The European Journal of Finance

ISSN: 1351-847X (Print) 1466-4364 (Online) Journal homepage: https://www.tandfonline.com/loi/rejf20

Corporate governance and dividend policy in

Southeast Asia pre- and post-crisis

Julia Sawicki

To cite this article: Julia Sawicki (2009) Corporate governance and dividend policy in
Southeast Asia pre- and post-crisis, The European Journal of Finance, 15:2, 211-230, DOI:
10.1080/13518470802604440

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The European Journal of Finance,
Vol. 15, No. 2, February 2009, 211–230

Corporate governance and dividend policy in Southeast Asia pre- and post-crisis

Julia Sawicki∗
Advance Research Centre, ISEG – Universidade Técnica de Lisboa, Lisboa, Portugal

The relationship between dividends and corporate governance in five East Asian countries over the period
1994–2003, comparing the outcome and substitute models, is investigated. Evidence of a pre-crisis neg-
ative relationship between dividends and governance indicates that dividends act as a substitute for other
corporate governance mechanisms during this exuberant period. A strong positive relationship between
governance and dividends emerges post-crisis, consistent with substantial improvements in governance
empowering shareholders. The relationship is incremental to the effect of the legal regime, confirming that
shareholder protection at the firm level is important to forcing firms to disgorge cash in an outcome model
of dividends.

Keywords: corporate governance; financial crisis; dividends; emerging markets

1. Introduction
Dividends and corporate governance are clearly related. That which is not clear is the nature
of the relationship: are dividends complements to, substitutes for, or the outcome of governance
practices? In the sense that corporate governance is a set of mechanisms that ensure a proper return
to investors, high dividends are evidence that the mechanisms are working properly. However,
investors’ returns are also in the form of capital gains and as Miller and Modigliani’s (1961)
classic work shows, investors are indifferent between the two and dividend policy is irrelevant.
Frictions like information asymmetry do not exist in Miller and Modigliani’s model however, so
a question arises of their role in the presence of agency conflicts. The Lintner–Gordon bird-in-
the-hand theory becomes relevant when investors face expropriation.1 Poorly governed firms may
find that dividend payout can be value-enhancing by, for example, soaking up free cash flow that
insiders might otherwise squander.
Several monitoring and control practices act as governance mechanisms which protect minority
shareholders from expropriation by corporate insiders. Their effectiveness, especially in countries
with weak institutions and little protection of property rights, is not well researched or understood.
Dividend payout is of particular interest in unraveling the effects of external and internal corporate
governance.
We pursue the investigation into governance and dividends in a particular setting: Southeast
Asia during a 10-year period surrounding the 1997–1998 financial crisis. This period and the
exogenous shock of the crisis provide a special opportunity for studying the relationship between
governance and dividends. Southeast Asian governments initiated programs of structural reforms
to remedy the inadequacies of governance mechanisms which are widely accepted as a major

∗ Email:jsawicki@iseg.utl.pt
ISSN 1351-847X print/ISSN 1466-4364 online
© 2009 Taylor & Francis
DOI: 10.1080/13518470802604440
http://www.informaworld.com
212 J. Sawicki

cause of the crisis (Harvey and Roper 1999; Stiglitz 1999). Our study tracks changes in practices
at the firm level through annual governance scores computed for each firm across the 1994–2003
period, providing evidence of particular changes in governance pre- and post-crisis. In addition
to documenting changes in practices, we specifically investigate dividend payout and its role
pre- and post-crisis in providing returns to minority shareholders at risk of expropriation.
An interesting picture of dividend policy emerges. Evidence of a negative relationship between
governance and payout pre-crisis suggests that dividends substitute for good governance practices.
Dividends are very high in many firms during this period of high growth and large inflows of
financial capital. The evidence that poor governance is related to high dividends supports the
substitute theory where poorly governed firms use dividends to establish trust which is important
in raising future equity.
The picture changes post-crisis. The onset of the crisis prompted a radical cut in dividend pay-
out in response to capital outflows and fall in profits. We find evidence of a positive relationship
between governance and payout, consistent with dividends as an outcome of good governance. The
post-crisis dividend role-reversal suggests that improvements in shareholder protection empow-
ered minority shareholders with the ability to extract cash from corporate insiders. We also find
that country-level governance is significantly related to payout, illustrating the importance of legal
regime where common law countries’ better protection of investor rights is associated with higher
dividends.
An important aspect of our results is that firm-level governance is incremental to legal regime
effects. Prior to the crisis firm-level governance is not significant, whereas the legal regime is
related to dividend payout. Both levels of governance are significant post-crisis, suggesting that
improvements in internal governance are important in shaping the nature of investor protec-
tion. This result indicates that dividends are an outcome of both legal and internal mechanisms
protecting minority shareholders’ interests.
The article proceeds with a discussion in the following section of the literature relevant to the
Asian financial crisis and governance theme of our study with particular focus on dividend policy.
Section 3 describes the data and methodology, followed by trend/comparative analysis and results
of regression tests in Section 4. Section 5 concludes with an overview of our findings, limitations
of the study and suggestions for future research.

2. Background
Poor corporate governance is often cited as a major cause of the breakdown of several East Asian
economies during the 1997–1998 financial crisis. Solid macroeconomic fundamentals like low
budget deficits, low inflation and high GDP growth during the years preceding the crisis obscured
weak corporate governance and structures inappropriate to open economies. The lack of proper
disclosure and auditing exacerbated minority shareholders’ exposure to abuses by controlling
families and/or governments. Claessens and Fan (2002) provide a comprehensive picture of
corporate governance in the region, confirming the lack of protection of minority rights as a major
issue, in an environment of low transparency, rent-seeking and relationship-based transactions,
extensive group structures and risky financial structures.
Many studies report evidence of the role of corporate governance in the Asian financial crisis.
Johnson et al. (2000) provide a direct link between governance and exchange rate and stock
market depreciation, with evidence that governance measures provide a stronger explanation for
the currency and equity declines than standard macroeconomic measures. Lemmon and Lins
(2003) capture the potential for expropriation by insiders with a ratio of cash flow rights to
 The European Journal of Finance 213

control rights. They find a positive relation between the ratio and value erosion during the crisis,
confirming the vulnerability of minority shareholders to expropriation.
The Asian financial crisis of 1997–1998 presents a unique opportunity for studying agency
conflicts and their effects. As Lemmon and Lins (2003) point out, endogeneity problems arising
from the joint determination of many of the relationships being tested in this literature weaken the
reliability of tests. As an exogenous event, the crisis offers the potential to allay these concerns.
This article investigates changes in governance over a 10-year period surrounding the crisis,
with a focus on a particular relationship: dividend payout and governance quality. Dividends have
been shown to play an important role in corporate governance. In early work Rozeff (1982) models
dividends as a function of growth, beta and agency costs. Underlying the model is the visibility
that dividend payout creates.2 Rozeff uses ownership concentration as a proxy for agency costs,
reasoning that more highly dispersed owners have more difficulty monitoring and controlling man-
agers. His evidence of a negative relationship between dividends and concentration confirms the
importance of payout policy in managing managers. Jensen, Solberg and Zorn (1992) corroborate
this using a system of equations to capture the simultaneous determination of ownership structure,
debt and dividend policy. In recent work, Kose and Knyazeva (2006) find that firms with weak
governance pay higher dividends and the relationship is stronger for firms with high free cash flow.3
Ownership concentration has been shown to be negatively related to dividends in Asia as
well (Faccio, Lang, and Young 2001). However, this has been interpreted as a result of agency
conflicts, rather than an alignment of interest. The preceding examples are in the context of
dispersed ownership, typical of firms in the United States and the United Kingdom where agency
problems arise in a traditional shareholder-versus-manager conflict. However, an alternative view
is more pertinent in countries where family and state ownership are common: outsiders have
cash flow rights but few control rights and need to protect themselves from expropriation by
controlling shareholders. The real conflict in these countries is between outside investors and
controlling shareholders who control the managers (La Porta et al. 2000). Supporters for this
view include Claessens, Djankov, and Lang (2000) who show that risk of expropriation is the
major principal–agent problem for firms in East Asia as opposed to empire building.
La Porta et al. (2000) present two models that can help in explaining dividend policies in the
emerging markets: the outcome model and the substitute model. According to the outcome model,
dividends are a result of the effective pressure by minority shareholders to force insiders to pay out
profits. Governance practices such as the power to change directors, induce payout, sue directors,
or liquidate the firm and receive the proceeds are some of the mechanisms that protect minority
shareholders. In such firms, shareholder insistence on the distribution of excess cash is less likely
to fall on deaf ears than in firms with attributes associated with managerial entrenchment or
weak governance. The ‘correct’ dividend policy is the outcome of the governance regime in this
view because managers of firms with good governance are more likely to act in the interests of
shareholders and pursue value-maximizing policies, such as the payment of dividends when the
firm’s fundamentals warrant such a policy, than are managers of firms with weak governance.
On the other hand, the substitute model predicts that weaker minority shareholder rights are
associated with higher dividends. According to this model, insiders can use dividend payout to
establish a reputation for decent treatment of minority shareholders. In this sense dividends act
as a pre-commitment or bonding mechanism.4 An important element in this view is the need for
firms to access funds in capital markets. Lowering the cost of future funds provides the incentive to
establish a positive reputation with minority shareholders. In this sense, payout is more valuable
in countries with weak legal protection since outsiders do not have other protective measures
on which to rely. Stronger shareholder protection lessens the need to establish a reputation via
214 J. Sawicki

dividends. Thus in the substitute model, a negative relationship is expected between payout and
governance quality.
What precisely determines the power of minority shareholders? La Porta et al. (1997, 1998)
focus on the legal regime: laws and the effectiveness of their enforcement. When the rules (such
as the voting rights of the shareholders) are properly enforced, minority shareholders are well
protected and are willing to finance firms. However, when the rules and their enforcement are weak,
minority shareholders are exposed to expropriation and tunneling. La Porta et al. (2000) document
evidence consistent with the outcome model. In countries with weak investor protection, minority
shareholders receive lower dividends than in countries where investor protection is relatively
strong.
Protection of minority shareholders depends not only on country-level governance but also
on firm-level governance practices. La Porta et al.’s (2000) investigation is conducted at the
country level, comparing dividend payouts across governance systems provided by different legal
regimes. They do not control for governance differences at the firm level. This article furthers
the investigation, applying their framework to a setting where firms in different legal regimes
have attributes that offer shareholders a differential voice in the governance of the corporation
depending upon proper/improper governance practices of the firm.
Considerable variation in firm-level governance mechanisms in Southeast Asian countries
makes this an ideal laboratory to relax La Porta et al.’s (2000) implicit assumption of within-
country consistency. Prior literature has used firm-level governance differences to explain different
aspects of firm performance. For example, Mitton (2002) uses the differences in firm-level cor-
porate governance mechanisms to explain firm performance in Indonesia, Malaysia, Thailand,
South Korea and Philippines. In a study looking at governance and investor protection in emerg-
ing markets, Klapper and Love (2004) confirm that better operating performance and valuation
are related to better governance in these countries.
We use these differences to explain another aspect of firm performance, dividend policy. The
article is similar in spirit to Mitton (2004) who uses Credit Lyonnais Securities Asia (CLSA) 2001
corporate governance ratings for firms from 19 emerging markets to study the impact of firm-
level corporate governance on dividend payouts. He shows that the firms with higher corporate
governance ratings have higher dividend payouts during the following year, 2002. The study
extends Mitton (2004) to a 10-year period spanning the Asian financial crisis providing important
time series evidence of the relationship pre- and post-crisis. We also document changes in dividend
policy and governance across the period. The tests are described in the following section.

3. Data and methodology

Five countries are represented in this study: Indonesia, Malaysia, Thailand, Hong Kong and
Singapore. The countries were affected by the Asian financial crisis to varying degrees and differ
with respect to corporate culture, national personality and priorities. Data for 20 listed firms of
each country cover a 10-year period, 1994–2003. Firm selection is based on three criteria: (1)
current market capital (USD) of each firm greater than the country median; (2) availability of
annual reports; (3) financial data on dividend payout ratio, return-on-investment (ROI), profit,
beta, sales, total asset and equity reported in the Thomson One analytical database.
The governance index constructed to measure corporate governance is based on nine criteria
identified in Table 1.
The criteria capture various aspects of a firm’s structure, policies and practices that constitute
good governance practices.5 A total score for each firm is calculated each year. Each question is
 The European Journal of Finance 215

Table 1. Criteria used in estimating the governance index.

Board of Directors One-third independence of the board, as measured by the number of independent
directors divided by total number of directors
Chairman and CEO separation
Largest director’s shareholding (as measured using direct interest and deemed
interest divided by total issued shares) below 5% of issued capital
Audit Existence of an audit committee
Disclosure of frequency of audit committee meeting
Expertise of audit committee
Engagement of Big Six auditors
Remuneration Existence of a remuneration committee
Nomination Existence of a nomination committee

This table identifies the criteria used in constructing the governance index. Each question is constructed in a manner such
that the answer ‘yes’ adds one point to the governance score. The rating is on a scale of zero to nine, with a higher score
indicating better governance. A total score for each firm is calculated each year.

constructed in a manner such that the answer ‘yes’ adds one point to the governance score. Thus,
the rating is on a scale of zero to nine, with a higher score indicating better governance. All of the
information is from the annual report and a company is deemed not to have followed a practice
if the fact is not explicitly stated in the annual report or cannot be inferred clearly from other
information provided in the annual report.
Descriptive statistics of the data by country classified into pre-crisis (1994–1996), crisis
(1997and 1998) and post-crisis 1999–2003 are reported in Table 2.
The scores indicate improvements in corporate governance with means of 3.08, 3.48 and
5.66 in the respective sub-periods. Malaysia’s average of 3.85 is the highest rating in the first
period, whereas Thailand’s average of 2.12 ranks last. From period two, Singapore holds the top
spot and Indonesia falls to the lowest rating, where they remain. Singapore’s rapid improvement
accords with its reputation for efficiency and responsiveness to changing conditions. On the other
hand, Indonesia has been long plagued by cronyism and corruption to which the country finally
responded with a coup deposing the long-time ruler Suharto in 1998. The country continues to
struggle with slow reforms and improvements.6
Table 3 compares the average values for payout, profitability and growth in the pre- and post-
crisis periods.
The differences pre- and post-crisis reflect the severity of the impact of the crisis and speed of
recovery of firms in the various countries. Indonesia, Thailand and Malaysia were among the hard-
est hit, whereas Singapore and Hong Kong’s economies were less affected. Although the impact
on the region was severe, many countries (with the exception of Indonesia) rebounded rapidly.
The dividend payouts are consistent with the substitute model in the pre-crisis period. In this
model, dividends provide evidence of fair treatment (i.e. investment returns) of minority sharehold-
ers. This is especially important in raising future capital on reasonable terms. During the pre-crisis
period, the highest dividends are paid in the Thailand and Indonesia with the lowest governance
scores (2.12 and 2.72, respectively, compared with around 3.5 for the others). This weakness
in firm-level governance is compounded by poor legal protection of minority shareholders and
corruption in these countries. In addition, the growth rates are very high.
The changes in the post-crisis period indicate support for the outcome model. Dividends fell
dramatically in Thailand and Indonesia, where the generous dividends were no longer sustainable,
216 J. Sawicki

Table 2. Descriptive statistics by country.

Governance Payout Equity¶

score∗ ratio† ROI‡ Growth§ USD million
Mean Mean Median S.D. Mean Mean Mean

Pre-crisis 1994–1996
Thailand 2.12 36.1 37.1 22.2 11.46 0.33 676.09
Indonesia 2.72 29.2 26.6 14.9 17.94 0.27 782.29
Hong Kong 3.07 39.1 36.4 16.1 11.26 0.14 7300.02
Singapore 3.67 29.0 23.2 21.1 8.22 0.20 1735.37
Malaysia 3.85 23.3 17.3 17.7 17.15 0.37 1271.29
All 3.08 31.4 27. 1 19.4 13.09 0.32 2412.89
Crisis 1997–1998
Thailand 2.95 13.3 0 23.6 −6.80 0.00 419.90
Indonesia 2.93 17.1 12.7 19.8 −3.47 −0.18 137.19
Hong Kong 3.60 48.4 49.3 24.0 9.34 0.14 7959.08
Singapore 3.98 33.1 27.7 22.6 8.55 0.00 1892.03
Malaysia 3.93 24.1 25.1 13.8 11.25 0.06 1117.38
All 3.48 28.6 26.7 24.2 3.80 0.01 2359.25
Post-crisis 1999–2003
Thailand 5.92 14.3 0 23.8 8.29 0.10 564.85
Indonesia 4.36 13.8 0 21.1 −1.44 0.20 351.08
Hong Kong 5.36 46.6 42.9 22.9 10.34 0.08 9923.07
Singapore 6.45 36.6 33.5 23.8 6.85 0.05 2266.24
Malaysia 6.19 27.6 23.3 19.2 7.93 0.09 1349.82
All 5.66 27.2 23.4 25.5 6.46 0.10 2903.90

This table reports descriptive statistics of the governance score, payout, profitability, growth and size of the firms in each
country.
∗ Governance score is calculated on a scale of 0–9. See Table 1 for measurement criteria.

† Payout ratio = Dividends (Cash)/Net Income − Preferred Dividend.

‡ ROI = Return-on-investment = Net Income/ Avgerage Shareholders Equity.
§ Growth = % change in assets.
¶ Equity = market value of equity at year end (shares outstanding xshare price).

Table 3. Comparison of means.

Payout ROI Growth

Pre Post p-value Pre Post p-value Pre Post p-value

Thailand 36.1 14.3 0.001∗ 11.46 8.29 0.034∗ 0.33 0.10 0.000∗
Indonesia 29.2 13.8 0.000∗ 17.94 −1.44 0.000∗ 0.27 0.20 0.001∗
Hong Kong 39.1 46.6 0.003∗ 11.26 10.34 0.406 0.14 0.08 0.008∗
Singapore 29.0 36.6 0.010∗ 8.22 6.85 0.247 0.20 0.05 0.000∗
Malaysia 23.3 27.6 0.552 17.15 7.93 0.008∗ 0.37 0.09 0.008∗

Pre- and post-crisis values for dividend payout, return-on-investment (ROI) and percentage growth in assets are provided
in this table.
Two tailed t-tests of the difference between the means were conducted.
∗ p-value indicates statistical significance.
 The European Journal of Finance 217

nor valuable in creating a bond lowering cost of capital. Dividends in Singapore, Hong Kong
and Malaysia rise in the post-crisis period, and their governance scores improved dramatically.
Profitability and growth are lower post-crisis in all counties.
The governance scores are used to investigate the relationship between governance and div-
idends over the decade. We compare the La Porta et al. (2000) outcome and substitute models
of dividends. In the former, dividends are expected to be related positively to governance qual-
ity, which gives minority shareholders power to force insiders to hand over cash. The latter
model predicts a negative relationship where dividends substitute for the lack of other governance
mechanisms. These predictions are tested with the following model:

Divi,t = α0 + α1 (Govi,t ) + α2 (Pr ofiti,t ) + α3 (Betai,t ) + α4 (Gri,t ) + α5 (Szi,t ) + α6 (Peri,t )

 
+ βc Ctrc + βs Inds (1)

where:

Dividends (Cash)
Divi,t dividend payout firm i, time t = × 100,
Net Income − Preferred Dividend
Govi,t index score for firm i, time t, determined by measures identified in Table 1,
Net Incomet
Profiti,t ROI firm i, time t = ,
(ShEquityt−1 + ShEquityt )/2
Betai,t proxy for risk (operating and financial leverage) of firm i, time t,
TotalAssetst − TotalAssetst−1
Gri,t % change in assets firm i, time t = ,
TotalAssetst−1
Szi,t size firmi (logarithm of market value of common equity, USD millions, year t),
Per binary variable partitioning pre-crisis (1994–1996) and post-crisis (1999–2003) periods,
Ctr binary variable to distinguish between countries,
Ind binary variable to distinguish between industries (consumer, industrial, basic materials,
energy, technology, utilities and financial).

Equation (1) specifies the relationship between corporate governance and dividends, while
controlling for other interactions. The main variable of interest is the governance score, Gov.
The outcome model predicts a positive coefficient, indicating that dividend payout increases with
minority shareholder ability to force dividends through better corporate governance. The alter-
native model predicts a negative governance coefficient with dividends increasing as governance
becomes weaker. In the substitute model, insiders use dividends to signal fair treatment of minor-
ity shareholders, which they deem important to raising funds on reasonable terms in the future.
Poorly governed firms have a greater need for this payout bond.
Critical to the tests of the alternative models is the time period. The exchange rate depreciations
and stock market declines in East Asian countries in 1997–1998 interrupted a period of robust
growth and profitability. The radical changes in the investment and financing opportunities, as
well as corporate governance, call for specific consideration. The pre-crisis environment of easy
access to capital, rapid growth and abundant investment opportunities, coupled with weak gov-
ernance, favors the substitute model. Less-established, growing firms without a reputation for
proper treatment of minority shareholders would be inclined to use dividend payout as a means
of sending this signal and establishing trust. Important to the substitute model is the foresight of
218 J. Sawicki

raising future capital, which is also apropos to the optimism and growth of the Asian tigers. A
negative coefficient for the governance variable would confirm this.
The crisis stimulated change in corporate governance. Rapid improvements are seen in the
governance scores reported in Table 2. In addition to this, investment opportunities, growth and
profitability were severely eroded. Although dividends are predicted to lose their substitute role,
it is not clear whether the empowerment of shareholders was sufficient to drive an outcome role.
If so, a positive relationship post-crisis (supporting an outcome model) is expected.
A binary variable is included in the equation to distinguish between time periods. This allows
the regression estimates to reflect different levels of dividends (due to profits, growth investment
opportunities and capital flows) and governance quality in the two periods. A further step is taken
in estimating separate regressions for the pre- and post-crisis period.
Controls for country differences (crisis severity, recovery and governance) as well as other
variables that have been shown to affect dividend policy have also been included. Dividends are
often modeled as a trade-off between costs of outside financing and agency. Proxies for these costs
that have been shown to be negatively related to dividends include growth (Fama and French,
2001; Smith and Watts 1992), leverage and beta (Jensen, Solberg, and Zorn 1992; Rozeff 1982).
Larger firms’ greater capacity to sustain dividends results in a positive relationship between size
and dividends (Fama and French 2001; Redding 1997). Industry has also been shown to be related
to dividend policy (Baker 1988; Michel and Shaked 1986).

4. Results
Country-level governance scores are calculated by the sum of individual firm scores. The maxi-
mum annual score for each country is 180 points (each firm can have a maximum score of nine
points and there are 20 firms in each country). A summary of the overall corporate governance
scores is depicted in Figure 1. Scores for the individual proxies are in Figures 2–10.
The general level of governance was relatively poor in the earlier years (1994–1997), with all
countries having scores below the mid-point of 90. Malaysia led in those 3 years with scores of 79,
76 and 78. Thailand on the other hand, has the lowest scores of 43, 42 and 48. The differentiating
factors were greater board independence and the use of ‘Big Six’ auditors.

Figure 1. Total Governance Score.

 The European Journal of Finance 219

Figure 2. Independence of the board.

Figure 3. CEO-chairman separation.

Figure 4. Director shareholding.

220 J. Sawicki

Figure 5. Existence of audit committee.

Figure 6. Frequency of audit committee meetings.

Figure 7. Expertise of audit committee members.

 The European Journal of Finance 221

Figure 8. Existence of nominating committee.

Figure 9. Existence of a remuneration committee.

Figure 10. Auditor.

222 J. Sawicki

Early improvements in governance addressed board independence and auditing with the engage-
ment of ‘Big Six’ auditors and establishment of audit committees. By 1998, Singapore replaced
Malaysia as the leader with 83 points. Thailand’s governance also improved tremendously from
48 in 1997 to 70 in 1998, leaving Indonesia with the lowest ranking of 60 points. In general, the
evidence is consistent with the belief that governance was an important factor in the crisis as the
worst hit countries (Thailand and Indonesia) had the lowest pre-crisis scores.
Governance scores continue to increase for all the countries after the crisis. The effect of
Thailand’s rapid economic restructuring and emphasis on governance improvements are evident in
its rise from last position in 1997 to leader in 1999 and 2000, and in being the first country to break
the 100 points barrier. Hong Kong follows an interesting trend. The substantial improvements
immediately following the crisis stall in 2001, while all the other countries’ scores continue to
improve. By 2003 it had fallen far behind Singapore, Malaysia and Thailand and is on par with
Indonesia.
Doidge, Karolyi and Stulz (2007) present a model that explains firm-level governance improve-
ments in terms of country-level characteristics and is helpful in interpreting the governance
changes documented here. The model relates legal and economic/financial development to the
incentives that firms have to institute good governance. Table 4 presents summary statistics that
are relevant to the model.
Singapore and Hong Kong are very different from the other countries in terms of prosperity (per
capita GDP) and susceptibility to the crisis. There is a clear distinction between the three common
law countries (Singapore, Malaysia and Hong Kong) and the civil law countries (Thailand and
Indonesia) on the basis of ownership concentration, and legal and corruption indices.
Doidge, Karolyi and Stulz (2007) model the effects of minority shareholder legal protection and
the level of economic and financial development on individual firm governance practices. They
argue that the trade-off between the costs and benefits of improved transparency and governance
determine the extent to which the firm will choose to improve on investor protection granted
by the state. In countries with weak development, costs of improvement are high because the
institutional infrastructure is weak. With lower costs of capital, the primary benefits are limited
because capital markets lack depth. They find that country characteristics explain most of the

Table 4. Factors relevant to governance improvements.

GDP per
Average capita USD % GDP
score (000’s) growth
Pre Post 1997 1996 1998 Ownership∗ Judicial† Rule of law† Corruption†

Singapore 3.67 6.45 15.47 7.6 0.4 29.9 10.0 8.57 8.22
Hong Kong 3.07 5.36 12.44 4.5 (5.1) 34.4 10.0 8.22 8.52
Malaysia 3.85 6.19 3.39 7.5 (7.5) 28.3 9.0 6.78 7.38
Thailand 2.12 5.92 1.87 5.5 (10.0) 53.5 3.25 6.25 5.18
Indonesia 2.72 4.36 0.78 8.0 (13.7) 61.7 2.50 3.98 2.15

This table summarizes the average governance scores, measures of economic performance and institutional environment.
Sources: World Bank Statistics, Claessens, Djankov and Lang (2000) and La Porta, Lopez-de-Silanes, Shleifer (1999).
∗ Ownership concentration = the percentage of control among the top 15 families.
† The indices rank from 0 to 10 (worst to best). The judicial index assesses efficiency and integrity of legal systems as it
affects business, especially foreign firms.
 The European Journal of Finance 223

variation in firm governance scores. A small portion of firm governance scores is explained by
firm characteristics, and in less developed countries the relationship is virtually nonexistent.
The evidence is consistent with Doidge, Karolyi and Stulz’s (2007) prediction and findings
that the incentives to improve firm-level governance increase with a country’s legal environment,
and financial and economic development. Pre-crisis governance scores for Singapore, Hong Kong
and Malaysia are much higher than Thailand and Indonesia. Increases in scores also accord with
the theory. All of the scores reflect initiatives at both the government and firm levels to respond
to corporate governance weaknesses exposed by the crisis. Singapore’s rapid rise to top spot
reflects the responsiveness of an efficient, progressive government and an open economy. Despite
its lower level of economic development, Malaysia’s capital market development and rule of
law are important factors in both the high pre-crisis score and improvements. Thailand’s low
score pre-crisis shows the most improvement and reflects the government initiatives to improve
governance.
The case of Indonesia can be summed up as the Suharto regime. Underlying the three-decade
rule were political manipulation, corruption and support from armed forces. The severity of the
effects of the crisis and its slow recovery are the results of the country’s failure to develop, for exam-
ple: political institutions, corporate governance, protection of intellectual property rights, defined
transparent bankruptcy laws and supervision of the financial sector. The firm-level governance
scores and improvements are a reflection of the lack of institutions and economic development,
and are certainly consistent with Doidge, Karolyi and Stulz’s (2007) model.
The governance scores are used in our investigation into the relationship between governance
and dividend policy over the decade. La Porta et al.’s (2000) outcome and substitute models of
dividends provide the framework for the tests. In the former, dividends are expected to be related
positively to governance quality which gives minority shareholders power to force insiders to hand
over cash. The latter model predicts a negative relationship where dividends substitute for the lack
of other governance mechanisms. Parameter estimates of Equation (1) are reported in Table 5.
The first two columns report results of estimating the model over the entire period. Governance
is insignificant when no distinction between pre- and post-crisis is made (column one), but it is
significant and positive when the period controls are added (column two). Investigating further, we
estimate the separate regressions for the pre-crisis (1994–1996) and post-crisis (1999–2003) peri-
ods. The negative governance coefficient in column three indicates that lower governance scores
are related to higher dividends, consistent with a substitute role for dividends. The relationship is
no longer significant when the country control variables are included (column four), indicating
that country-level variation replaces the role of firm-level variation in explaining dividend payout.
These dynamics are related to the fact that the countries paying the highest dividends prior to the
crisis, Indonesia and Thailand, tend to have the lowest governance scores. The results suggest that
country-level governance is relevant to explaining dividends and are consistent with the substitute
model pre-crisis. This is further investigated and supported by our subsequent legal regime tests.
The post-crisis results reveal an entirely different relationship. Many firms responded to the
capital flight and currency depreciation by cutting dividend payments drastically. Dividends’ pre-
crisis negative relationship to governance reverses. The positive governance coefficient in column
five is consistent with the outcome model where better governance is related to higher dividends
and the weaker governance firms are paying lower dividends. Also contrasting with the pre-crisis
results is the continued significance of the governance coefficient in column six after adding the
country-level controls. The post-crisis positive relationship between dividends and governance
holds at the firm level, consistent with dividends as an outcome of governance practices adopted
by the individual firm.
 224
J. Sawicki
Table 5. Governance and dividend payout.

Entire period Pre-crisis Post-crisis

(1) (2) (3) (4) (5) (6)

Gov 0.04 (1.10) 0.12∗(2.64) −0.14 (−2.01) 0.03 (0.43) 0.14∗ (2.97) 0.17∗
(3.66)
Profit 0.05 (1.48) 0.04 (1.31) −0.023 (−0.32) −0.039 (−0.56) 0.055 (1.26) 0.039 (0.95)
Beta −0.23∗ (−6.63) −0.23∗ (−6.59) −0.27∗ (−4.02) −0.27∗ (−4.05) −0.27∗ (−6.01) −0.24∗ (−5.35)
Gr −0.05 (−1.65) −0.06 (−1.76) −0.07 (−1.12) −0.06 (−1.01) 0.077 (1.79) 0.087∗ (2.10)
Sz 0.02 (0.37) 0.01 (0.20) −0.11 (−1.45) −0.24∗ (−2.83) 0.28∗ (5.93) 0.03 (0.44)
Period No Yes No No No No
Industry Yes Yes Yes Yes Yes Yes
Country Yes Yes No Yes No Yes
Adj. R 2 0.22 0.22 0.13 0.23 0.25 0.32

This table reports regression coefficients estimated with the model:

Divi,t = α0 + α1 (Govi,t ) + α2 (Pr ofiti,t ) + α3 (Betai,t ) + α4 (Gri,t ) + α5 (Szi,t )

 
+ α6 (Peri,t ) + βc Ctrc + βs Inds

Div is dividend payout. Gov is a score on scale of 0–9 rating governance quality (Table 1). Profit is return-on-investment, Beta is systematic risk, Gr is the 1-year growth
rate of assets and Sz is the log of common equity. Per, Ctr and Ind are period, country and industry binary control variables. t-statistics are reported in parentheses.
∗ Statistical significance at 95% confidence level.
 The European Journal of Finance 225

In all tests, beta is negative and significant, consistent with a well-supported inverse relationship
between risk and payout.7 ROI is not significant. Other studies that find a positive relationship
between profitability and dividends are explained by the fact that profitable firms have more cash
available payout (Fama and French 2001; Mitton 2004). The volatility of this measure for many
of the firms in this sample over the period may explain this result.
The growth coefficient is negative in the pre-crisis period, consistent with the reasoning that
high growth firms retain cash for expansion, confirmed in other studies. The positive relationship
post-crisis could point to a lack of forward-looking investment opportunities during this period,
or the fact that firms with the highest governance scores are good firms with sufficient cash to pay
out dividends while adding to their asset base.
Size is negatively related to payout in the pre-crisis period, indicating that the smaller the
firm, the higher the payout. This contradicts the expectation that the greater stability and cash
reserves of large firms support a higher dividend level and common empirical findings that size
and payout are positively related (Fama and French 2001; Rozeff 1982). In the context of the
Thai and Indonesian economic bubble, it may be explained by smaller, less-established firm’s
greater susceptibility to the exuberance and optimism of the period, and a willingness to dis-
tribute earnings freely. However, easy access to capital does not necessarily mean firms will
be generous with payouts. When investment opportunities are abundant, firms will still want
to retain earnings to avoid transaction costs of raising new capital. The negative relationship
between governance and dividends we find supports the substitute theory where poorly governed
firms use dividends to establish trust which is important in raising future equity. A crucial ele-
ment of the substitute view is the need for firms to come to the market to raise external funds.
Smaller firms with higher levels of expected growth, as well as lower levels of reinvested earn-
ings, would have a greater need to ‘assure’ investors, thus leading to a negative relationship
between size and payout. The post-crisis size coefficient is positive but insignificant after con-
trolling for country. This is driven by the fact that the largest firms are in the highest dividend
paying countries. Thus after adding the country controls, the variation at the firm level is not
significant.
Finally, we incorporate the impact of the legal regime following La Porta et al. (2000) who argue
that legal structure is very important to investor protection. They test this with country random
effects using dummy variables for legal origin and shareholder protection laws. Using a similar
approach, we use a binary variable to distinguish between civil law (Thailand and Indonesia)
and common law (Singapore, Malaysia and Hong Kong) countries. Equation (1) is modified
by replacing the country control binary variables with a binary variable to distinguish between
common law and civil law regime. The results are reported in Table 6.
The governance index is not significant when estimated across the entire period (columns one
and two) even after controlling for period, which contrasts with the results in Table 4. The negative
relationship between governance score and dividends is not significant; however, the substitute
model of dividends is confirmed for country-level governance through the negative significant
legal coefficient. The control for the law regime usurps the explanatory power of the governance
index, with a coefficient of 0.115 at a significance level of 1%.
Sub-period estimates are reported in columns three, four and five. As before, beta is negative and
significant in all periods. Similar to earlier tests, the negative pre-crisis size coefficient reverses
when the crisis hits, and becomes significant post-crisis. The negative relationship between size
and payout is not significant pre-crisis with the legal regime usurping the size effect. The negative
legal coefficient reverses to positive, consistent with the dividend payout in common law countries
higher (lower) post- (pre-) crisis as the descriptive statistics and earlier tests indicate.
226 J. Sawicki

Table 6. Dividend payout and legal regime.

Gov Profit Beta Growth Size Legal Adj. R 2

Pre-crisis −0.087 −0.019 −0.290∗ −0.062 −0.044 −0.162∗ 0.13

(−1.20) (−0.268) (−4.240) (−0.977) (−0.551) (−1.98)
Post-crisis 0.122∗ 0.045 −0.236∗ 0.078 0.149∗ 0.252∗ 0.25
(2.70) (1.06) (−5.03) (1.84) (2.65) (4.42)

This table reports regression coefficients estimated with the model:

Divi,t = α0 + α1 (Govi,t ) + α2 (Profiti,t ) + α3 (Betai,t ) + α4 (Gri,t ) + α5 (Szi,t )


+ α6 (Per) + α7 (Leg) + βs Inds

Div is dividend payout. Gov is a score on scale of 0–9 rating governance quality (Table 1). Profit is return-on-investment,
Beta is systematic risk, Gr is the 1-year growth rate of assets and Sz is the log of common equity. Per, Leg and Ind are
period, legal regime and industry binary control variables. t-statistics are reported in parentheses.
∗ Statistical significance.

The significant, positive post-crisis legal coefficient is consistent with La Porta et al.’s (2000)
findings and lends support to the outcome model of dividends. It is also reflective of the fact
that the common law countries were also less affected by the crisis and their recovery was much
smoother than countries in the civil law regime.
An important result of these tests is the evidence provided by the governance coefficient.
Its relationship to dividend payout pre-crisis is insignificant; however, post-crisis it is signifi-
cant at a 1% level with a coefficient of 0.122. This result reinforces the view that governance
began to have significant influence on payout only after implementation of good practices. It
also indicates that both country-level and firm-level governance are important to dividends paid
out to shareholders. Although country-level governance sets the overall tone for the economy,
each firm can choose to ignore the prescribed code of governance or even implement addi-
tional measures. The significance of both the governance and legal variables confirms that both
levels of governance play complementary roles in improving transparency, accountability and
protection.
Some comments on limitations and extensions are appropriate before concluding. The sample
comprises 100 large, surviving firms (20 in each of five countries). These large firms would have
less need for external financing in general and their survival suggests robustness not applicable to
the general population of firms, especially during the turbulent crisis period. Also, their size and
visibility would make them more inclined to improve governance. This can be reasoned in the
context of the Doidge, Karolyi and Stulz (2007) model where firms trade-off costs and benefits in
deciding to improve governance. This subset of largest firms would face lower costs (the value of
control rights is lower for these firms due to visibility) and benefits are potentially higher because
they are more likely to be active in capital markets. An important extension would be to expand the
data to include more firms and countries to provide more comprehensive evidence of governance
practices and dividends.
The governance scores are computed using the annual reports and are based on ‘yes or no’
answers, rather than inference. Although this provides a degree of objectivity, the information
available depends upon disclosure in the annual reports. If practices are followed but not reported,
results will be biased. For example, it is possible that some of the changes in the governance scores
reflect the post-crisis emphasis on governance prompting firms to report practices that had been
 The European Journal of Finance 227

Table 7. Governance index.

Variable Theory and evidence

Board independence Independent directors are in a better position to protect shareholders’

interest from managerial opportunism due to their independence from
management influence (Fama and Jensen 1983)
Firms with a higher percentage of independent directors have higher
market valuation (Dahya and McConnell 2007)
The fraction of stock held by the Board of Directors positively influences
Tobin’s Q at lower levels of ownership and declines at higher levels of
inside ownership (Morck et al. 1988)
CEO duality One person with a dual role as chairman and CEO faces conflicts of
interest in carrying out these separate roles (Conyon and Peck 1998)
Combined roles concentrate too much power in the hands of the CEO,
constraining board independence and reducing its ability to execute its
oversight and governance roles (Finkelstein and D’Aveni 1994)
Independent directors of the board perform a valuable role in mitigating
the agency conflicts and protecting minority shareholders’ interests
(Anderson and Reeb 2003)
Largest director ownership At a high level of equity ownership, mangers become entrenched and
pursue private benefits. Managerial ownership insulates top executives
from internal monitoring (Denis, Denis, and Sarin 1997)
Turnover is less sensitive to performance when officers and directors own
5–25% of the firm’s shares, than when they own less than 5%. At high
levels of ownership the effects of managerial entrenchment exert a
negative influence on firm value (Denis et al. 1997)
Audit committee Audit committees were first recommended by the New York Stock
Exchange as early as 1939. SEC followed suit in 1972 advocating
the establishment of audit committees. The audit committee is legally
bound to protect shareholder investment. Hence the existence of audit
committee is inseparable element of corporate governance
An effective audit committee is a salient feature of a sound corporate
governance system (DeZoort and Salterio 2001)
Auditor type External auditors have the role of ensuring reliability and fairness of the
financial statements prepared by management
The Big Six accounting firms are more likely to ensure transparency and
eliminate mistakes in firm’s financial statements because they have a
greater reputation to uphold (Michaely and Shaw 1995)
A firm has better disclosure if its auditor is one if the Big Six international
accounting firms (Fan and Wong 2004)
Remuneration committee The absence of independent remuneration committees would appear to
allow executives to write their own contracts with one hand and sign
them with the other (Williamson 1988)
Companies that have introduced remuneration committees between 1988
and 1993 have lower rates of growth in top director pay (Conyon and
Peck 1998)
Nomination committee Companies should establish a Nominating Committee to make
recommendations to the board on all board appointments (Singapore
Code of Corporate of Governance 2001)
A Nominating Committee provides an independent opinion and
recommendations for the best candidates to the board. In addition,
its existence indicates a formal and transparent process for the
re-appointment of existing directors and new directors (Singapore Code
of Corporate of Governance 2001)
228 J. Sawicki

followed but not reported. Also, low scores may reflect poor disclosure and not that a practice is
not followed. To the extent that the overall quality of governance (which our measure is meant to
capture) and disclosure are highly correlated, we do not expect biased results, especially in the
post-crisis period.
The scoring system is based on nine variables that are widely cited and used as proxies of
governance. Increased depth and breadth of criteria could help produce more accurate measures.
There remains much scope for investigation into the relationship between country-level and
firm-level governance in examining the interaction between them and their influence on firm
performance, agency problems and dividends. For example, interacting the legal regime with the
governance score would indicate whether the outcome model applies to firms in both regimes in
post-crisis. An important extension of this work would be explicit consideration of changes in the
investment opportunities and the reduction in the need for external funding following the crisis.
Firm characteristics are also helpful in explaining pre- and post-crisis relationships. Ownership
concentration is an important aspect of agency conflicts in the region and could be explicitly
modeled and tested. Also, focusing on dividend events over the period (i.e. whether payout was
maintained, reduced, eliminated or resumed) could yield interesting insights. These are just some
examples. As Claessens and Fan (2002) observe in their survey of corporate governance in Asia:
’Overall, the understanding of firm organizational structures, corporate governance practices and
outcomes remains limited, however’.

5. Concluding remarks
This study investigates dividends and governance in the context of the Asian financial crisis of
1997–1998 and the expropriation problem that minority shareholders face in countries with an
ownership structure that combines high control rights with low cash flow rights. We address
a question on the nature of the relationship: are dividends substitutes for, or the outcome of
governance practices? The answer in this particular setting: it depends.
In the pre-crisis period, there is a negative relationship between dividends governance. Higher
payout related to poor governance supports the substitute model. This is consistent with the
environment of rapid GDP growth, large capital inflows and generally poor governance. In the
substitute model, a key element is the incentive to lower the costs of future equity by building a
positive reputation with minority shareholders. Dividend payout is a clear effective mechanism,
especially useful to firms lacking other sources of reputation. Further evidence supporting this
interpretation is that during this period there is a negative relationship between size and dividends.
Smaller firms would have a greater need to establish their reputation with minority shareholders
as well as a higher likelihood of planning to return to capital markets for external funds.
Governance scores improved substantially after the onset of the crisis and dividends fell radi-
cally as the need to conserve cash to deal with the lack of capital and liquidity became paramount.
While dividends could be expected to lose their boom-time substitute role, a reversal in the rela-
tionship between governance and dividends does not necessarily follow. Yet, the results indicate
a positive relationship between dividends and corporate governance post-crisis period consis-
tent with the outcome model. After reforms were instituted, higher dividends are paid by better
governed firms, indicating the influence of governance in protecting minority rights by forcing
more cash to be returned to investors.
Finally, the findings indicate that dividends are an outcome of both legal and internal mech-
anisms protecting minority shareholders’ interests, confirming that both firm- and country-level
governance are important in shaping the nature of investor protection.
 The European Journal of Finance 229

Acknowledgements
The author is grateful for comments from an anonymous referee, Omar Farooq, and Marvin Wee; and for the research
assistance of Ryan Chan.

Notes
1. Lintner (1956) and Gordon (1959) argue that investors prefer dividends (in the hand) to capital gains (risky because
these gains are in the bush). This is moot in the Miller and Modigliani model because reinvestment of dividends at
risk identical to retained earnings.
2. Firms subject themselves to the scrutiny of capital markets by paying dividends and increasing frequency of raising
capital (see Easterbrook 1984).
3. Dividends commit free cash flows, thereby forcing managers to operate more efficiently and avoid unprofitable
projects (Jensen 1986).
4. See Kose and Knyazeva’s (2006) work on dividends as a pre-commitment.
5. Theoretical and empirical substantiation of the measures as contributors to better corporate governance is provided
in Table 7.
6. Details and discussion of governance changes in all countries are provided in Section 4.
7. Earnings and sales volatility were also used as proxy for risk and we find similar results, not reported here.

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