Changing Dividend Policy in Korea: Explanations Based on Catering, Risk, and the Firm's Lifecycle

Abstract

We examine the dividend payment patterns of Korean firms and test competing hypotheses that explain the decreasing dividend patterns since the Asian crisis. We run a horse race to explain this decreasing propensity to pay dividends (PPD). Although catering theory, when used alone, explains 22% of this decreasing PPD, it loses most of its explanatory power when risk and lifecycle measures are used together. We observe dramatic and permanent changes in systematic and idiosyncratic risks after the crisis. Firms are affected heterogeneously, such that large and stable firms face less risk after the shock, while small and unprofitable firms face greater uncertainty, which in turn results in high concentrations of dividend payments among the top payers. We also find evidence of firms' time varying risk aversion toward costly dividend payments. Firms in boom periods become less risk averse and do not reduce dividends for the same perceived level of risks as they do during an economic downturn, when firms tend to react to risks more sensitively. Risks explain over 30% of the decreasing PPD when combined with a lifecycle measure. The added contribution of a lifecycle measure is mainly driven by the sign of retained earnings and not the magnitude of positive retained earnings.