The Journal of Financial Research • Vol. XXVI, No. 3 • Pages 371–387 • Fall 2003

DO EMERGING MARKET FIRMS FOLLOW DIFFERENTDIVIDEND POLICIES FROM U.S. FIRMS?

Varouj Aivazian and Laurence BoothUniversity of Toronto

Sean ClearySaint Mary’s University

Abstract

We find that emerging market firms exhibit dividend behavior similar to U.S.firms, in the sense that dividends are explained by profitability, debt, and themarket-to-book ratio. However, empirical dividend policy equations are struc-turally different, indicating different sensitivities to these variables. Additionally,emerging market firms seem to be more affected by asset mix, which seems to bedue to their greater reliance on bank debt. Overall, country factors are as impor-tant in dividend policies as previous studies find them to be in capital structuredecisions.

JEL Classifications: G35, G32

I. Introduction

The fact that firms pay dividends is referred to as the dividend puzzle byBlack (1976). We investigate this puzzle empirically using a sample of companiesfrom eight developing economies to gain a different perspective on this issue.We examine the influence of factors shown to influence the dividend behavior ofcompanies operating in more developed economies. We compare the results for oursample of emerging market firms with those for a sample of U.S. firms over thesame period to draw inferences about the importance of institutional and financialmarket development features for the dividend decision.

Our choice of real and financial variables is motivated by previous empir-ical findings that suggest a firm’s investment, capital structure, and dividend poli-cies are interrelated. For example, Fama and French (1997) examine the dividendand debt decisions of U.S. firms and conclude that debt is the residual financing

The authors would like to thank an anonymous referee whose comments led to substantial improve-ments. We would also like to thank the Social Sciences and Humanities Research Council of Canada(SSHRC) for financial support provided for this project, and participants at the 1999 Annual FMA meet-ings and at the Queen’s University seminar series.

371

372 The Journal of Financial Research

decision made by corporations. In addition, there exists a large empirical literaturethat shows corporate investment is sensitive to financial constraints. As a result, afirm’s dividend decision, which directly affects its free cash flow, could affect itsinvestment.

Higgins (1981) shows a direct link between growth and financing needs:rapidly growing firms have external financing needs because working capital needsnormally exceed the incremental cash flows from new sales. Consequently, prof-itable, slow-growing firms will be cash rich, and rapidly growing firms will becash poor. Higgins’s work is important in identifying firms likely to have financingproblems. However, it raises the issues of why excess cash should be paid out as adividend or, conversely, why an external funding need should not be met throughnew financing.

The two key theories addressing these issues are the signaling and agencycost models. The intuition behind signaling models is simple; with costs attached toissuing a dividend, caused by the transaction costs of issuing new common equity,and with regulatory considerations, only “good-quality” firms expecting high cashflows will pay dividends (e.g., see Bhatacharya 1979).

Poor-quality firms cannot afford to match the dividend payments becausethey will be faced with high transactions costs when the cash flow does not ma-terialize. Knowing this, investors take the firm’s dividend payment as a signal ofits future free cash flows. Similarly, Jensen (1986) shows that agency costs areattached to free cash flows, and Easterbrook (1984) argues that a commitment to ahigh-dividend policy attenuates managerial opportunism by forcing the firm to in-teract with the capital market more frequently, thereby imposing market disciplineon the manager.

Most signaling models and agency cost models assume that there is a sep-aration of ownership and control, and that financing is raised externally throughcapital markets. However, the financial systems in emerging markets are usuallycharacterized by closely held bank-financed firms. In this case, direct communica-tion with shareholders and regular site visits from corporate lenders who haveaccess to confidential information reduce the need to use dividends as a sig-nal. Similarly, the agency cost argument assumes that there is imperfect moni-toring of management, so that high dividend payments substitute for direct com-munication between shareholders and managers, forcing them to interact withinvestors. Again, this argument is weaker for closely held bank-financedfirms.

The preceding discussion highlights the importance of institutional featuresto dividend policy and points to the advantages of studying dividend policy indifferent institutional environments. We examine a sample of firms from eightemerging markets, where financial systems are significantly different from thosein the United States, and compare them with a sample of ninety-nine firms from theUnited States. Our results provide insight into the role environmental factors play

Emerging Market Firms 373

in creating dividend policy at the firm level. We also identify firm-level factors thathave a consistent effect across operating environments.

II. Institutional Background

Table 1 provides aggregate corporate financial data, along with some broadmacroeconomic data, to assess the importance of the relation between financingand growth rates emphasized by Higgins (1981). It provides the average real andnominal gross domestic product (GDP) growth rates as well as the average inflationrate for each country from 1981 to 1990. Except for Jordan (at 1.37%), real economicgrowth rates for these countries are greater than that for the United States (at 2.73%).Furthermore, the average inflation rates are generally greater than in the UnitedStates, except for those in Malaysia and Thailand.

The reason aggregate growth rates are important is that economic growth,from the gross national product identity, drives aggregate expenditure. Assumingthe sample firms are representative of economic activity in each country, companiesin high-growth economies are faced with high sales growth rates and the financialconstraints discussed by Higgins (1981). Gordon (1962) shows that each firm’ssustainable growth rate can be approximated as the product of the firm’s return onequity (ROE) and its retention rate (1 – the dividend payout). If firms grow fasterthan this sustainable growth rate, their financial policies have to change, or theyhave to raise external equity.

For our sample, the sustainable growth rate is less than the nominal GDPgrowth rate for the median firm in every emerging market country except Pakistan.In contrast, the U.S. median firm’s sustainable growth rate is 8.97%, greater thanthe nominal GDP growth rate of 7.60%. For seven of these eight emerging mar-ket countries, there seems to be growth pressures on the median firm. This im-plies these companies have greater external financing needs than equivalent U.S.firms.

Table 2 provides a classification of the firms in the emerging market samplein terms of their financial development and financial orientation. The countriesare classified based on stock market development, banking system development,corporate governance, investor and creditor protection, accounting standards, legalsystem, and level of corruption.1

Jordan, Pakistan, Zimbabwe, and India are classified as bank oriented be-cause their equity markets were poorly developed during this period. Similarly,Korea and Malaysia are classified as market oriented because these countries hadaccounting systems and investor-protection regulations in place. Based on weak

1For more details, please refer to a previous version of this article, available at www.rotman.utoronto.ca/∼booth.

374 The Journal of Financial Research

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Emerging Market Firms 375

TABLE 2. Financial System Classification.

Financial Orientation

Financial Development Bank Market

Developed Jordan South Korea, MalaysiaUnderdeveloped Pakistan, Zimbabwe, India, Turkey Thailand

measures of capital market development and strong enforcement of creditor rights,Turkey is classified as underdeveloped and bank oriented. Thailand is classifiedas underdeveloped and market orientated because even though it scores poorly onequity market indicators, it has strong enforcement of shareholder rights.

Ownership of public companies is more highly concentrated in emergingmarkets than in U.S. markets (and most other developed economies). Accordingto the concentration measures reported in La Porta et al. (1998), the three largestshareholders of a given company owned an average of 20% of the ten largest U.S.publicly held firms. The corresponding numbers for the emerging market sampleare: India, 40%; Malaysia, 54%; Thailand, 47%; Zimbabwe, 55%; Pakistan, 37%;and Turkey, 59%. The only country that seems to have ownership concentrationsimilar to the United States is Korea (23%).

Tax rate data for these countries suggest that in six of the eight countries thecorporate tax rate is less than the highest personal tax rate. Furthermore, the ratioof after-tax dividend income to after-tax capital gains income, assuming accrualtaxation, is less than or equal to 1.0 for every country (including the United States)except Thailand. When the deferral advantage to capital gains is factored in, it seemsthat in most of these countries, even possibly in Thailand, there are incentives similarto those in the United States to avoid paying dividends for tax reasons. Consequently,we do not expect tax distortions to play a significant role in differentiating thedividend policies of these emerging market firms from their U.S. counterparts.

Both tax and institutional factors indicate high costs are attached to payingdividends for firms in all eight emerging market countries relative to the UnitedStates. This is due to the extra taxes imposed on investors (except in Thailand) andthe greater difficulty in replacing equity lost through dividend payments with newissues. These difficulties appear to be most acute in bank-oriented countries and lesssevere in Malaysia and Korea, particularly toward the end of the period. Therefore,within our eight-country sample, we expect firms operating in the market-orientedeconomies of Korea and Malaysia to pursue dividend policies most similar to U.S.firms. Conversely, we expect the dividend policies of firms in the bank-orientedsystems of Turkey, Zimbabwe, Pakistan, and India to be the least similar to thoseof U.S. firms, with firms in Jordan and Thailand falling into a gray zone (“other”).We use these institutional groupings along with the country identifiers to test theimportance of dividend policy.

376 The Journal of Financial Research

III. Sample Characteristics

The World Bank (International Finance Corporation, or IFC) database isdescribed in Glen et al. (1994) and Booth et al. (2001). The firms in the database arethe largest firms listed on the local stock exchange. The data set consists largely ofabbreviated balance sheet and income statements, with limited cash-flow and mar-ket data, and it has the largest available coverage of companies for these countries.However, the coverage is not uniform across countries, or across time, and is limitedin terms of nonfinancial statement data, such as industry groupings. For compar-ison purposes, we include a sample of ninety-nine of the largest U.S. companiescontained in the Research Insight (Compustat) database.

Table 3 provides summary measures of dividend policy as well as basic datato assess the financial health of these firms. It includes three operating measures,three debt measures, and two summary measures. The first operating measure is thetangibility of the firm’s assets (Tangibility), defined as total assets minus currentassets divided by total assets. This ratio is designed to measure the proportion oflong-term (“hard”) assets in the firm’s asset structure. The other two operatingmeasures are the firm’s business risk (Busrisk), measured by the standard deviationof its return on investment, and the scale of the firm’s operations (Size), measuredby the natural logarithm of sales. The three debt measures are the debt ratio (Debt),defined as total liabilities divided by total assets; the times interest earned ratio(Coverage); and the current ratio (Current). The two summary measures are thefirm’s ROE and the firm’s market-to-book ratio (M/B), defined as the averagecommon stock price divided by book value per share.

The summary statistics reported in Table 3 suggest that the U.S. sampleconsists of high-quality, profitable firms. They also indicate that the financial healthof the emerging market firms is poorer than that of the U.S. firms. In particular,except for firms from Zimbabwe and Jordan, emerging market firms are morehighly indebted than U.S. firms, and judging from the current ratio statistics, muchof this debt is short term.

Fazzari, Hubbard, and Petersen (1988) argue that financially constrainedfirms are less likely to maintain high dividends. In general, it seems that the emerg-ing market firms are more financially constrained than the U.S. firms and, all elseconstant, less likely to pay dividends. This observation is consistent with the dis-cussion in section II, which suggests that these firms were operating in relativelyhigh-growth economies with relatively undeveloped capital markets. When firmsgrow faster than their sustainable growth rate, their financial health will deteriorateunless they raise new equity, as seen in Table 3.

Table 3 also provides summary statistics for four measures of dividend pol-icy. In addition to dividend yield and the dividend payout ratio, it reports statisticsfor aggregate dividends divided by total assets and by stockholders’ equity. Thelatter two measures are reported to avoid pricing problems that may exist with the

Emerging Market Firms 377

TABLE 3. Basic Financial Data.

UnitedKorea India Malaysia Thailand Zimbabwe Jordan Pakistan Turkey States

Tangibility 0.49 0.40 0.57 0.38 0.44 0.51 0.38 0.41 0.350.50 0.38 0.56 0.37 0.41 0.50 0.36 0.39 0.310.15 0.17 0.22 0.18 0.13 0.24 0.20 0.19 0.15

Busrisk 0.03 0.05 0.05 0.04 0.08 0.08 0.06 0.05 0.040.03 0.04 0.04 0.03 0.05 0.07 0.06 0.05 0.030.02 0.03 0.04 0.04 0.14 0.05 0.04 0.03 0.03

Size 0.12 0.14 0.12 0.13 0.10 0.08 0.06 0.10 0.070.12 0.14 0.11 0.13 0.10 0.07 0.06 0.10 0.070.01 0.01 0.01 0.01 0.01 0.02 0.01 0.02 0.01

Debt ratio 0.73 0.67 0.42 0.58 0.42 0.46 0.66 0.59 0.410.75 0.69 0.42 0.59 0.42 0.45 0.66 0.61 0.410.12 0.13 0.21 0.20 0.13 0.19 0.19 0.17 0.12

Coverage 2.46 5.77 20.96 13.36 20.33 N/a 5.25 11.21 12.901.48 2.27 6.11 5.60 7.27 N/a 1.16 2.49 5.855.44 15.38 31.47 20.03 29.51 N/a 13.32 23.48 28.74

Current 1.16 1.23 1.66 N/a N/a 1.80 1.28 1.44 2.361.07 1.18 1.36 N/a N/a 1.34 1.15 1.27 2.230.50 0.37 1.18 N/a N/a 1.84 0.68 0.76 0.98

ROE 0.08 0.16 0.06 0.16 0.13 0.07 0.21 0.23 0.120.08 0.15 0.07 0.15 0.13 0.08 0.19 0.22 0.130.11 0.11 0.19 0.26 0.13 0.31 0.48 0.18 0.16

M/B 0.75 1.42 2.32 2.47 0.58 1.42 0.92 1.90 1.860.58 1.13 1.85 1.82 0.39 1.19 0.86 1.44 1.530.67 1.17 1.81 2.07 0.62 0.68 0.75 1.25 1.33

Payout 0.42 0.35 0.50 0.43 0.35 0.40 0.27 0.60 0.330.33 0.30 0.40 0.44 0.36 0.44 0.00 0.62 0.310.42 0.41 0.86 0.40 0.33 0.39 0.88 0.41 0.84

Yield 0.13 0.04 0.02 0.04 0.10 0.04 0.06 0.15 0.050.04 0.04 0.02 0.03 0.10 0.04 0.06 0.13 0.040.25 0.04 0.02 0.04 0.08 0.04 0.05 0.13 0.04

Div/TA 0.01 0.02 0.04 0.06 0.05 0.04 0.03 0.06 0.020.01 0.02 0.03 0.05 0.04 0.04 0.00 0.06 0.020.01 0.05 0.07 0.04 0.04 0.05 0.09 0.06 0.02

Div/BV 0.03 0.05 0.04 0.08 0.05 0.06 0.05 0.16 0.050.03 0.05 0.03 0.07 0.04 0.06 0.00 0.14 0.040.02 0.05 0.05 0.10 0.05 0.07 0.18 0.14 0.03

Note: The individual ratios for each country are the average, the median, and the standard deviation ofeach value across all the firms in the sample. N/a is not available. Tangibility is the tangibility of assets:total assets minus current assets dividend by total assets. Busrisk is the standard deviation of the return oninvestment. Size is the natural logarithm of sales in local currency. The debt ratio is total liabilities dividedby total assets. The current ratio is current assets divided by current liabilities. ROE is the net incomedivided by stockholder’s equity. M/B is the market value of the common stock divided by its book value.Coverage is the interest coverage ratio, EBIT/I. Payout is the dividend per share divided by the earningsper share. Yield is the dividend per share divided by the average of the high and low price for the year.Div/TA is the aggregate dividends divided by total assets. Div/BV is the aggregate dividends divided bythe book value of stockholder’s equity.

378 The Journal of Financial Research

dividend yield measure and to avoid the instability of the payout ratio when earningsare low.

The average dividend payout ratio for the U.S. sample is 33%, and themedian is 31%. The median dividend payout ratios for the eight developing countriesare similar to those for the United States, averaging 36% across all eight countries.The significant outliers are Turkey with a median payout of 62% and Pakistan witha median payout of 0%. In Turkey, firms are constrained to provide dividends equalto the larger of 50% of earnings or 20% of paid-in capital, up to 75% of earnings.

Except for Turkey and Zimbabwe, median dividend yields are similar tothose in the United States. For Turkey, this is due to high payouts, whereas forZimbabwe, it is due to low market values as indicated by the low median M/Bvalue of 0.39. The same general picture emerges for dividends divided by totalassets and by stockholders’ equity, with Turkish firms again being the only outlier.Overall, the dividend data indicate that emerging market firms pay dividends atlevels comparable to those paid by U.S. firms, with the exception of Turkey.

A question arising from these summary statistics is whether there are sys-tematic differences in dividend levels across the countries. In Table 4 the dividendmeasures for each country are compared with (a) the United States, (b) the wholesample minus that country, and (c) the whole sample minus that country and theUnited States. For example, for Korea the first observation tests whether the av-erage payout ratio in Korea of 42% is significantly different from that of the U.S.sample of 33%. The t-statistic of the difference in means of 3.3 indicates this is asignificant difference.

Initially, most of the differences in Table 4 appear significant. The U.S.column indicates that these measures of dividend policy are significantly differentfrom those in the United States for every country except India. This suggests thatU.S. firms are different from emerging market firms. However, a similar messageemerges when comparing each country in turn with the overall sample, both withand without the United States. For example, the values for Korea are significantlydifferent from the sample averages obtained by including all other firms fromemerging markets, indicating that the dividend policy for Korean firms differssignificantly both from U.S. firms and from other emerging market firms. A similarresult emerges in country-by-country pairwise comparisons, although the resultsare not reported here. This shows there is significant heterogeneity both within thesample of emerging market firms and between these firms and U.S. firms.

In the subsequent analysis we focus on the dividend-to-total-assets measure,which we refer to as “dividend policy,” for several reasons. First, the dividend payoutratio is highly unstable and nonnormal as earnings get close to zero; consequently, itis not useful as a dependent variable in cross-sectional regression analysis. Second,the dividend yield reflects pricing effects that are beyond management control.Finally, dividends deflated by earnings or by the book value of equity are moresensitive to accounting distortions than those deflated by total assets.

Emerging Market Firms 379

TABLE 4. Cross-Country Comparisons of Dividend Measures.

Variables U.S. All + U.S. All – U.S.

Korea Payout 3.3∗∗ −1.0 −6.2∗∗

Yield 11.4∗∗ 11.4∗∗ 11.4∗∗

Div/TA −15.0∗∗ −23.6∗∗ −18.1∗∗

Div/BE −11.7∗∗ −17.1∗∗ −12.5∗∗

India Payout 0.9 −5.9∗∗ −8.3∗∗

Yield 1.7 −8.4∗∗ −9.2∗∗

Div/TA −0.1 −9.1∗∗ −10.2∗∗

Div/BE 0.6 −5.5∗∗ −6.2∗∗

Malaysia Payout 4.2∗∗ 2.2∗∗ 1.1Yield −10.9∗∗ −16.4∗∗ −15.6∗∗

Div/TA 6.8∗∗ 3.9∗∗ 2.8∗∗

Div/BE −3.3∗∗ −8.0∗∗ −8.6∗∗

Thailand Payout 6.2∗∗ 4.3∗∗ 2.6∗∗

Yield −6.5∗∗ −13.2∗∗ −13.0∗∗

Div/TA 13.3∗∗ 10.6∗∗ 9.6∗∗

Div/BE 11.9∗∗ 9.7∗∗ 8.7∗∗

Zimbabwe Payout 1.5 −0.8 −1.6Yield 5.8∗∗ 1.9 0.8Div/TA 5.9∗∗ 4.7 4.4∗∗

Div/BE 3.2∗∗ 2.0 1.7Jordan Payout 2.6∗∗ −1.0 −2.5∗∗

Yield −2.2∗∗ −10.2∗∗ −10.7∗∗

Div/TA 7.6∗∗ 4.6∗∗ 3.6∗∗

Div/BE 4.4∗∗ 2.4∗∗ 1.7Pakistan Payout 7.1∗∗ 6.6∗∗ 6.3∗∗

Yield 4.3∗∗ −0.3 −1.6Div/TA 8.1∗∗ 7.7∗∗ 7.5∗∗

Div/BE 8.3∗∗ 8.2∗∗ 8.2∗∗

Turkey Payout 6.4∗∗ 5.0∗∗ 4.3∗∗

Yield 8.1∗∗ 6.2∗∗ 5.5∗∗

Div/TA 6.5∗∗ 5.1∗∗ 4.7∗∗

Div/BE 8.3∗∗ 7.8∗∗ 7.6∗∗

Note: The t-statistics are reported for differences in the average value for each country from the averagevalue for three other samples: (a) U.S. firms, (b) all other firms minus firms from that country, butincluding U.S. firms, and (c) all other firms minus firms from that country and U.S. firms.

∗∗Significant at the 5% level.

For six of the eight countries, the average dividend payment is higher foremerging market firms than for U.S. firms. The two exceptions are Korea, whichas noted before is most like the United States and pays out less, and India. Whythese emerging market firms tend to have higher dividend payments than their U.S.counterparts while facing greater external growth pressures is a puzzle, especiallybecause they have less access to funds (particularly equity) and their overall finan-cial health is much poorer. One answer may be that their dividend policies simplyreflect different firm characteristics.

380 The Journal of Financial Research

IV. Dividend Hypotheses

In this section we examine the influence of several firm-level characteristicshypothesized to affect the dividend decision. We analyze these characteristics ina cross-sectional setting, which allows us to monitor for the influence of countryfactors.

Dividend signaling models suggest that maintaining a dividend during pe-riods of earnings declines comes at a cost because the equity paid out as a dividendmust be replaced. It follows that dividend payouts should be inversely related tobusiness risk, which we measure by the standard deviation of the firm’s return oninvestment over the complete period. As argued earlier, financial constraints canaffect dividend decisions. In addition, we expect that more long-term debt is usedas the tangibility of the firm’s assets increases and more collateral accumulates.2

Therefore, we use the tangibility of a firm’s assets, along with the firm’s debt ratio,as a proxy for long-term debt, where tangibility is measured as total assets minuscurrent assets divided by total assets. We hypothesize that firms with relatively lessdebt and more tangible assets have greater financial slack and are more able to payand maintain their dividends.

We use firm size as a proxy for financial market access, where size ismeasured as the natural logarithm of the firm’s sales level. We hypothesize thatlarger firms with better market access should be able to pay higher dividends, andwe therefore expect a positive relation between size and dividend payments. Wemeasure the importance of the investment opportunity set using the market-to-book ratio, which serves as a proxy for the present value of growth options. Highergrowth opportunities should mean lower dividend payments; however, high marketvalues could also result for “cash cows” that have high present value from existingopportunities. To control for this, ROE is used to measure the present value fromexisting opportunities.

The IFC data represent an unbalanced panel, with varying numbers of firmsin each country across time. To make maximum use of the data, we use panel datatechniques to pool both cross-sectional and times-series data. Consequently, allobservations are in terms of firm-year observations.

The empirical model is expressed as,

Di,t

Ai,t= αi +

n∑

j=1

β j Xi, j,t + εi,t , (1)

where X i,j,t is explanatory variable j for firm i at time t, εi,t is the random error termfor firm i at time t, Di,t/Ai,t is the dividend-to-total-assets ratio subscripted for firm

2This is especially true in developing countries where transaction costs of enforcing (unsecured) long-term financial contracts tend to be high.

Emerging Market Firms 381

i at time t, and αi is the intercept. We estimate this regression system using pooledordinary least squares. We obtain regression estimates both with and without themarket-to-book ratio because in some countries the absence of market values limitssample size.

V. Empirical Results

Table 5 provides the pooled time-series cross-sectional regression estimatesfor each country. For the U.S. sample, the overall explanatory power is good fora cross-sectional model with an adjusted R2 of 30.0%. The results for this sam-ple suggest that dividends are inversely related to debt and positively related toboth ROE and the market-to-book ratio. In other words, profitable firms with lowdebt levels that have relatively high market values seem to pay out larger amountsof dividends. This is consistent with Higgins’s (1981) sustainable growth modeland the absence of financial constraints for these firms, leading them to pay outsurplus funds. We had expected that once ROE was used to control for currentprofitability, the influence of the market-to-book ratio would be negative, indi-cating the reluctance to pay dividends from growth opportunities. However, themarginal effect of the market-to-book ratio is positive. The remaining conclusionsto be drawn from the regression results are not well supported; however, thereis some evidence that larger firms with more tangible assets and lower businessrisk pay higher dividends. When the market-to book ratio is dropped, the effectof both debt and ROE is even stronger, whereas the other three variables remaininsignificant.

The adjusted R2 values seem reasonable for most of the emerging marketfirms. With respect to the individual variables, the debt ratio shows the same sig-nificant negative relation in every country. The market-to-book ratio has a positivecoefficient for every country, although for Turkey and Pakistan the limited samplesizes contribute to insignificant coefficients. Finally, ROE has a positive coeffi-cient for every country; however, the coefficient for Pakistan is negative when themarket-to-book ratio is excluded. In short, we observe a similar relation betweendividends and these three variables as that exhibited by U.S. firms.

For the other variables, the results are mixed. Neither the size coefficientnor the business risk coefficient displays consistent signs; although they may beimportant in one country, their importance is the opposite or insignificant in anothercountry. The only significant difference from the U.S. results is that firms with moretangible assets tend to have lower dividends, and in six countries this is significant.A possible explanation for this is that when the assets are more tangible, fewershort-term assets are available for banks to lend against. This imposes financialconstraints on firms operating in more primitive financial systems, where the mainsource of debt is short-term bank financing.

382 The Journal of Financial Research

TABLE 5. Regression Estimates.

Observations Constant Busrisk Size Tangibility ROE M/B Debt Ratio Adj R2

Korea 0.068 − 0.067 −0.201 −0.005 0.029 0.003 −0.043 31.6%951 (13.92) (−3.73) (−5.23) (−2.45) (9.75) (5.60) (−15.42)965 0.061 −0.074 −0.107 −0.004 0.027 −0.046 28.8%

(12.25) (−3.99) (−2.84) (−1.76) (8.94) (−16.07)India 0.109 0.034 −0.145 −0.038 0.050 0.003 −0.094 49.4%

841 (11.56) (1.52) (−2.40) (−11.78) (9.34) (5.02) (−21.11)931 0.118 0.143 −0.157 −0.044 0.069 −0.104 11.8%

(4.52) (2.32) (−0.97) (−4.94) (4.74) (−8.18)Malaysia 0.045 −0.130 0.516 −0.031 0.029 0.003 −0.114 11.7%

687 (1.77) (−1.66) (2.60) (−2.41) (1.67) (1.81) (−7.66)710 0.052 −0.092 0.527 −0.038 0.029 −0.111 11.6%

(2.14) (−1.26) (2.78) (−3.15) (2.11) (−7.95)Thailand 0.056 0.049 0.086 0.012 0.195 0.003 −0.114 48.1%

192 (2.06) (0.63) (0.43) (0.96) (7.78) (2.87) (−9.25)210 0.031 0.089 0.365 0.022 0.109 −0.098 35.9%

(1.10) (1.03) (1.78) (1.67) (5.17) (−7.61)Zimbabwe 0.149 0.481 0.260 −0.227 0.073 0.026 −0.170 55.6%

54 (1.12) (1.72) (0.25) (−4.58) (1.02) (2.78) (−3.14)54 0.355 0.423 −1.129 −0.294 0.141 −0.222 49.3%

(2.99) (1.42) (−1.15) (−6.41) (1.97) (−4.10)Jordan 0.047 −0.030 0.356 −0.045 0.058 0.021 −0.086 41.5%

316 (2.99) (−0.56) (1.64) (−3.91) (5.09) (6.19) (−4.57)334 0.091 −0.073 −0.007 −0.050 0.076 −0.048 33.7%

(7.09) (−1.46) (−0.04) (−4.34) (7.02) (−2.68)Pakistan 0.583 0.466 −4.041 −0.222 0.018 0.008 −0.257 28.9%

196 (6.32) (1.69) (−3.46) (−4.57) (0.62) (0.54) (−5.54)890 0.055 0.175 0.682 −0.035 −0.003 − − 0.097 4.4%

(1.92) (1.89) (1.95) (−2.15) (−0.50) (−5.68)Turkey 0.216 −0.180 −1.171 −0.001 0.174 0.002 −0.107 71.1%

57 (5.55) (−1.31) (−3.38) (−0.03) (8.67) (0.55) (−3.69)363 0.115 0.064 −0.361 0.016 0.204 −0.123 52.7%

(5.44) (0.69) (−2.44) (1.28) (15.67) (−8.45)United States 0.028 −0.012 0.051 0.005 0.012 0.005 −0.048 30.0%

988 (7.86) (−0.64) (1.26) (1.48) (3.51) (11.98) (−10.3)988 0.043 −0.028 0.032 0.000 0.024 −0.057 19.9%

(12.44) (−1.38) (0.73) (0.08) (6.85) (−11.72)

Note: Regression coefficients are estimated using pooled ordinary least squares for each country sample,with and without the market-to-book ratio. Dividends divided by total assets is the dependent variable. Theindependent variables are as follows. Busrisk is the standard deviation of the return on investment. Size isthe natural logarithm of sales in local currency. Tangibility is the tangibility of assets: total assets minuscurrent assets dividend by total assets. ROE is the net income divided by stockholder’s equity. M/B is themarket value of the common stock divided by its book value. The debt ratio is total liabilities divided bytotal assets. The t-statistics are given in parentheses.

Although the dividend policies of firms operating in different countriesappear to react to similar variables (i.e., debt, ROE, and market-to-book ratio),their sensitivity to these variables may differ substantially. We examine this issueusing a pairwise regression, where firms from multiple countries are combined.

Emerging Market Firms 383

For example, Korean firms can be added to U.S. firms and the following regressionequation can be estimated:

Di,t

Ai,t= αi +

n∑

j=1

β j Xi, j,t +n∑

j=1

γ j Xi, j,t DUM + DUM + εi,t . (2)

This is similar to equation (1), except that all of the Korean firms are identifiedwith a dummy variable set to 1 (DUM), and the coefficient (γ ) then measuresthe significance of the interactive term that indicates whether each independentvariable has a different effect depending on whether the firm is from Korea or theUnited States. If the empirical dividend policy is identical in each country, theseinteractive terms will all be insignificant.

The results are reported in Table 6, where each country is compared withthe United States and then with the whole sample, excluding itself, both with andwithout the U.S. firms. For illustrative purposes, we examine the results for Koreanfirms, which exhibit a significantly different reaction to size, tangibility, ROE,and market-to-book ratio from U.S. firms, even after the Korean firms have beenseparately identified as such (using the Korean dummy variable). This indicatesthat the marginal effect of profitability, for example, on Korean firms’ dividendpolicy is more severe than on U.S. firms. The remainder of this column suggeststhat profitability has more of an effect on dividend payments for emerging marketfirms than for U.S. firms in all countries except Jordan, although not all of thedifferences are significant.

The other variables provide similar results. Increased debt reduces dividendpayments for these emerging market firms, and except for firms in Korea andJordan, the effect of the increased debt is significantly more pronounced than inthe United States. Similarly, as the asset mix moves toward long-term tangible assets,the dividend payments for the emerging market firms are reduced significantly ascompared with the U.S. firms, except for firms from Thailand and Jordan. For theother variables, the evidence is mixed.

Whereas the results in Table 5 suggest that these emerging market firmsrespond to the same factors as U.S. firms, the results in Table 6 indicate that theirsensitivity to these factors is in fact significantly different. We now consider howsimilar these emerging market firms are to each other by examining the number ofsignificantly different coefficients. For example, for Korean firms four coefficientsare significantly different from U.S. firms. The second-to-last column shows the co-efficients that are significantly different from all the other emerging market firms,and the results suggest that three of the coefficients for Korea are significantlydifferent, which is reported as 4-3 in the final column. The last column suggeststhat except for Malaysia and Pakistan, these emerging market firms seem to havemore in common with each other than with U.S. firms. However, heterogeneity is

384 The Journal of Financial Research

TABLE 6. The Significance of Interactive Dummy Variables Included in Regressions.

Variables U.S. All + U.S. All – U.S. Differencea

Korea Busrisk −1.8 −2.8∗∗ −1.5 4-3Size −3.9∗∗ −1.1 2.7∗∗

Tangibility −2.5∗∗ 1.1 5.5∗∗

ROE 3.3∗∗ −2.1∗∗ −1.7M/B −3.1∗∗ 0.3 0.2Debt ratio 0.8 1.7 4.2∗∗

India Busrisk 1.6 −2.5∗∗ 0.4 4-1Size −2.6∗∗ −1.2 2.0∗∗

Tangibility −8.9∗∗ −2.0∗∗ 1.4ROE 5.9∗∗ −0.8 −0.9M/B −3.5∗∗ 0.3 −0.6Debt ratio −7.2 −2.0∗∗ −0.1

Malaysia Busrisk −1.7 −5.9∗∗ −2.6∗∗ 3-4Size 2.8∗∗ 3.5∗∗ 6.4∗∗

Tangibility −2.9∗∗ −1.0 1.8ROE 1.2 −2.2∗∗ −2.2∗∗

M/B −1.6 −0.5 −2.5∗∗

Debt ratio −4.3∗∗ −5.3∗∗ −1.8Thailand Busrisk 1.1 −1.1 0.2 3-2

Size 0.3 0.3 1.7Tangibility 0.7 1.2 2.9∗∗

ROE 10.8∗∗ 3.2∗∗ 2.9∗∗

M/B −2.3∗∗ 0.9 0.3Debt ratio −6.8∗∗ −2.4∗∗ −1.0

Zimbabwe Busrisk 3.6∗∗ 0.8 1.2 4-1Size 0.4 0.2 0.5Tangibility −9.6∗∗ −3.3∗∗ −2.6∗∗

ROE 1.8 0.1 0.1M/B 4.6∗∗ 1.9 1.7Debt ratio −4.6∗∗ −1.5 −1.0

Jordan Busrisk −1.8 −1.1 −1.0 1-0Size −3.6∗∗ −1.8 −1.2Tangibility 0.8 0.6 0.8ROE −0.8 −0.5 −0.1M/B 0.5 0.7 −0.0Debt ratio 1.8 0.5 −1.3

Pakistan Busrisk 3.7∗∗ 4.4∗∗ 4.9∗∗ 4-5Size −8.1∗∗ −11.0∗∗ −9.3∗∗

Tangibility −9.6∗∗ −12.8∗∗ −10.6∗∗

ROE 0.3 −3.0∗∗ −4.3∗∗

M/B 0.4 0.9 0.7Debt ratio −8.5∗∗ −11.2∗∗ −9.6∗∗

Turkey Busrisk −1.8 −1.4 −0.7 3-1Size −5.2∗∗ −1.8 −1.0Tangibility −0.4 0.4 1.3ROE 11.8∗∗ 3.0∗∗ 2.7∗∗

M/B −1.6 −0.1 −0.3Debt ratio −3.0∗∗ −0.7 −0.2

Note: The reported values are the resulting t-statistics on coefficients that are estimated on interactive dummy variables, which

are included in the regression to determine the difference in sensitivity to the independent financial variable across different

countries, as represented by the dummy variable. Busrisk is the standard deviation of the return on investment. Size is the

natural logarithm of sales in local currency. Tangibility is the tangibility of assets: total assets minus current assets dividend

by total assets. ROE is the net income divided by stockholder’s equity. M/B is the market value of the common stock divided

by its book value. The debt ratio is total liabilities divided by total assets.

aDifference in the number of significant coefficients: U.S. sample compared with emerging market sample.

∗∗Significant at the 5% level.

Emerging Market Firms 385

TABLE 7. Regression Estimates for the Entire Pooled Nine-Country Sample.

Country Dummies Firm-Level Variables Full Model Group: Pooled

Constant 0.024 (15.7) 0.056 (14.0) 0.060 (11.7) 0.095 (23.1)Busrisk 0.186 (7.5) 0.038 (1.6) −0.01 (0.40)Size 0.015 (0.5) 0.081 (1.3) −0.525 (−15.1)Tangibility −0.015 (−3.8) −0.035 (−8.7) −0.034 (−8.2)ROE 0.061 (13.0) 0.035 (7.8) 0.047 (10.5)M/B 0.002 (4.1) 0.004 (6.5) 0.004 (7.5)Debt ratio −0.066 (−15.1) −0.102 (−21.2) −0.089 (−21.0)Korea −0.011 (−5.0) 0.029 (7.6)India −0.000 (−0.0) 0.022 (4.5)Malaysia 0.018 (7.5) 0.023 (6.1)Thailand 0.039 (10.4) 0.036 (6.7)Zimbabwe 0.045 (6.7) 0.047 (7.1)Jordan 0.021 (6.8) 0.033 (10.5)Pakistan 0.090 (23.7) 0.114 (29.7)Turkey 0.041 (6.3) 0.056 (8.5)Most like U.S. 0.054 (19.9)Least like U.S. 0.072 (23.8)Other 0.052 (18.2)Adjusted R2 18.0% 13.5% 29.6% 24.1%

Note: Regression estimates of debt and total assets against the independent variables indicated in the rowheadings. The t-statistics are given in parentheses. Each model has 4,282 observations. Busrisk is thestandard deviation of the return on investment. Size is the natural logarithm of sales in local currency.Tangibility is the tangibility of assets: total assets minus current assets dividend by total assets. ROE is thenet income divided by stockholder’s equity. M/B is the market value of the common stock divided by itsbook value. The debt ratio is total liabilities divided by total assets.

apparent across the countries. Overall, the evidence suggests that the responsivenessof dividend policy to firm-level factors differs across these emerging markets,although they seem to have more in common with each other than with the UnitedStates.

We now examine the direct influence of country or institutional factors ondividend policies, following Booth et al.’s (2001) analysis of capital structure. Weregress dividends to total assets on a set of country dummy variables. We use theUnited States as the reference point, so that the coefficients on the dummy variablesmeasure the significance of dividend policy differences relative to the United States.These results are reported in the first column of Table 7. The adjusted R2 of theregression is 18.0%, and all of the dummy variables are significant except the onefor India. This supports our earlier assertion that there are significant differencesacross these countries in terms of their dividend policies.

The second column in Table 7 provides regression estimates of the simpleempirical dividend policy model with no country dummies. This model is “wrong”because the data reported in Table 6 already show that the coefficients are sig-nificantly different in some of these countries, although this model forces all of

386 The Journal of Financial Research

them to be the same. However, it is a measure of the effectiveness of the financialvariables alone in understanding dividend policy. In this case the adjusted R2 is13.5%. This is not surprising, given that our previous results already demonstratethe existence of significant heterogeneity across these countries. Country factorsare at least as important as the firm-level variables used to examine dividend policyin these countries.

The third column of Table 7 presents the expanded model that includes thesix financial variables and the country dummies. Similar to Booth et al. (2001),there is incremental explanatory power in the additional financial variables. Theindependent variables provide the same general results obtained by examining theindividual country samples, and all of the dummy variables continue to be signifi-cant. All of the signs on the country dummy variables are positive and significant,indicating that after taking into account firm-specific factors (such as profitabil-ity) firms from these emerging markets all pay higher dividends than their U.S.counterparts.

Finally, the last column in Table 7 uses dummy variables based on ourtaxonomy of financial systems to categorize the eight emerging market countries incomparison with the United States. Although the adjusted R2 value declines relativeto when individual country dummies were included, indicating that informationis being lost with this coarser grouping, the sign on the significant independentvariables remains much the same. Finally, the group dummies are significant inshowing some homogeneity in our groupings, particularly because the “least like theU.S.” dummy variable has the largest coefficient, indicating the biggest differencewith the United States. However, they still have larger dividends than U.S. firms,even after including independent variables to control for differences in firm-levelcharacteristics.

VI. Conclusions

Our empirical results reveal that for both U.S. firms and emerging mar-ket firms, profitability affects dividend payments; high ROE tends to mean highdividend payments. This provides strong support for the residual cash flow theoryof dividends. Similarly, higher debt ratios correspond to lower dividend payments,suggesting that financial constraints affect dividend policy. In addition, the market-to-book ratio has a positive effect on dividend payments, contrary to expectations.There is little evidence that business risk or size affects dividend policy in a signif-icant or consistent way. Finally, for emerging market firms, we find that dividendsare negatively related to the tangibility of firm assets. We attribute this to the cor-responding drop in short-term assets that are available as collateral for short-termbank debt, which we expect would reduce short-term borrowing capacity in bank-dominated markets. In general, we find that the same factors are important for

Emerging Market Firms 387

emerging market firms as for U.S. firms. However, emerging market firms aremore sensitive to some of the variables, indicating the greater financial constraintsunder which they operate.

We conduct a pooled cross-country analysis including country dummyvariables to examine the differences that do exist. Overall, the simple countrydummies have as much explanatory power as the six independent financial variables,which demonstrates the importance of these factors. In the fully expanded version ofour model, country dummies are significant even after adjusting for differences infirm-level characteristics such as profitability and debt. This suggests that firms inthese emerging markets pay out more in dividends than do similar firms in the UnitedStates. Finally, our taxonomy of countries based on the structure of their financialsystems has some validity, but the overall explanatory power of the “grouped”model is less than the model with the individual country dummies. This indicatessignificant heterogeneity across countries, even after adjusting for differences intheir financial systems.

Our results suggest that the dividend policies of firms in emerging marketsreact to variables similar to those in the United States; however, their sensitivity tothese variables varies across countries. The largest puzzle resulting from our analysisis that emerging market firms pay higher dividends than their U.S. counterparts,even after controlling for firm-specific characteristics and even though they operateunder more severe financial constraints. As yet, we have no solution to this puzzle.

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