SEO, Cash Dividends And Over-investment In Listed Companies

As one of the major financial decisions, dividend policy is not only important to the investors, but also an essential part of optimal supervision contract (Rozeff,1982). After reviewing and summarizing the relevant literatures, this paper examines the impact of cash dividends on the relationship between free-cash-flow(FCF) and over-investment, based on the principal-agent theory. Considering the special semi-mandatory dividend policy in China, cash dividends distributed by equity refinancing company could have a dual nature. On one hand, they can reduce free cash flow controlled by the company and inhibit over-investment; on the other hand, cash dividends could be utilized to meet the requirements for refinancing, which ultimately weakens the inhibitory effect. This paper examines the dual mechanism of cash dividends and the effect of semi-mandatory dividend policy issued by SEC in2008.We use the data of listed companies in Shanghai and Shenzhen A-share between2004and2013. Primarily, the paper estimates the optimal scale of investments according to Richardson model, and verifies the positive relationship between free cash flows and over-investment. Secondly, SEC issued several semi-mandatory dividend policies, which requires cash dividend payout ratio should be achieved by equity refinancing companies. Whether cash dividends can reduce FCF and inhibit excessive investment, or just for the purpose of refinancing is a matter of debate. To study this, all companies would be divided into two groups, one has raised capital through equity refinancing(SEO group)and one hasn’t(NSEO group).Compared with NSEO group, Cash dividends in SEO group significantly weaken the over-investment of free cash flows. Finally, given the newly issued semi-mandatory dividend policy in2008, we further investigate the impact on governance role of cash dividends imposed by the new policy. The result shows that, the governance effect of cash dividends has been improved after the issue of semi-mandatory dividend policy in2008.The main innovations of this paper is to bring SEO, cash dividends and over-investment into an integrated framework of analysis under the influence of semi-mandatory dividend policy. By discovering the differences of governance effect of cash dividends between SEO companies and NSEO companies, and the differences of governance effect of cash dividends before and after the newly-issue policy in2008, we examine whether the semi-mandatory dividends policy has achieved the expected purpose.