Dividend Payout and Executive Compensation: Theory and Evidence

Abstract

Recent studies have documented an association between managerial compensation and firm dividend policy. Bhattacharyya (2000) develops a model of dividend payout that is based in the principal-agent paradigm. In Bhattacharyya's model, managerial quality and effort are unobservable to shareholders and therefore first best contracts are not possible. He demonstrates analytically that the second best compensation contract motivates high quality managers to retain and invest firm earnings, and motivates low quality managers to distribute income to shareholders. This study presents results of tobit regression analyses of US firm dividend payouts over the period 1992-2001 that are consistent with the Bhattacharyya model.