Shareholder protection and dividend policy: an experimental analysis

For nearly half a century, the literature on dividend payments has questioned why firms pay dividends at all. Two competing models have emerged to explain this. In low investor protection regimes, corporate insiders give dividends to signal trust. In high-protection regimes, outside investors have the power to demand dividends. Using a unique laboratory experiment, our results back the empirical literature, favoring the complement (outcome) model over the substitute model. An increase in outside shareholders’ rights increases dividend payments, reducing overall efficiency. The efficiency loss moving from lowto high-protection treatments can occur via multiple channels, and we find significant evidence of losses through each. One benefit of laboratory analysis is that some of these channels are not observable outside the lab (such as insider expropriations). Additionally, we find that high investor protection causes a greater efficiency loss than dividend taxes do. ∗LaRiviere: Department of Economics, University of Tennessee-Knoxville ([email protected]). McMahon: Department of Economics, University of Tennessee-Knoxville ([email protected]). Neilson: Department of Economics, University of Tennessee-Knoxville ([email protected]). Affiliation changes are pending. We will be grateful to anybody who will give us useful feedback.