In 2019, companies such as IBM, Apple, and Disney paid shareholder dividends of approximately $6 billion, $14 billion, and $3 billion respectively. What explains the decision to pay out dividends and the amounts involved? In a recent study, we focus on the impact of CEO past professional experience on payout policy, which executives confess is one of the most important corporate decisions. Payout policy includes both dividends and share repurchases. Despite a vast finance literature, the determinants of payout policy are still not well understood, giving rise to the so-called “dividend puzzle” in the academic literature. Our consideration of the influence of CEO career experience, which is a novel idea, belongs to the emerging behavioral corporate finance research.
“Hot-Stove” Effects in Payout Decisions
Our study is titled “Hot Stove Effects: The Impact of CEO Professional Experiences on Dividend Policy” and is a play on the following quote attributed to Mark Twain: “If a cat sits on a hot stove, that cat won’t sit on a hot stove again. That cat won’t sit on a cold stove either. That cat just doesn’t like stoves.” We examine what happens if a CEO who was exposed to a “hot stove” in a past career role later makes a payout decision. It is reasonable to expect the CEO will make more cautious decisions than other CEOs, but what this means in practice is unclear. On the one hand, lower dividend payouts and hence lower firm cash outflows may be the more conservative decision for the CEO; on the other hand, the CEO may prefer to distribute higher payouts to shareholders, rather than making decisions regarding the use of cash for risky long-term investments.
We construct the employment history of CEOs and inspect whether the CEO experienced a distress event in his career while working in a non-CEO capacity at a different firm. To measure CEO “career distress”, we examine the past employment of a CEO and if the CEO worked at a firm that experienced distress, we classify the CEO as having experienced professional career distress. We use four measures of distress: dividend cuts, extreme price declines, extreme operating cash flow decreases (OCF), and credit rating downgrades. For example, if the (future) CEO worked at a company that had to cut a dividend payment, we classify the CEO as having experienced a distress event. The classification applies when the person later becomes CEO of a company different from the one that cut the dividend. We exclude cases in which the (future) CEO was also working as a CEO when the distress event occurred. We then examine dividend policy both in terms of likelihood to pay a dividend and the level of dividend paid (relative to total assets).
We find that CEOs with career distress are approximately 19% less likely to pay dividends. This finding represents a choice of experience-driven conservatism by reducing the cash outflow commitment of the firm. We also find that CEOs with career distress pay lower levels of dividends, again supporting an experience-driven conservatism reflected in lower dividend amounts. Dividend levels are approximately 12% lower than the average value of the dividend-to-assets ratio in our sample. For instance, if a CEO had past career distress and paid $8 billion in dividends at a 3.5% value to assets, the CEO without past career distress would pay $9 billion in dividends; a difference of $1 billion due to career experience, all else equal. Our findings are consistent with the notion that CEOs with past professional career distress become more conservative regarding dividend policy decisions, compared to CEO counterparts without past professional career distress.
Impact on Other Aspects of Payout Policy
Furthermore, we examine other facets of payout policy: share repurchases (also known as buybacks), total payouts, dividend smoothing, and the use of dividends versus share repurchases. We find evidence of CEO experience-driven conservatism for these payout policy decisions more broadly. First, we find that CEOs with prior professional distress are less likely to use share repurchases than those CEOs without prior career distress. Second, CEOs with past professional career distress are less likely to pay out cash at all, whether in the form of dividend or repurchase, which again indicates experience-driven conservatism to minimize firm cash outflows. Third, CEOs having past career distress experiences tend to smooth dividends more; these managers avoid increasing the cash outflow commitment of a dividend too quickly, hence avoiding the risk of a possible future dividend cut. Lastly, when the firm does pay out cash to shareholders, CEOs with past professional career distress are more likely to repurchase shares than to pay dividends. This finding is consistent with prior studies showing repurchases are more flexible (i.e., they might be viewed as less “risky” by a conservative manager) and adds to the literature on the substitution of repurchases for dividends by showing that experience-driven conservatism alters the preferred method to return cash to shareholders.
We perform the first investigation on whether conservatism associated with prior professional experience affects payout policy, one of the most important corporate decisions. We find evidence of a new characteristic that affects payout policy, CEO past professional distress experience. The finding that CEOs will alter the payout policy decision based on behavioral experiences of past professional career distress is important, because it may explain some of the inconclusive results in prior studies; it can potentially help resolve the “dividend puzzle.”
Moreover, our study is also interesting from a practical standpoint. The size and timing of dividends and share repurchases is a critical financing decision every year for firms around the country and world. This decision has major impact on companies, investors, and markets. Managers, boards of directors, creditors, and regulators all recognize the importance of cash distributions to shareholders. Thus, it is important to understand what influences these decisions, and we show there are behavioral determinants the existing literature has previously ignored. Additionally, based on our findings, a consideration of past professional experiences may be relevant for the hiring and monitoring of CEOs.
More broadly, our investigation offers interdisciplinary theories explaining differences in management decision-making across corporate executives based on past professional experiences.