Corporate Governance and Dividend Policy: Shareholders' Protection or Expropriation?

We investigate the relationship between corporate governance quality and dividend policy in Canada. Based on the agency theory predictions, we consider the effect of two conflicting hypotheses about the effect of corporate governance on dividend payouts: the outcome and substitution hypotheses. The effectiveness of firm-level governance mechanisms is assessed through the Globe & Mail annual corporate governance index and four sub-categories scores (board composition, shareholding and compensation issues, shareholder rights issues and corporate governance disclosure policy). Using a sample of 714 firm-years listed on the Toronto Stock Exchange over the period 2002-2005, our results show that firms with stronger corporate governance have higher dividend payouts. Among the four components of the corporate governance index, we document that board composition and shareholder rights' policy are positively related to payout ratios. We also find a positive association between firm size, the level of free cash flows and dividend payouts. Finally, we document a negative relationship between firm risk, US cross-listing and dividend payouts. Taken together our results are consistent with the outcome model of dividend policy.