is only such limited numbers of companies.

Denmark	OMX Copenhagen 20 (C-20)
Finland	OMX Helsinki-25
Norway	OBX-20
Sweden	OMX Stockholm-20
Iceland	OMXI8

Firm selection is basic on the following two criteria:

1: Financial data on dividend pay-out ratio, return-on-investment (ROI), profit, beta, sales, total asset and equity reported in the database.

2: Availability of Annual reports.

The will be 9 Criteria used in estimating the governance index and the criteria capture different aspects of firms: Board of Directors, audit, Remuneration and Nomination. Just use the estimating of governance index model of Sawicki as standard to mark each firm per year. The 9 criteria represented 9 score respectively and question type is “yes or no”. “Yes” represent 1 score and “no” equal to zero. All information is from annual reports and higher core means the better governance.

Descriptive statistics of the data by country classified into pre-crisis (2004–2006), crisis (2007 and 2008) and post-crisis (2009–2013). The score indicate improvements in governance with three different mean by calculating in three periods. Each countries have its average numerical value and then can figure out the performances on improvements (Whether they are slow or not).

The table of Descriptive statistics by country requires the following factors which on the first row:

1. Governance score is calculated on a scale of 0–9. See Table 1 for measurement criteria.

2. Payout ratio = Dividends (Cash)/Net Income − Preferred Dividend.

3. ROI = Return-on-investment = Net Income/ Average Shareholders Equity.

4. Growth=% change in assets.

5. Equity=market value of equity at year end (shares outstanding X share price).

The next table is to compare the average values (means) for payout, ROI (return on investment) and Growth in pre-and post-crisis for each country. The differences of the two periods reflect the different impacts of the crisis and the recovery speed. Just rely on the hypothesis of this article. The dividend payouts are consistent with substitute model in the pre-crisis period. And find out which country have the highest dividends payments but with lowest corporate governance which represent the poor legal protection of minority shareholders. The trend of growth rate need also be observed. The alterative hypotheses is the dividends are act as an outcomes of governances which crucial to shareholders protections. Evaluate the changes of dividends (fall or increase and how strong). The type of two tailed test of table is as following:

		Payout			ROI			Growth
	Pre	post	P-value	Pre	Post	P-value	Pre	post	P-value (Significance)
Denmark
Finland
Norway
Sweden
Iceland

The comparison will use La Porta et.al outcome and substitute models. The former model expects dividends are positive to governance quality which forces insiders of companies to protect minority shareholders rights. The latter model expects dividends are negative and act as substitutes for governance tools. Use the same methods research below as Sawicki (2009) to estimate North Europe as a powerful sources base and support resources. I want forecast whether there have some new evidences at the changes. The basic prediction models are the picture below the test function is the explanations of each variable by Sawicki (2009) and just as an example for me to illustrate my object in the new crisis time and Northern Europe:

Divi,t = α0 + α1(Govi,t ) + α2(Pr ofiti,t ) + α3(Betai,t ) + α4(Gri,t ) + α5(Szi,t ) + α6(Peri,t )+∑βcCtrc +∑βs㏑dss

The changes of score of governance indicate the level of corporate performances whether improve or not during the financial crisis (10 years period). After analysis the descriptive statistic by country, the stimulation of crisis to corporate governance can be predicted. Although the dividends are predict to lose their substitute role according to the time lapses, people still cannot sure the result totally caused by shareholders’ empowerment which tend to outcome model.

Country-level score are the sum of each firm score. From this view, a table of total governance score will be represented from 2004 to 2013 among the five countries in North Europe. After that, use the trend of scores to compare the five countries. Figure out the greater factors which impacts on the trends of governance, such as board independence and auditing process (Like audit committee, auditing meetings, the professional level of auditors and the using Big six auditor).

According to Doidge, Karolyi and Stulz (2007) the further step is to use other separate regressions to estimate the other firm-level variables may reflect different level of corporate governance. The factors are from country levels which are broad environment like GDP growth (2006 to 2008) and GDP per capita (2007). The firm level contains the Ownership, Judicial, and Rule of law and Corruption. The aim of this regression is to verify the findings of Karolyi and Stulz that increase of country legal environment and financial and economic development can be incentives to improve the firm-level governance. Due to different scores of each firm, it is clearer to find which incentives play a significant role in improving governance.

The next step is to consider the regression coefficients estimated in entire periods and pre-and post-crisis periods by using the above model (Function) which introduce in the beginning of this section. The dependent variables are Dividend payout (Divi,t ). The key dependent variables are score of governance quality (Gov)，return on investment (Profit), systematic risk (Beta), growth rate of assets (Gr) and firm size (Sz). The control variables are the period control (Per) (pre-and post-periods) and country control (Ctr) as well as industry effect (Ind).

Both three periods two columns indicate different control by firm or country. In the entire periods (ignore the period variables), there are two results if add period control in entire period. In the Pre-crisis, the country control variables added will impact on the dividend policy than firm-level. The result of this article will examine the Sawicki’s findings combine with the actual situation of North Europe that country-level governance is relevant to dividend policy and meet the standards of substitute model in pre-crisis period. Legal regime test also could support this finding as an important portion of country-level factors. The post-crisis period, if add the country level variables will change the negative relationship to positive relationship which lead to a higher dividends and weaker governance (the possible for cut dividends by calculating the (Divi,t) model in post-crisis period). The dividends act as outcomes of governance because the possible lower dividends payments is closely depend on the real board environments. The score of corporate governance comes from the data of annual report of the firms.

Now there should have a Legal regime test the relationship with dividends because the result could better support the country-level consequences on dividends. Then test the key dependent variables which same as above regression coefficients estimated in entire periods and pre-and post-crisis periods. The only change is the country control factor (Ctr) change into legal regime (Leg). There are two periods to test: Pre-and Post-crisis. The legal regime is according to each country’s law. However, prior research on Northern Asian considers the different law systems: civil law (Thailand and Indonesia) and common law (Singapore, Malaysia and Hong Kong) countries. In this article when studying the Northern Europe, they only have same law systems-civil law system. Nordic countries mainly use Scandinavian law which derive from civil law (Bernitz, 2010). So in the research of Northern Europe, the test may have no senses. From this point, the La Porta’s legal protection (2007) may lose the comparison significance of the different strength of the laws. In a word, both country-level and firm-level of governance are crucial to dividend policy and definitely shows differences of different periods of financial crisis.

Conclusion

To sum up, financial crisis 1997-1998 and financial crisis 2007-2008, the results depends on the data observations and processing by using the same model and I have to say that all the above explanations are just predictions. That why I apply Sawicki’s study into a new background which may found some changes if compare with late 1990s. The Northern Europe is totally different from Northern Asian, not to mention the changes of generational. Northern Europe has distinctive human environment and regional economy. Moreover, the most preciousness thins is Northern Europe has both common character and differences with other Europe countries. Some countries are even not members of Europe Union. However, the actual effect from 2008 financial crisis was different among the five Northern Europe courtiers. For example, there are less negative effects on Norway. However the Iceland suffers a lot from that global financial crisis (Qin, 2010). Such differences stimulate me to do some research and update the relevant empirical researches as well as contribute to the development of corporate governance and dividend policy by following the outstanding achievements of predecessor’s researches.

References

Bernitz, U. (2010). What is Scandinavian Law? Concept, Characteristics, Future [Online]. Available from: http://www.scandinavianlaw.se/pdf/50-1.pdf [Accessed 03/05/2015].

Black, F. (1976). The Dividend Puzzle. Journal of Portfolio Management, Vol. 2, PP5-8

Bhattacharya, S. (1979). Imperfect Information, Dividend Policy, and ‘The Bird in the Hand’ Fallacy, Bell Journal of Economics, Vol 10(1), PP259-270

Claessens, S. and Fan, J. (2002). Corporate governance in Asia:A survey. International Review of Finance 3, no. 2: 105–29.

Doidge, C., A. Karolyi, and R. Stulz. (2007). Why do countries matter so much for corporate governance? Journal of Financial Economics 86, no. 1: PP1–39.

Freeman, R. Edward, and William Evan. (1990). Corporate Governance: A Stakeholder Interpretation. The Journal of Behavioral Economics 19 (4): 337-359.

Grant Kirkpatrick. (2009). The Corporate Governance Lessons from the Financial Crisis, ISSN 1995-2864 Financial Market Trends © OECD 2009 Pre-publication version for Vol. 2009/1

Jensen, M. (1989). The eclipse of the public corporation. Harvard Business Review, May–June, PP67–74.

Johnson, S., P. Boone, A. Breach, and E. Friedman. (2000). Corporate governance in the Asian financial crisis. Journal of Financial Economics 58, no. 1–2: PP141–186.

John, K. & Knyazeva, A. (2006). Payout policy, agency conflicts, and corporate governance. [Online]. Stern School of Business Working Paper. Available from: http://ssrn.com/abstract=841064 . [Accessed 28/04/2015].

Kashyap, A. Rajan, R. and Stein, J. (2008). Rethinking Capital Regulation. Working paper, University of Chicago

La Porta, R., F. Lopez-de-Silanes, A. Shleifer, and R. Vishny. (2000). Agency problems and dividend policies around the world. Journal of Finance LV, no. 1: PP1–33.

Lemmon, M., and K. Lins. (2003). Ownership structure, corporate governance and firm value: Evidence from the East Asian financial crisis. Journal of Finance LVIII, no. 4: 1445–1468.

Marek Dabrowski. (20/07/2009). The Global Financial Crisis: Lessons for European Integration [Online]. Available from: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1436432 [Accessed 29/04/2015].

Myers, S. and Majluf, N. (1984). Corporate Financing and Investment Decisions When Firms Have Information that Investors Do Not Have. Journal of Financial Economics, Vol.13, PP187–221

Qin Aihua. (13/04/2010). 金融危机下的北欧经济 (Under the Northern Europe Economically of the Financial Crisis). [Online]. Available from: http://www.docin.com/p-194013338.html [Accessed 05/05/2015].

Rozeff, M. (1982). Growth, beta and agency costs as determinants of dividend payout ratios. Journal of Financial Research 5, no. 3: PP249–259.

Sawicki, J. (05/02/2009). The European Journal of Finance: Publication details, including instructions for authors and subscription

Solberg, G., D. and Zorn, T. (1992). Simultaneous determination of insider ownership, debt, and dividend policies. Journal of Financial and Quantitative Analysis 27, no. 2: PP247–263.

Walter W. Eubanks. (13/08/2010). The European Union’s Response to the 2007-2009 Financial Crisis Specialist in Financial Economics

Zhang Huijun. (2011). 北欧福利国家向何处去:挪威经验及启示 (The Nordic welfare state where to go: Norway experience and enlightenment). Journal of the Nordic model, no. 3.

�

�

�