Corporate Governance, Financial Constraints and Dividend Policy: Endogenous Switching Model

Firms operating in the same country normally offer different levels of corporate governance practices. Therefore, it is very important to properly gauge firm-level corporate governance. Eventually, the influence of financial constraints on dividend policies also varies across different corporate governance regimes (i.e., strongly and weakly governed regimes). The current study intends to investigate the impact of corporate governance on dividend policy by explicitly considering the role of external financing constraints faced by firms on listed in the KSE. To investigate how the changes in firm-level governance affect its dividend policy, the sample in the present study was divided into two groups on the bases of corporate governance variables, which were determined via ESM. The results of the ESM analysis suggest that the effect of financial constraints on dividend policies indeed varies across different corporate governance states. Firms in a weak corporate governance regime are especially apt to pay lower dividends in order to avoid costly external financing. Due to the existence of a high agency problem in weakly governed firms, external investors discount the risk of expropriation by requiring a high cost for their capital as a reward for monitoring costs.