Delivering on the Dividend Promise: Dynamic Dividend Behavior and Managerial Incentives

This paper examines the effect of governance and managerial alignment on dynamic dividend behavior of managers. I use a novel empirical approach to provide evidence on the role of governance and managerial alignment in explaining variation in dividend smoothing, incremental dividend decisions, and dynamic dividend behavior. Managers subject to weak monitoring and misaligned incentives are under greater pressure from shareholders to honor the implicit dividend contract as a trade-off between current period’s private benefits and future job security. The main finding is that weak board quality and institutional investor monitoring, CEO characteristics associated with misalignment, and greater separation of ownership and control rights in dual class firms contribute to stronger adherence to the implicit dividend contract, avoidance of dividend cuts and omissions, and non-decreasing persistent dividend path. Misaligned managers are also more likely to raise dividends and use dividend increases as the primary form of additional payouts. Methodologically, this paper contributes to the dividends and governance literature by identifying and addressing endogeneity of managerial alignment and dividend behavior in the instrumental variables framework and adjusting for selection bias. JEL classification: G30, G34, G35