An Investigation of Dynamic Dividend Behavior in Korea

The purpose of this study is to investigate the dynamic dividend policy of the firms in Korea. In particular, this study empirically tests whether Korean firms follow stable dividend policies as in developed markets where dividend smoothing is a stylized fact. The paper also identifies firm-level factors that influence the degree of dividend smoothing. For this purpose, 299 firms listed on Korea Stock Exchange over a twenty six-year period from 1981 to 2006 were investigated. The empirical results show that Korean firms make dividend payment based on the stock’s face value, which is very closely related to the average interest rate during the sample period. A change in dividend payments is less likely to reflect a change in the fundamentals of the companies. Instead, changes in the annual dividend payments are closely related to the interest rate of one-year time deposit. For the degree of dividend smoothing, the study finds that the majority of Korean firms pay smoothed dividends. However, the speed of adjustment to the target payout ratio is faster than that of the developed market. In addition, the results show that the long–term target ratio is significantly lower than the observed payout ratio. Dynamic dividend behavior in Korea is less explained by the Lintner model. For the determinants of dividend smoothing, company risk, size, and growth factors play important roles in explaining the cross-section of dividend smoothing behaviour. But the relationship between these explanatory variables and the degree of dividend smoothing is systematically different between US and Korean firms. Growth is positively related to the degree of dividend smoothing as suggested by the previous studies. However, contrary to the theoretical predictions, empirical results show that the larger and older firms are more likely to smooth dividends in Korea. Leverage and controlling shareholder’s ownership have insignificant effects on dividend smoothing. The results suggest that information and agency theories do not explain the dynamic dividend policy of Korean firms. Instead, the study finds that riskier firms tend to pay more smoothed dividends, supporting the prediction made by Kumar (1988). The results also show that there is a systematic difference in the degree of dividend smoothing between different types of ownership structure. The results suggest that ownership structure of the firm may play an important role in deciding the firm’s dynamic dividend policy.