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IJMF
19,4 International evidence on the
relationship between corporate
ethics and dividend policy
890 Omar Farooq
School of Business, ADA University, Baku, Azerbaijan, and
Received 2 November 2020
Revised 12 June 2022 Neveen Ahmed
17 June 2022
9 August 2022
Institute of National Planning, Cairo, Egypt and
14 August 2022 American University of Beirut, Beirut, Lebanon
16 August 2022
Accepted 19 August 2022
Abstract
Purpose – This paper aims is to document the relationship between corporate ethics prevailing in the country
and the dividend policies adopted by firms.
Design/methodology/approach – The paper uses the data of non-financial firms from 61 countries to test
the arguments presented in this paper. The data cover the period between 2010 and 2017.
Findings – This paper shows that dividend policies adopted by firms are sensitive to corporate ethics
prevailing in the country. The firms headquartered in countries with relatively strong corporate ethics are less
likely to pay dividends than firms headquartered in countries with relatively weak corporate ethics. These
findings are robust across various proxies of dividend policy and across various estimation procedures. The
paper, however, also shows that the relationship between corporate ethics and dividend policies is confined
only to countries with strong institutional environment. This relationship breaks down in countries with weak
institutional environment. Lastly, the paper shows that the value of dividend policy is more pronounced in
countries with relatively weak corporate ethics.
Originality/value – Unlike the attempts to relate firm-level ethics and dividend policy, this paper focuses on
the relationship between country-level indicator of corporate ethics and dividend policies. The benefit of using
the country-level indicator of corporate ethics is that it highlights the general attitude of corporations with
respect to ethics.
Keywords Ethical behavior, Dividend policy, Reputation, Social responsibility
Paper type Research paper

International Journal of Managerial
Finance
Vol. 19 No. 4, 2023
pp. 890-909
© Emerald Publishing Limited
1743-9132
DOI 10.1108/IJMF-11-2020-0561
1. Introduction
Plentiful of prior literature has highlighted the factors responsible for dividend polices
adopted by firms (Farooq and Aktaruzzaman, 2020; Farooq and Ahmed, 2019; Kowalewski
et al., 2008; La Porta et al., 2000). These factors range from country-specific factors (legal
tradition, national culture, enforcement mechanisms, political uncertainties and shareholder
rights) to firm-specific factors (profitability, growth opportunities, agency problems and
corporate governance mechanisms). Farooq and Ahmed (2019), for example, highlight the
importance of country-specific factors by documenting significant impact of political
uncertainty on dividend policies adopted by firms. They show that firms pay higher
percentage of their earnings as dividends during periods characterized by high political
uncertainty. In contrast, Lin et al. (2017) document the importance of firm-specific factors by
reporting significant relationship between agency problems and dividend payments. They
show that firms with higher information asymmetries are less likely to pay dividends.
A closer look at prior research reveals that one factor that has received relatively lower
attention is how corporate ethics affect the dividend policies adopted by firms. The initial
attempts on documenting the relationship between corporate ethics and dividend policies
were made by Cheung et al. (2018), Benlemlih (2019) and Salah and Amar (2022) [1]. They
show that ethical firms (as measured by corporate social responsibility) are more likely to pay
dividends. Our paper is closer in essence to these papers, but it differs from them by focusing Corporate
on the country-level indicator of corporate ethics. We believe that the benefit of using country- ethics and
level indicator of corporate ethics, instead of using the firm-level indicator, is that it highlights
the general attitude of corporations toward ethics and how dividend policies are affected by
dividend policy
this general attitude. We expect that the general attitude toward ethics should affect every
firm operating in the country.
In this paper, we argue that corporate ethics prevailing in the country can affect the dividend
policies adopted by firms. We highlight two possible reasons for this relationship. First, the 891
countries that score high on corporate ethics have strong institutional infrastructure. Agyemang
et al. (2014), for instance, report strong correlation between corporate ethics prevailing in the
country and the institutional characteristics, such as rule of law, regulatory quality, control of
corruption and democracy. They argue that, in countries where institutional environment is
compromised, ethical issues are also largely neglected. We argue that strong institutional
environment associated with countries that score high on corporate ethics can have significant
impact on dividend policies adopted by firms. Prior literature notes that, in countries with strong
institutional environment, firms have relatively lower incentives to pay dividends (Botoc and
Pirtea, 2014; Jordan et al., 2014; Sawicki, 2009; La Porta et al., 2000). The argument underlying this
relationship is that dividends can act as a substitute for legal protection provided to shareholders
(La Porta et al., 2000). However, when institutional environment is strong, there is relatively lower
need to use dividends as a substitute for legal protection. Second, the countries that score high on
corporate ethics tend to have lower cost of capital. Prior literature documents that firms
headquartered in countries with high corporate ethics are less likely to hide or misreport
information (Barth et al., 2013; Cao et al., 2012; Francis et al., 2004, 2005). This strand of literature
maintains that these firms are more likely to produce high quality financial statements and have
relatively lower information asymmetries. Consequently, these firms have lower cost of capital
(Cao et al., 2015; Loughran and Schultz, 2005; Lehavy and Sloan, 2008). One outcome of lower cost
of capital is that it should encourage firms to reinvest, rather than pay dividends. We also argue
that whenever cost of capital is low, the opportunity cost of hoarding cash is low, thereby
increasing incentives for reinvestment. Under low cost of capital regimes, firms can accept projects
that were otherwise not feasible in the past, thereby leaving less room for paying dividends.
Consistent with above arguments, this paper shows that dividend policies adopted by
firms are sensitive to the corporate ethics prevailing in the country. Using a large data set
consisting of non-financial firms from 61 countries, this paper documents significantly lower
dividend payout ratios for firms headquartered in countries with relatively strong corporate
ethics than firms headquartered in countries with relatively weak corporate ethics. These
findings are robust across various proxies of dividend policy and across various estimation
procedures. Interestingly, this paper also shows that the negative relationship between
corporate ethics and dividend policies is confined only to countries with strong institutional
environment. In countries with weak institutional environment, this relationship reverses.
That is, corporate ethics and dividend payout ratios are positively related in countries with
weak institutional environment. More specifically, the paper shows that the effect of
corporate ethics on dividend payout ratios turns positive in countries that have weak
minority shareholder interests and weak auditing and reporting standards. This finding is
consistent with substitute model of dividends proposed by La Porta et al. (2000). In countries
with weak institutional environment, firms are more likely to use dividends as a signal to
build their reputation. As a result, we observe positive impact of corporate ethics on dividend
payouts in these countries. Lastly, the paper shows that the impact of dividend payout ratios
on firm value is more pronounced for firms headquartered in countries with relatively weak
corporate ethics. In these countries, dividends have greater ability to reduce information
asymmetries. Therefore, relative to countries with strong corporate ethics, dividend payout
ratios have stronger impact on firm value in countries with weak corporate ethics.
IJMF The remainder of the paper is structured as follows: Section 2 develops the hypothesis.
19,4 Section 3 summarizes the data and Section 4 presents assessment of our arguments. Section 5
presents additional tests and the paper ends with Section 6 where we present our conclusions.

2. Literature review and hypothesis development

2.1 Corporate ethics, information asymmetries and dividend policy
892 The traditional arguments in finance suggest that agency problems embedded in modern
corporations give rise to information asymmetries between managers and shareholders. An
important outcome of information asymmetries is that corporate managers are able to pursue
their self-serving motives with relative ease. The shareholders, therefore, want their firms to
adopt mechanisms that can reduce managerial opportunism [2]. One such mechanism that is
often used by firms to discipline managers is the dividend policy. Grossman and Hart (1980)
argue that high dividend payments curb managerial opportunism by reducing the free cash
flows available with managers. Jensen (1986) also presents similar arguments by reporting
that high dividend payouts lessen the agency conflicts between managers and shareholders.
He notes that high dividend payouts lower the agency conflicts by reducing the free cash
flows that can be expensed on unprofitable projects. La Porta et al. (2000) formalized the
above findings in the substitute model of dividends. According to their model, dividends can
substitute for the monitoring roles of stakeholders. They argue that firms respond to
information asymmetries by setting high dividend payments. By distributing high
proportion of earnings as dividends, firms send signals to investors and shareholders that
there is less cash that can be expropriated by managers, thereby reducing the agency
conflicts between managers and shareholders. Plentiful of literature that followed La Porta
et al. (2000) also showed that dividends can indeed substitute for corporate governance
mechanism. He et al. (2012) consider dividends as an effective way to communicate the
fairness and ethicality of wealth distribution among shareholders. Consistent with above
arguments, Ben Amar et al. (2018) document higher dividend payouts for firms with opaque
financial reporting. It is an indication that firms can use dividends to reduce information gap
that emerges due to opaque financial reporting. Farooq and Ahmed (2019) also maintain that
firms pay high dividends during uncertain times to convey relevant information to investors
and shareholders. Hail et al. (2014) argue that information asymmetries exacerbate agency
conflicts, thereby leading to greater pressure on managers to pay dividends.
In this paper, we hypothesize that the dividend policy adopted by firms is a function of the
ethical environment prevailing in the country. The firms headquartered in countries that
score high on corporate ethics are less likely to pay dividends than firms headquartered in
other countries. The argument underlying this hypothesis is based on assumption that
information asymmetries are already less in countries that score high on corporate ethics.
Prior literature shows that firms headquartered in countries with high ethical standards are
less likely to engage in actions that are not consistent with what society expects from them
(Mella and Gazzola, 2015). As a result, they are less likely to act in a way that is detrimental to
the welfare of shareholders, thereby resulting in lower agency conflicts between managers
and shareholders. In countries with high ethical standards, firms are under increasing
pressure to demonstrate that their actions meet various pre-determined social and ethical
criteria. Mella and Gazzola (2015) argue that firms are often under considerable pressures
from governments, international organizations and civil society to demonstrate that they set
forth conditions of accountability for their own actions. The organized actions by citizen
groups, protests by non-governmental organizations (such as GreenPeace and Amnesty
International), consumer boycotts, press campaigns that become widespread in the wake of
human rights violations (such as the case of Nike) or natural catastrophes (such as the case of
Shell) are some of the examples of the pressures faced by firms. The social pressures are
generated with an expectation that firms recognize that they will be judged not only for the Corporate
“effects” of their actions, but also for their “intentions”. Therefore, it is important that firms ethics and
behave in a way that is expected of them (Wilson, 1999). Such a behavior can minimize agency
conflicts by ensuring that managers do not abuse their control over corporate resources. Cui
dividend policy
et al. (2018) also show that ethical behavior, as defined by firm’s engagement in socially
responsible practices, lowers information asymmetries and makes firms act in the best
interest of all stakeholders.
Another reason that may be cited for lower information asymmetries in the countries that 893
score high on corporate ethics is based on the strength of institutional infrastructure associated
with these countries. Agyemang et al. (2014) document significantly positive correlation between
country-level indicator of ethical behavior of firms and country-level measures of rule of law,
regulatory quality, control of corruption and democracy. They argue that, in countries where
governance is compromised, ethical issues in firms also remain largely neglected. In the absence
of strong country-level institutions, there are no mechanisms that can be applied to compel firms
to behave ethically [3]. It will be hard for firms to behave ethically, if the required institutions are
not put in place. The firms should be sensitized to what may happen if they fail to incorporate
ethics in their decision-making (Amankwah-Amoah, 2014). We argue that high quality
institutional environment associated with countries that score high on corporate ethics lead to
lower information asymmetries in these countries.
In this paper, we maintain that strong institutions and social pressure to act responsibly
can lower the need of using dividend policy as a mechanism to reduce information
asymmetries. Therefore, we should expect lower dividend payments in countries that score
high on corporate ethics. Our arguments are consistent with the substitute model of
dividends proposed by La Porta et al. (2000). According to this model, dividends are
substitute for governance mechanisms. By disgorging high dividend payments, firms aim to
establish a reputation for not expropriating minority shareholders. We argue that this
incentive for paying dividends (for building reputation) is supposed to low in countries where
information asymmetries are relatively low. Our arguments are consistent with prior
literature, such as Jiraporn and Ning (2006), who show that firms pay lower dividends where
information asymmetries are low. They document relatively low dividend payout in countries
with strong shareholder rights. Hail et al. (2014) also document similar findings by reporting
lower dividends when information asymmetries are low. They argue that managers are under
lesser pressure from shareholder to pay dividends when information asymmetries are low.

2.2 Corporate ethics, cost of equity and dividend policy

Prior literature associates lower cost of capital with countries that score high on corporate
ethics (Barth et al., 2013; Cao et al., 2012; Lehavy and Sloan, 2008; Francis et al., 2004, 2005;
Loughran and Schultz, 2005). This strand of literature argues that firms headquartered in
countries with strong ethics are less likely to deviate from what society expects from them.
As a result, firms in these countries are more likely to produce high quality financial
statements and do not engage in information hoarding. We argue that these characteristics
lead to lead to lower cost of capital for firms headquartered in these countries. Our arguments
are consistent with Ghoul et al. (2011) who associate lower cost of capital with firms that
behave ethically. They show that firms that invest in improving responsible employee
relations, environmental policies and product strategies have significantly lower cost of
capital than other firms. Choi (2012) also document a significantly lower cost of capital for
firms that behave ethically. Cheng et al. (2014) come to similar conclusion by reporting that
socially responsible firms have lower cost of capital. More recently, Zouari-Hadiji and
Chouaibi (2021) show that firms with high ethics scores are associated with a reduced cost of
equity capital. Similarly, Duong et al. (2022) also highlight the importance of corporate ethics
IJMF by documenting that a higher quality code of ethics is associated with a lower cost of equity.
19,4 Above strand of literature argues that ethicality reduces the cost of capital because firms with
strong emphasis on ethics are more likely to cultivate better relationships with their
stakeholders. Good relationships with stakeholders can reduce managerial opportunism,
lower transaction costs, enhance competitive advantage and reduce the cash flow shocks
when negative events occur. Furthermore, the lower cost of capital may also be due to the fact
that firm performance is positively affected by ethicality (Choi and Wang, 2009; Heal, 2005;
894 Hillman and Keim, 2001; Jones, 1995). Yang et al. (2019), for example, document significantly
positive impact of socially responsible behavior on firm performance. Casado-Dıaz et al.
(2014) also show that activities related to social responsibility have positive impact on firm
performance. They argue that socially responsible activities cultivate relationships with
different stakeholders and lead to better performance. We argue that better performance
lowers perceived risk and leads to lower risk premium demanded by investors (Harjoto and
Jo, 2011; Ghoul et al., 2011; Luo and Bhattacharya, 2009; Jo and Na, 2012; Albuquerque et al.,
2019). Therefore, it should lower the cost of capital.
In this paper, we maintain that lower cost of capital associated with ethical firms have
significant implications for dividend policies. We argue that lower cost of capital encourages
firms to hold cash or reinvest it instead of paying dividends (Cao et al., 2015). Our argument is
based on the assumption that whenever cost of capital is low, the opportunity cost of
hoarding cash is also lower, thereby increasing the incentives for firms to withhold cash.
Furthermore, the incentives for firms to invest are also higher when cost of capital is low. In
such situations, the external financial constraint is less binding on firms. Without binding
financial constraints, firms can accept projects that were otherwise not feasible in the past,
thereby leaving less room for paying dividends.

2.3 Corporate ethics, reputation and dividend policy

Another argument that may support lower dividend payments in countries that score high on
corporate ethics is based on investor behavior. Breuer et al. (2014) argue that shareholders’ trust in
managerial decisions can significantly affect dividend policies adopted firms. Saeed and Sameer
(2017) maintain that shareholders are more likely to demand instant dividends (as compensation
against their investments in firms), if they lack of trust in managerial decisions. The lack of trust in
management refrain shareholders from waiting for future dividend payments. The signaling role
of corporate ethics would suggest greater confidence and trust of shareholders in managerial
decisions (Swift, 2001). We argue that the lack of trust can be eradicated through committing
ethical practices. Therefore, as firms adopt ethical practices, shareholders do not demand
immediate return in the form of dividends (Saeed and Zamir, 2021). Following this view, we argue
that the demand for dividends is less in countries that score high on corporate ethics.

3. Data
3.1 Sample
This paper utilizes the data of non-financial firms from 61 countries to document the effect of
corporate ethics that prevail at the country-level on the dividend policies adopted by firms. The
data cover the period between 2010 and 2017 and includes firms from 61 countries. Our data stop
at 2017 because the data on the ethical behavior of firms are available till 2017. We start our
sample period from 2010 to leave out the effect of global financial crisis of 2007-09 on our analysis.

3.2 Methodology and definition of variables

This paper argues that corporate ethics prevailing at the country-level significantly affect the
dividend policies adopted by firms. In order to test this argument, we estimate various
versions of the following pooled OLS regression. We would like to highlight that all Corporate
estimations in this paper are performed using the robust regression. The robust regression ethics and
generates heteroskedasticity consistent standard error estimates. The regression equation is
similar in spirit to prior literature, such as Dewasiri et al. (2019), Farooq and Ahmed (2019) and
dividend policy
Tran (2020).
DIV ¼ α þ β1 ðETHICSÞ þ β2 ðSIZEÞ þ β3 ðLEVERAGEÞ þ β4 ðEY Þ þ β5 ðGROWTH Þ
X
N 1 895
þ β6 ðANALYSTÞ þ β7 ðCAPEX Þ þ β8 ðCASH Þ þ δS ðYDUM Þ
Y ¼1

X
N 1 X
N 1
þ γ C ðCDUM Þ þ θI ðIDUM Þ þ ε (1)
C¼1 I ¼1

In the above regression equation, the dependent variable (DIV) measures the dividend policy
adopted by firms. For the purpose of this paper, we use the percentage of earnings paid out as
dividends as our proxy for dividend policy. The data for dividend policy are obtained from
the Worldscope. The main independent variable (ETHICS) measures the ethical behavior of
firms in a country (Agyemang et al., 2014; Ekici and Onsel, 2013). It is based on the answer to
the following question: “In your country, how do you rate the corporate ethics of companies
(ethical behavior in interactions with public officials, politicians and other firms)”?
This variable is obtained from the Global Competitiveness Report issued by the World
Economic Forum. The report is globally accepted as one of the most comprehensive reports
developed to measure global competiveness. This variable is used to know the level of trust
worthiness of the firms in a country. The Global Competitiveness Report indicates that “an
economy is well served by businesses that are run honestly, where managers abide by strong
ethical practices in their dealings with the government, other firms, and the public at large”.
The variable takes the value between 1 and 7 with higher values indicating more ethical
behavior. It is important to mention that this variable does not consider firm’s payout policy.
Therefore, using it in the analysis will not cause the reverse causality problem.
In addition to above variables, the paper also includes several firm-specific characteristics
as control variables. For example, log of firm’s total assets in dollars (SIZE) is added to control
for the effect of size on dividend policy. We argue that larger firms are more mature and have
relatively fewer growth opportunities (Dewasiri et al., 2019; Al-Malkawi, 2007; Eriotis, 2005).
Therefore, they are in a better position to pay dividends. Total debt to total asset ratio
(LEVERAGE) is used to control for the effect of financial leverage. Firms with higher levels of
financial leverage are more likely to be financially constrained and have lower capacity to pay
dividends because (Farooq and Ahmed, 2019; Kowalewski et al., 2007; Gugler and Yurtoglu,
2003). We also include earnings yield (earnings per share scaled by starting year price) in the
regression analysis. Firms with higher levels of earnings are more likely to pay dividends
(Abdulkadir et al., 2016; Adesola and Okwong, 2009). The ratio of capital expenditures to total
assets (CAPEX) and growth in total assets over the last one year (GROWTH) are also used as
control variables. High growth firms and firms incurring high capital expenditures have
higher capital needs, which negatively affect dividend payouts (Abdulkadir et al., 2016; Chen
and Dhiensiri, 2009). The number of analysts covering a firm (ANALYST) and the ratio of
cash and equivalents to total assets (CASH) are used to control for the effect of information
environment on dividend payouts (Lang et al., 2004; Huang et al., 2014). The data for these
control variables are obtained from the Worldscope and Thomson Reuters Eikon. See
Appendix for the summary of these variables. Furthermore, we also include set of year
dummies (YDUM), country dummies (CDUM) and industry dummies (IDUM) to control for
year-specific effects, country-specific effects and industry-specific effects on dividend policy.
IJMF 3.3 Descriptive statistics
19,4 Table 1 documents the average values of the two main variables (DIV and ETHICS) used in
this paper. The table shows huge variation in the dividend payout ratios across different
countries. The dividend payout ratio ranges from 4.07% in Canada to 54.83% in Bahrain.
An interesting observation from the table is that firms from emerging markets appear to
distribute more earnings in the form of dividends than firms from developed countries. The
firms with the highest payout ratios are from Bahrain, Morocco, Qatar, Oman and Saudi
896 Arabia. The firms with the lowest payout ratios are from Canada, Greece, Australia, United
States and Bulgaria. The table also shows high variation in the corporate ethics across
different countries. The corporate ethics index ranges from 3.03 in Argentina to 6.52 in New
Zealand. Interestingly, the table shows that lowest corporate ethics are observed in emerging
markets. The bottom five countries in the corporate ethics ranking are Argentina,
Bangladesh, Nigeria, Romania and Hungary. This is in contrast to the developed countries
that score high on the corporate ethics ranking. The top five countries in the corporate ethics
ranking are New Zealand, Finland, Singapore, Denmark and Switzerland. The results of this

Country ETHICS DIV Observations Country ETHICS DIV Observations

Argentina 3.0338 15.3869 306 Malaysia 4.9750 20.6511 4,959

Australia 5.8435 7.3569 9,448 Mauritius 4.4743 24.9542 125
Austria 5.7234 27.5522 277 Mexico 3.5794 16.7859 601
Bahrain 5.1603 54.8295 88 Morocco 3.9313 49.0236 233
Bangladesh 3.0600 23.4265 447 The 6.1087 18.2436 632
Netherlands
Belgium 5.4804 23.0817 437 New Zealand 6.5287 29.5415 579
Brazil 3.4759 21.2768 1,119 Nigeria 3.3081 23.6868 402
Bulgaria 3.5151 8.8889 501 Norway 6.1882 15.4865 715
Canada 5.9649 4.0759 10,668 Oman 5.1813 36.8476 316
Chile 5.0959 33.5634 667 Pakistan 3.5405 19.2767 1,595
China 4.1205 31.3101 15,272 Peru 3.5301 25.5359 401
Colombia 3.6085 28.5850 160 The 3.6793 16.8198 969
Philippines
Denmark 6.3472 16.7923 639 Poland 4.1417 13.5828 2,410
Egypt 3.9437 28.6805 775 Portugal 4.4543 24.0571 237
Finland 6.4433 31.4821 655 Qatar 5.6026 44.8387 141
France 5.2645 16.7335 3,224 Romania 3.3930 13.3164 405
Germany 5.6973 20.3829 2,799 Russia 3.5720 14.7795 880
Greece 3.4663 5.9659 915 Saudi Arabia 5.0785 34.3606 768
Hong Kong 5.6790 13.4854 6,286 Singapore 6.3742 20.4421 2,634
Hungary 3.4271 10.6548 101 South Africa 4.4270 27.5915 1,155
India 3.9709 10.9140 16,327 Sri Lanka 3.9310 19.5799 1,087
Indonesia 3.8996 13.2755 2,866 Sweden 6.1929 16.5463 2,903
Ireland 5.4830 16.2304 420 Switzerland 6.2710 28.0063 1,023
Israel 4.8308 18.4183 1,616 Thailand 3.8023 32.7271 3,075
Italy 3.6102 19.8417 1,143 Tunisia 4.2344 33.5891 244
Japan 5.7610 24.1283 21,360 Turkey 3.8426 13.8528 1,698
The United 5.7414 17.3576 5,475 The United 5.6989 26.6516 282
Kingdom Arab
Emirates
Kenya 3.6810 28.1358 186 Jordan 4.5706 23.8130 489
Table 1. South Korea 3.9247 11.7833 12,033 United States 5.0879 7.9654 23,133
Descriptive statics for Kuwait 4.1109 26.7742 390 Vietnam 3.7078 28.9380 3,760
corporate ethics and Luxembourg 6.0023 18.6412 195
dividend policy Note(s): The definition of ETHICS and DIV is provided in Section 3
table indicate that, at least in our sample, the firms from emerging markets pay higher Corporate
dividends and score low on corporate ethics. This observation is also consistent with our ethics and
hypothesis of negative relationship between the corporate ethics prevailing at country-level
and the dividend policies adopted by firms.
dividend policy
Table 2 documents the descriptive statistics for the control variables used in this paper.
The table shows relatively low debt ratio (20.14%), low earnings yields (0.38%) and low
capital expenditures (5.28%) among our sample firms. An interesting observation is that the
average cash holding of the firms is relatively high – around 19.82%. The analyst coverage 897
seems to be low. An average firm in our sample is covered by less than three analysts.
Table 3 presents the correlation between variables use in this paper. The table shows that there
is no severe multicollinearity between control variables. We can, therefore, include all control
variables simultaneously in our study. Furthermore, as hypothesized, the correlation between
ETHICS and DIV is negative. However, unlike our expectations, the magnitude of correlation is
extremely low. It may be because ETHICS is a country-level measure (with little changes across
the sample) and DIV is a firm-level measure (with significant changes across the sample).

4. Methodology and results

4.1 Effect of corporate ethics on dividend policy
Table 4 documents the results of our analysis. The main variable of interest in this table is
ETHICS. Our results show significantly negative coefficient estimate of ETHICS for four out
of five models with t-values ranging from 1.37 to 5.13. It indicates that firms
headquartered in countries that have better corporate ethics tend to pay lower dividends
than firms headquartered in countries that have poor corporate ethics. Our results also hold
for sub-samples of large and small firms. We argue that firms headquartered in countries
with better corporate ethics are less likely to use dividends to signal that they will not misuse
corporate resources. It is important to highlight that the effect of corporate ethics (country-
level characteristic) is not subsumed by country dummies. Therefore, we can argue that
country-level indicator of corporate ethics has an explanatory power over and above the
country-level factors.

4.2 Effect of corporate ethics on dividend policy: alternate proxies of dividend policy
In order to check the robustness of our results, we re-estimate Equation (1) for alternate
proxies of dividend policy. For the purpose of this paper, our alternate measures of dividend
policy are dividend yield and total dividends to market capitalization ratio. The results of our
analysis are reported in Table 5. We show that our results are robust across both proxies of
dividend policy. We report significantly negative coefficient of ETHICS for all estimations.
We would like to highlight that our findings become more significant with t-values increasing

Variables 25th percentile Mean Median 75th percentile Standard Deviation Observations

SIZE 9.8052 11.4654 11.3346 13.1642 2.4218 156,877

LEVERAGE 2.1300 20.1450 15.9300 32.1900 19.5141 161,836
EY 1.0700 0.3824 4.3300 8.6900 19.5350 149,487
GROWTH 16.4600 23.5452 7.4070 41.3830 72.5071 147,008
CAPEX 0.0096 0.0528 0.0282 0.0644 0.0769 168,833
ANALYST 0 2.5913 0 2 5.8031 174,646 Table 2.
CASH 0.0456 0.1986 0.1242 0.2694 0.2151 173,735 Descriptive statics for
Note(s): All variables are as defined in Section 3 control variables
 19,4

898
IJMF

Table 3.
Correlation matrix
Variables DIV ETHICS SIZE LEVERAGE EY GROWTH CAPEX ANALYST CASH

DIV 1.000
ETHICS 0.058 1.000
SIZE 0.354 0.004 1.000
LEVERAGE 0.069 0.158 0.020 1.000
EY 0.261 0.137 0.231 0.033 1.000
GROWTH 0.050 0.007 0.077 0.022 0.078 1.000
CAPEX 0.036 0.007 0.008 0.051 0.028 0.017 1.000
ANALYST 0.177 0.054 0.639 0.043 0.083 0.019 0.036 1.000
CASH 0.081 0.196 0.031 0.373 0.116 0.056 0.097 0.051 1.000
Note(s): All variables are as defined in Section 3
 All firms Small firms Large firms
Variables Model (1) Model (2) Model (3) Model (4) Model (5)

ETHICS 0.3150 (1.37) 1.0446*** (4.58) 1.3325*** (5.13) 1.1265*** (3.45) 1.9294*** (4.75)
SIZE 3.5392*** (140.86) 4.0047*** (88.70) 3.6161*** (44.41) 4.1446*** (42.52)
LEVERAGE 0.1003*** (28.76) 0.1178*** (28.24) 0.0984*** (17.37)
EY 0.1680*** (63.12) 0.1379*** (52.71) 0.2567*** (32.67)
*** ***
GROWTH 0.0358 (48.57) 0.0250 (28.84) 0.0466*** (38.63)
CAPEX 3.9790*** (4.79) 0.6347 (0.71) 11.2395*** (7.32)
ANALYST 0.1992*** (13.77) 0.3734*** (3.51) 0.2108*** (11.39)
CASH 2.7131*** (7.97) 0.0247 (0.06) 5.7844*** (10.22)
Year Dummies Yes Yes Yes Yes Yes
Industry Dummies Yes Yes Yes Yes Yes
Country Dummies Yes Yes Yes Yes Yes
Observations 174,646 156,877 130,408 60,283 70,125
F-value 421.15 849.61 775.18 256.08 294.42
R-square 0.1429 0.2371 0.2444 0.2077 0.2042
Note(s): All variables are as defined in Section 3. The t-values are presented in parenthesis. The variables significant at 1% are followed by ***, at 5% by ** and at 10%
by *
Corporate

899
dividend policy
ethics and

ethics on dividend
Table 4.

policy
Effect of corporate
 19,4

policy
900
IJMF

Table 5.
Effect of corporate
ethics on (alternate
measures of) dividend
Dividend yield Total dividend to market capitalization ratio
Variables Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)

ETHICS 0.0986*** (4.94) 0.1493*** (7.62) 0.1799*** (8.46) 0.0020*** (8.93) 0.0024*** (10.78) 0.0024*** (9.94)
SIZE 0.2130*** (109.49) 0.1741*** (46.61) 0.0021*** (90.42) 0.0020*** (44.51)
LEVERAGE 0.0069*** (25.15) 0.0001 (0.40)
EY 0.0314*** (92.26) 0.0002*** (63.48)
GROWTH 0.0030*** (48.96) 0.0001*** (68.82)
CAPEX 0.9608*** (12.86) 0.0123*** (14.53)
ANALYST 0.0098*** (9.47) 0.0001*** (14.90)
CASH 0.0262 (0.90) 0.0010*** (3.09)
Year Dummies Yes Yes Yes Yes Yes Yes
Industry Dummies Yes Yes Yes Yes Yes Yes
Country Dummies Yes Yes Yes Yes Yes Yes
Observations 179,557 177,547 149,074 178,204 178,174 150,007
F-value 414.64 688.14 653.86 273.45 467.36 397.05
R-square 0.1514 0.1970 0.2556 0.1191 0.1494 0.1831
Note(s): All variables are as defined in Section 3. The t-values are presented in parenthesis. The variables significant at 1% are followed by ***, at 5% by ** and at 10%
by *
up to 8.93 (when dividend yield is used as a dependent variable) and up to 9.94 (when total Corporate
cash dividends to market capitalization ratio is used as a dependent variable) in the ethics and
estimation of the most comprehensive models.
dividend policy

4.3 Effect of corporate ethics on dividend policy: alternate estimation procedures

In order to give further credibility to our findings, we use two alternate estimation procedures.
The first alternate estimation procedure recognizes the fact that our data are organized as a 901
panel. Therefore, we use the panel regression with fixed effects to re-estimate Equation (1) [4].
It will allow us to mitigate the concerns regarding the unobserved firm heterogeneity. The
second alternate estimation procedure makes use of the fact that our dependent variable is
censored on the left and on the right side. The payout ratio cannot take a value below zero and
above 100%. Therefore, we estimate Equation (1) by using the TOBIT regression. The results
are reported in Table 6. As was documented before, we report significantly negatively
coefficient of ETHICS for both procedures.

5. Additional tests
5.1 Effect of country-specific characteristics on the relationship between corporate ethics and
dividend policy
An important question that arises from above analysis is: Are there any mechanisms that can
weaken/strengthen the relationship between corporate ethics and dividend policy? One
obvious argument that can be made is that when institutional environment is weak, ethical
behavior should be to distribute higher proportion of earnings as dividends. It is because, in
such institutional environments, the likelihood that corporate resources can be expropriated
by insiders is high. Therefore, firms have stronger need to use dividends as a device to build
reputation. La Porta et al. (2000) also point out that the shareholders are, usually, more
interested in receiving dividends in weak institutional environments. In contrast, when
institutional environment is strong, the need to use dividends as a mechanism to build
reputation is relatively weak. In strong institutional environments, shareholders have enough
power to extract dividends on their own (if they wish to get them). Therefore, shareholders are
less interested in receiving dividends in these institutional environments (Farooq and
Aktaruzzaman, 2020; Grullon et al., 2018). In order to test this conjecture, we re-estimate
Equation (1) for sub-samples characterized by different institutional environments. For the
purpose of this paper, we use protection of minority shareholder interests, strength of
auditing and reporting standards and efficacy of corporate boards as representative
measures of institutional environment [5]. The data for these variables are obtained from the
“Global Competitiveness Report” issued by the World Economic Forum.
The results of our analysis are reported in Table 7. The main variable of interest in this table
is also ETHICS. Interestingly, the findings of this paper show that the coefficient estimate of
ETHICS is significantly negative only in countries characterized by strong institutional
environment. We report that the negative effect of corporate ethics is confined only in countries
that have strong minority shareholder interests, strong auditing and reporting standards and
strong efficacy of boards. In contrast to countries with strong institutional environment, we
report positive impact of corporate ethics in countries with weak institutional environment. We
show that the positive coefficient estimate of ETHICS in countries that have weak minority
shareholder interests, weak auditing and reporting standards and weak efficacy of boards. This
finding is consistent with substitute model of dividends proposed by La Porta et al. (2000). In
countries with weak institutional environment, firms are more likely to use dividends as a signal
to build their reputation. As a result, we observe positive impact of corporate ethics on dividend
payouts in these countries.
 19,4

902
IJMF

Table 6.

procedures
policy: Alternate
ethics on dividend
Effect of corporate
Tobit regression Fixed effect panel regression
Variables Model (1) Model (2) Model (3) Model (4) Model (5) Model (6)
*** *** *** ***
ETHICS 0.6734 (1.37) 1.9316 (4.14) 2.3046 (4.93) 0.5655 (2.91) 0.8921 (4.39) 1.4927*** (6.17)
*** *** ***
SIZE 9.1635 (176.69) 9.2759 (113.91) 1.1173 (17.80) 2.3149*** (19.03)
LEVERAGE 0.2333*** (33.86) 0.0154*** (2.56)
EY 0.9274*** (77.19) 0.0135*** (4.72)
GROWTH 0.0653*** (38.93) 0.0214*** (30.11)
CAPEX 6.5355*** (3.43) 2.7985*** (3.05)
ANALYST 0.6182*** (28.55) 0.0106 (0.28)
CASH 11.6294*** (15.55) 0.3936 (0.74)
Year Dummies Yes Yes Yes Yes Yes Yes
Industry Dummies Yes Yes Yes
Country Dummies Yes Yes Yes
Observations 174,646 156,877 130,408 174,646 156,877 130,408
Groups 28,424 26,759 24,436
F-value 533.83 864.58 650.30 98.71 94.88 107.33
R-square (Pseudo/Overall) 0.0379 0.0701 0.0715 0.0037 0.1181 0.1061
Note(s): All variables are as defined in Section 3. The t-values are presented in parenthesis. The variables significant at 1% are followed by ***, at 5% by ** and at 10%
by *
 Strong institutional environment Weak institutional environment
Strong protection of Weak protection of
minority shareholder Strong auditing and Strong efficacy of minority shareholder Weak auditing and Weak efficacy of
Variables interests reporting standards corporate boards interests reporting standards corporate boards

ETHICS 2.7060*** (6.97) 2.5554*** (6.51) 2.5210*** (6.59) 1.0882*** (2.85) 0.8387** (2.15) 0.1788 (0.46)
SIZE 4.1334*** (66.26) 4.1738*** (65.84) 4.1837*** (66.61) 3.7364*** (55.65) 3.6178*** (54.95) 3.6269*** (54.23)
*** *** *** *** ***
LEVERAGE 0.1032 (22.12) 0.1017 (21.26) 0.0935 (19.80) 0.0997 (18.81) 0.1040 (20.19) 0.1064*** (20.28)
EY 0.1545*** (43.25) 0.1588*** (44.51) 0.1490*** (41.30) 0.1731*** (43.16) 0.1621*** (40.59) 0.1710*** (43.32)
GROWTH 0.0397*** (43.40) 0.0388*** (41.49) 0.0398*** (42.54) 0.0344*** (28.11) 0.0348*** (29.40) 0.0311*** (26.86)
CAPEX 9.0816*** (8.95) 8.8316*** (8.67) 10.8529*** (10.86) 6.0772*** (4.24) 6.4699*** (4.56) 8.6258*** (5.88)
ANALYST 0.2332*** (10.29) 0.1911*** (8.41) 0.2351*** (10.68) 0.1633*** (8.64) 0.1912*** (10.21) 0.1643*** (8.59)
CASH 5.2340*** (13.17) 5.3129*** (13.25) 5.5833*** (14.28) 2.4717*** (3.87) 2.9545*** (4.78) 3.9902*** (6.02)
Year Yes Yes Yes Yes Yes Yes
Dummies
Industry Yes Yes Yes Yes Yes Yes
Dummies
Country Yes Yes Yes Yes Yes Yes
Dummies
Observations 68,282 67,263 66,793 62,126 63,145 63,287
F-value 672.50 694.07 701.17 376.00 409.55 379.58
R-square 0.2621 0.2651 0.2686 0.2355 0.2346 0.2279
Note(s): All variables are as defined in Section 3. The t-values are presented in parenthesis. The variables significant at 1% are followed by ***, at 5% by ** and at 10%
by *
Corporate

903
dividend policy
ethics and

corporate ethics and

relationship between
characteristics on the
Table 7.

dividend policy
Effect of country
IJMF 5.2 Effect of corporate ethics on the value of dividend policy
19,4 We have shown that firms headquartered in countries with strong corporate ethics
distribute lower proportion of their earnings as dividends. The main argument
underlying this result is that firms are less likely to need dividends to build their
reputation in these countries. Consequently, they pay lower proportion of their earnings
as dividends. A corollary of this argument is that the dividends should be more desirable
in countries with weak corporate ethics. In these countries, firms that pay dividends
904 should be preferred by investors more than firms that do not pay dividends. In other
words, when firms headquartered in countries with weak corporate ethics pay dividends,
and they are able to create better reputation, which leads to higher firm value. In order to
test this conjecture, we modify Equation (1) as follows. In the following regression, Q is a
measure of firm value. We use the Tobin’s Q as a proxy for firm value. All other variables
are as defined above.
Q ¼ α þ β1 ðETHICSÞ þ β2 ðDIV Þ þ β3 ðETHICS * DIV Þ þ β4 ðSIZEÞ þ β5 ðLEVERAGEÞ
þ β6 ðEY Þ þ β7 ðGROWTH Þ þ β8 ðANALYSTÞ þ β9 ðCAPEX Þ þ β10 ðCASH Þ
X
N 1 X
N 1 X
N 1
þ δS ðYDUM Þ þ γ C ðCDUM Þ þ θI ðIDUM Þ þ e (2)
Y ¼1 C¼1 I ¼1

The results of our analysis are provided in Table 8. The main variable of interest in this
analysis is ETHICS*DIV. Our results report significantly negative coefficient of
ETHICS*DIV. It indicates that dividend policy is less valuable in countries with strong
corporate ethics. In other words, the ability of dividends to improve reputation of firms should
be more pronounced in countries with weak corporate ethics. Therefore, relative to countries
with strong corporate ethics, the dividends should have stronger impact on firm value in
countries with weak corporate ethics.

6. Conclusion
This paper documents that corporate ethics prevailing at the country-level is an important
determinant of dividend policies adopted by firms. We show that firms headquartered in
countries with strong corporate ethics pay significantly lower dividends than firms
headquartered in countries with weak corporate ethics. Our findings are robust across
various proxies of dividend policy and across various estimation procedures. We, however,
also show that this relationship between corporate ethics and dividend policies is confined
to countries with strong institutional environment. In countries with weak institutional
environment, this relationship breaks down. We report that corporate ethics and dividend
payouts are positively related in countries with weak institutional environment. We argue
that, in countries with weak institutional environment, firms have stronger incentives to
use dividends as a mechanism to build reputation. Furthermore, this paper shows that the
value of dividend policy is more pronounced for firms headquartered in countries with
relatively weak corporate ethics. The findings of this paper have significant implications
for investors. It indicates that countries where corporate ethics are relatively weak, firms
can use dividend policy to signal their good behavior toward shareholders. This is in
contrast to countries where corporate ethics are relatively strong. The findings indicate
that dividend policy is more likely to reduce agency conflicts in countries where corporate
ethics are relatively weak. The investors, therefore, can use dividend policy as an important
indicator for their investment decisions in countries where corporate ethics are
relatively weak.
 All firms Small firms Large firms
Variables Model (1) Model (2) Model (3) Model (4) Model (5)

ETHICS 0.1670*** (9.16) 0.1577*** (8.86) 0.1212*** (7.46) 0.1117*** (5.64) 0.0953*** (3.75)
DIV 0.0116*** (12.89) 0.0124*** (14.20) 0.0033*** (4.02) 0.0054*** (7.60) 0.0017 (1.33)
ETHICS*DIV 0.0024*** (13.40) 0.0034*** (19.31) 0.0009*** (5.75) 0.0017*** (10.88) 0.0003 (1.36)
SIZE 0.1495*** (65.46) 0.1798*** (56.29) 0.1599*** (27.71) 0.2485*** (38.43)
*** ***
LEVERAGE 0.0058 (24.80) 0.0026 (9.35) 0.0136*** (36.93)
EY 0.0073*** (36.45) 0.0030*** (15.04) 0.0186*** (31.38)
GROWTH 0.0038*** (47.73) 0.0025*** (25.52) 0.0051*** (39.96)
CAPEX 1.4303*** (19.35) 0.9208*** (9.37) 2.2096*** (19.70)
ANALYST 0.0091*** (9.05) 0.1384*** (17.21) 0.0157*** (12.48)
CASH 2.2045*** (60.02) 1.9914*** (39.32) 2.3238*** (43.58)
Year Dummies Yes Yes Yes Yes Yes
Industry Dummies Yes Yes Yes Yes Yes
Country Dummies Yes Yes Yes Yes Yes
Observations 146,327 146,304 126,791 57,951 68,840
F-value 317.83 379.96 390.72 96.01 236.78
R-square 0.1632 0.1900 0.3152 0.2466 0.3345
Note(s): All variables are as defined in Section 3. The t-values are presented in parenthesis. The variables significant at 1% are followed by ***, at 5% by ** and at 10%
by *
Corporate

905
dividend policy
ethics and

ethics on the value of

Table 8.

dividend policy
Effect of corporate
IJMF Notes
19,4 1. Benlemlih (2019) claims, that his is the first paper to study the effect of firm-level ethical behavior on
dividend policy.
2. These mechanisms can take variety of forms, such as inducting independent members in the board,
linking compensation with performance, using reputable external auditors, voluntarily disclosing
information and introducing an optimal level of debt in capital structure.
906 3. These arguments are also advocated by the World Bank that considers governance as “the political
direction and control exercised over the actions of the members, citizens or inhabitants of communities,
societies and states” (Brautigam, 1991). This proposition implies that, for various segments of society to
behave ethically, the governments should priorities the issue of good governance.
4. The Hausman test is used to decide between the fixed effect and the random effects.
5. Protection of minority shareholder interests is based on the following question: In your country, to
what extent are the interests of minority shareholders protected by the legal system? The variable
takes the value between 1 and 7 with higher values indicating more protection of minority
shareholder interests. Strength of auditing and reporting standards is based on the following
question: In your country, how strong are financial auditing and reporting standards? The variable
takes the value between 1 and 7 with higher values indicating stronger auditing and reporting
standards. Efficacy of corporate boards is based on the following question: In your country, to what
extent is management accountable to investors and boards of directors? The variable takes the value
between 1 and 7 with higher values indicating more effective boards.

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Appendix

Variable Definition Source

ETHICS Country-level indicators representing the ethical behavior of World Economic

corporations Forum
DIV Proportion of earnings paid out as dividends Worldscope
SIZE Log of firm’s total assets in dollars Worldscope
LEVERAGE Total debt to total asset ratio Worldscope
EY Earnings per share scaled by starting year price Worldscope
GROWTH Growth in total assets over the last one year Worldscope
CAPEX Capital expenditures to total assets ratio Worldscope
ANALYST Number of analysts covering a firm Thomson Reuters
Eikon
CASH Cash and equivalents to total assets ratio Worldscope
YDUM Set of year dummies Worldscope
IDUM Set of industry dummies based on Industry Classification Worldscope
Benchmark (ICB) Table A1.
CDUM Set of country dummies Worldscope Definition of variables

Corresponding author
Omar Farooq can be contacted at: omar.farooq.awan@gmail.com

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