Does Conservative Accounting Matter to Cash Dividend Policy

1. Does Conservative Accounting Matter to Cash Dividend Policy William Bradford University of Washington, Seattle Chao Chen Fudan University Song Zhu Beijing Normal University

2. The story Chinese listed firms on average paid out just 22% of their earnings in 2001-2006 period. Their average dividend yield was as lower as 0.70% in the this period. The Chinese stock market is considered as an emerging market with weak shareholder protection due to low cash dividends. However, high dividend may affect the interest of bondholders.

3. The story Very few Chinese listed firms repurchased their stocks prior to 2008. Stock dividends are not unusual. No bond covenant restriction of paying dividend in our studying period. Earnings management is a wide spread phenomenon of Chinese listed firms. SOEs have less capital constraint relatively to NSOEs.

4. Motivation Without the restriction by corporate bond covenants of Chinese listed firms, does accounting conservatism influence corporate dividend policy? Can conservative accounting reduce dividends and thereby protect creditor claims and mitigate the creditor-shareholder agency conflict? SOEs adopt less conservative accounting than NSOEs, do they pay more cash dividends?

5. Main Findings • Conservative accounting reduces the payment and the probability of overpayment of cash dividends of listed firms in China, and thus mitigates the stockholder-creditor agency problem. • Even though the SOEs are more conservative than NSOEs due to political costs, lenders (mostly banks) are less concerned with downside risk for SOEs than for NSOEs, which will result in fewer restrictions on cash dividend payout. • Due to the less capital constraint, SOEs are more likely and pay more cash dividends than NSOEs.

6. Hypotheses • H1: Ceteris paribus, firms with more conservative accounting are less likely to pay cash dividends to shareholders. • H2: Ceteris paribus, firms with more conservative accounting tend to pay less cash dividends to shareholders.

7. Hypotheses • H3: Ceteris paribus, firms with more conservative accounting are less likely to overpay cash dividends to shareholders. • H4: The influence of conservative accounting on dividend policy is smaller for state-owned firms than for non state-owned firms.

8. Samples and Data Source • The new accounting standards became effective in China on January 1, 2007. • The corporate bond new issues were started in 2007. • The ownership reform to convert non-tradable shares to tradable shares was implemented for a small group of companies in 2005, then gradually expanded to most of the companies in 2007.

9. Samples and Data Source • Eliminate those sample firms without ultimate shareholder information; with missing financial data; listed less than one year; in the financial industry; and with negative earnings but paid dividend.

10. Samples and Data Source • The final samples include 4,458 firm-year observations from 2001 to 2006. • Cash dividend policy data and other financial data are collected from the Wind/CSMAR database • The information about ultimate shareholders is collected manually from annual financial reports.

11. Samples and Data Source • Eliminate those sample firms without ultimate shareholder information; with missing financial data; listed less than one year; in the financial industry; and with negative earnings but paid dividend.

12. Cash dividend • To pay or not to pay cash dividend Div: Div=1, if the firm paid cash dividend, 0 otherwise. • The degree of cash dividend Payout: cash dividend per share / current year EPS Yield: cash dividend per share / stock price per share at the beginning year • Overpayment of cash dividend OverPay=1, if Payout > payout of the industry average OverYield =1, if Yield > yield of the industry average

13. Accounting conservatism • Givoly and Hayn (2000) proposed accrual based measure of conservative accounting • We follow the accrual measure used by Ahmend et al. (2002) and Ahmend and Duellamen (2007): Conserv= (Three-year cumulative accruals/year end total assets) * (-1), so the higher of this measure, the higher the accounting conservatism. Accruals of each year = earnings after extraordinary items + depreciation – cash flow from operation

14. Other measures • Conserv > 0, the accounting is conservative • Conserv <0, the accounting is aggressive • Beatty et al. (2008) Khan and Watts (2009): Cscore • M/B: The total market value divided by book value of equity at the end of the year

15. Table 1Descriptive Statistics

16. Table 1Descriptive Statistics(for SOEs)

17. Table 1Descriptive Statistics(for Non-SOEs)

18. Table 2Spearman vs. Pearson Correlation Matrix

19. Table 3Mean Comparison of Fundamentals between Aggressive Accounting and Conservative Accounting

20. Table 4Mean Comparison of Cash Dividend Policy between Aggressive Accounting and Conservative Accounting

21. Table 5Mean Comparison of Conservatism for Firms with and without Cash Dividends

22. Table 6Cash Dividend Payment and Accounting Conservatism

23. Table 6Cash Dividend Payment and Accounting Conservatism (Continued)

24. Table 7Accounting Conservatism, Cash Dividend Payment Level and Ownership Structure

25. Table 7Accounting Conservatism, Cash Dividend Payment Level and Ownership Structure(continued)

26. Table 8Cash Dividend Policy and Accounting Conservatism - SOEs and NSOEs

27. Table 8Cash Dividend Policy and Accounting Conservatism - SOEs and NSOEs(continued)

28. Table 9Probit Model for Accounting Conservatism, Cash Dividend Overpayment, and Ownership Structure

29. Table 9Probit Model for Accounting Conservatism, Cash Dividend Overpayment, and Ownership Structure (continued)

30. Table 10 Other Conservatism Measures

31. Table 10 Other Conservatism Measures (continued)

32. Table 11Endogenous Issue

33. Table 11Endogenous Issue (continued)

34. Table 12Endogenous Issue

35. Table 12Endogenous Issue (continued)