In this paper, we examine dividend payment patterns of Korean firms over the past 20 years and test competing hypotheses that can explain changing dividend patterns in Korea. Firms after Asian crisis have permanently changed their dividend policies and the proportion of dividend payers dropped from 72% to 49% over the period. We run a horse race to explain this decreasing propensity to pay dividends (PPD).
Although Baker and Wurgler’s Catering theory, when used alone, explains 22% of this decreasing PPD, the catering theory lose most of its explanatory power when Hoberg and Prabhala’s risk measure and DeAngelo et al’s lifecycle measure are used together. We observe dramatic and permanent changes in both systematic and idiosyncratic risks after the Asian crisis and the shock affected firms in such a
heterogeneous fashion that large and stable firms face less risks after the shock, while small and unprofitable firms face greater uncertainty, which in turn results in high concentration of dividend payments among top payers. We also find evidence of firms’ time varying risk aversion toward costly dividend payments. Firms in boom periods become less risk averse and do not reduce dividend for the same perceived level of risks while during the economic downturn, firms tend to react to risks more sensitively. In summary, Hoberg and Prabhala’s risk measure plays a key role in explaining decreasing PPD. Especially, risks explain over 30% of the decreasing PPD when combined with DeAngelo et al’s lifecycle measure, The added contribution of firm’s life cycle measure is mainly driven by the distinction whether a firm has positive or negative retained earnings, not by the magnitude of positive retained earnings.
Keywords: Catering; Dividend; Idiosyncratic risk; Korea; Lifecycle; Systematic risk;
