Profit distribution and regulation: the impact of mandatory dividend in corporate internal funding

Abstract

The purpose of our research is to verify the impact of mandatory dividends on Brazilian publicly traded companies, focusing on both the value of cash holdings and the impact on corporate investment. Our work aims to reach the research objective making significant improvements over the previous works on the subject. First, we separate firms according to their dividend status. Second, in addition to investment regressions, we use the value of cash approach to test the impact of mandatory dividend on corporate financial decisions. Finally, our manual data collection makes it possible to allocate the dividend distributed to its reference period. Considering our context, where sources of financing are expensive and scarce, evidences obtained by the present research has great relevance. The law aims to protect the minority investor against the expropriation of resources. However, in dealing with all cases equally, legislation ends up harming companies that rely on these resources for their financing, thereby damaging their shareholders. This article brings new evidences, from an innovative approach, on factors affecting the availability of resources and its impact on the value of cash and on corporate investment in Brazil. We analyzed a sample of 1,654 dividend distributions from 2008 to 2015, using investment and firm value regressions. Our results indicate that companies paying just the minimum dividend have higher value attached to an extra unit of cash, corroborating our view that those companies will likely use these resources to fund future profitable investments. We also find that mandatory dividend has a negative impact on investment, but only for companies paying dividends above the minimum, contrary to our expectations. We argue that the marginal value of cash approach is a more effective way to test the impact of regulation on corporate financial decisions and this last evidence may be the result of endogeneity problems in investment regressions.

The effects of financial constraints on the market value of cash in a mandatory dividend context

“…In Brazil, for example, the current legislation does not tax the distribution of dividends. Furthermore, corporate law in Brazil requires all profitable public companies to include in their statutes a percentage of annual profits, usually 25%, to be paid out as dividends (Martins & Novaes, 2012; Vancin & Kirch, 2020). Therefore, Brazil's dividend rules force all publicly traded firms to pay dividends in cases of positive profit during the fiscal year; thus, Brazilian firms that pay dividends are not necessarily in the dividend distribution regime, which Faulkender and Wang (2006) indicate that the market value of cash should be valuated at a discount.…”

“…The mandatory dividend rules, in turn, remove part of the management discretion over the use of internal funds (Martins & Novaes, 2012; Vancin & Kirch, 2020) in a scenario where Brazilian companies already face difficulties in obtaining external funds (Manoel et al, 2022). This means, among other things, the reduction of funds available that could be used to invest in positive NPV projects, which could lead to the loss of valuable growth opportunities (Martins & Novaes, 2012; Vancin & Kirch, 2020).…”

“…The mandatory dividend rules, in turn, remove part of the management discretion over the use of internal funds (Martins & Novaes, 2012; Vancin & Kirch, 2020) in a scenario where Brazilian companies already face difficulties in obtaining external funds (Manoel et al, 2022). This means, among other things, the reduction of funds available that could be used to invest in positive NPV projects, which could lead to the loss of valuable growth opportunities (Martins & Novaes, 2012; Vancin & Kirch, 2020). Thus, if shareholders believe that difficulty in accessing outside funding on reasonable terms may sometimes lead a financially constrained company to bypass value‐increasing projects, then an additional dollar of cash may be worth more for a company in this position compared to the cash value of financially unconstrained companies (Faulkender & Wang, 2006; Denis & Sibilkov, 2010).…”