European Journal of Operational Research 241 (2015) 783–795 Contents lists available at ScienceDirect European Journal of Operational Research journal homepage: www.elsevier.com/locate/ejor Decision Support Dividend policy, managerial ownership and debt ﬁnancing: A non-parametric perspective Chris Florackis a,∗ , Angelos Kanas b,1 , Alexandros Kostakis c,2 a University of Liverpool, The Management School, United Kingdom b University of Piraeus, Department of Economics, Greece c University of Manchester, Manchester Business School, United Kingdom article info Article history: Received 12 March 2013 Accepted 19 August 2014 Available online 15 October 2014 Keywords: Dividends Managerial ownership Semi-parametric approach Non-linearity Capital structure abstract This paper examines the relation between dividend policy, managerial ownership and debt-ﬁnancing for a large sample of ﬁrms listed on NYSE, AMEX and NASDAQ. In addition to standard parametric estimation methods, we use a semi-parametric approach, which helps capture more effectively non-linearities in the data. In line with the alignment effect of managerial ownership, our results support a negative relationship between managerial ownership and dividends when managerial ownership is at relatively low levels. However, this negative relationship turns into a positive one at very high levels of managerial ownership. We also ﬁnd that the nature of the relationship between managerial ownership and dividends may be more complex than it has been previously thought, and it also differs signiﬁcantly across ﬁrms with different levels of debt/ﬁnancial constraints. The results are consistent with the view that agency theory provides useful insights but cannot fully explain how ﬁrms determine their dividend policy. © 2014 Elsevier B.V. All rights reserved. 1. Introduction The separation between ownership and control in large corpo- rations creates fundamental conﬂicts of interest between managers and shareholders, which are commonly referred to as agency conﬂicts (Fama & Jensen, 1983; Jensen & Meckling, 1976). The main agency conﬂict centres around the use of free-cash-ﬂow by managers; that is, the cash ﬂow in excess of that required to fund all projects that have positive net present values (Jensen, 1986). The problem stems from self-serving managers who divert cash ﬂow to beneﬁt themselves (e.g. by increasing ﬁrm size to justify higher salaries, lavish expenses and excessive perks) at the expense of shareholders. Various mechanisms have been proposed as potential solutions to the free-cash-ﬂow problem. 3 Dividends, debt-ﬁnancing and man- agerial ownership are three of the most important ones. Dividend payments have been interpreted as a “bonding” mechanism to re- solve the conﬂict between managers and shareholders (Easterbrook, 1984; Jensen & Meckling, 1976; Jensen, 1986; Rozeff, 1982). This is because the payment/non-payment of dividends causes the ﬁrm to ∗ Corresponding author. Tel.: +44 (0) 151 7953807. E-mail addresses: c.ﬂorackis@liv.ac.uk (C. Florackis), akanas@unipi.gr (A. Kanas), alexandros.kostakis@mbs.ac.uk (A. Kostakis). 1 Tel.: +30 (0) 210 4142295. 2 Tel.: +44 (0) 1612756333. 3 See Denis (2001) and Gillan (2006) for a comprehensive review of the literature on the different types of mechanisms available to ﬁrms. undergo a third-party audit (i.e. from equity markets), which results in lower agency costs. Debt-ﬁnancing also works as a monitoring force for reducing agency-related problems (see Ross, 1977 and Stulz, 1990). The issuance of debt gives debt holders the option to take the ﬁrm into bankruptcy if managers default on their debt obligations. 4 Managerial ownership (at low levels) has been suggested as a third mechanism that helps align the interests of managers with those of shareholders. This is because managers who own equity in the ﬁrm will act as owners and reduce the degree of expropriation from out- side investors (Jensen & Meckling, 1976)(alignment effect). At higher levels of managerial ownership, however, managers may exert insuf- ﬁcient effort, collect private beneﬁts and entrench themselves at the expense of external shareholders (entrenchment effect). 5 4 The “disciplinary” role of debt has been questioned by several researchers showing that debt facilitates expropriation when capital market institutions are ineffective (see e.g., Bunkanwanicha, Gupta, & Rokhim, 2008). 5 Demsetz and Lehn (1985), Stulz (1988) and Morck, Shleifer, and Vishny (1988), among others, have identiﬁed offsetting costs associated with high levels of manage- rial ownership. For example, by accumulating a large block of ownership and voting rights, a manager may have enough voting power and inﬂuence to guarantee his/her employment with the ﬁrm at an attractive salary (Morck et al., 1988). In an attempt to protect a managerial position, a manager may also impede the market for corporate control (e.g. act against a potentially beneﬁcial acquisition for shareholders) by re- questing a high takeover premium (Stulz, 1988). High levels of managerial ownership also give management greater ability to control the board and undertake “manager- speciﬁc” investments, which makes it costly for shareholders to replace them (Shleifer & Vishny, 1989). Such manager-speciﬁc investments often involve opportunistic and http://dx.doi.org/10.1016/j.ejor.2014.08.031 0377-2217/© 2014 Elsevier B.V. All rights reserved.