Controlling shareholders may feel tempted to capture benefits for themselves at other shareholders’ expense. For instance, the majority shareholder may make the firm trade at unfair prices with another firm he or she owns, make the firm hire family members at excessive salaries, and use the firm’s resources to build personal prestige. Because such majority benefits may be financed by reduced dividends, minority shareholders are more vulnerable to opportunistic expropriation the more of the earnings the majority shareholder chooses to retain. The opposite strategy is to pay high dividends in order to mitigate conflicts with the minority and build reputation for being a fair majority shareholder. This conflict-reducing strategy may lower the cost of capital by ensuring higher minority investment in the future. Hence, dividends will be lower the more serious the potential shareholder conflict under the opportunistic strategy, but not under the conflict-reducing strategy. Our paper investigates which of these two very different governance strategies firms use in practice.
We analyze a sample of about 10,000 private Norwegian firms per year from 2006 to 2013 that have majority shareholders. We chose these firms because shareholder conflicts are particularly serious in majority-controlled firms, majority control is much more common in private firms than in public firms, private firms with majority control have particularly low conflicts between shareholders and managers, and because the majority shareholder can single-handedly make the dividend decision. A family is the majority shareholder in more than 80% of our sample firms, and the family provides the CEO in 73%.
Our evidence shows that most majority shareholders choose the conflict-reducing strategy rather than the opportunistic strategy. For instance, the average dividends to earnings ratio is 50% higher when the potential shareholder conflict is high rather than low. Thus, the larger the conflict potential, the more the conflict is reduced through high payout. We also find that such minority-friendly payout succeeds in building trust, as minority shareholders who have observed high dividends from a high-conflict firm invest more in the firm later on. When minority investment occurs, the additional equity is twice the average dividend minority shareholders received in preceding years. Thus, the firm may be better off paying out the cash as dividends now and asking the minority shareholders for new funding later when the investment opportunity emerges. This evidence suggests the majority shareholder’s best interest is to abstain from opportunism and instead use a minority-friendly approach. Overall, we show that dividend policy is used as a governance mechanism, and that it mitigates rather than exploits shareholder conflicts. This minority-friendly payout is rewarded with higher minority investment later on. Finally, this happens in a country with strong, mandatory minority protection in the law. Thus, the reputation incentive for each individual firm seems to complement rather than substitute minority-friendly regulation for all firms. This evidence suggests that reducing conflicts of interest by market mechanisms and voluntary action rather than by institutions and mandatory law is an important perspective on how dividend decisions are made.