Payout Policy with Legal Restrictions


  • Sattar A. Mansi,

    1. Sattar A. Mansi is a Professor in the Department of Finance, Insurance, and Law, Pamplin College of Business at Virginia Tech, Blacksburg, VA.
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  • John K. Wald

    1. John K. Wald is a Professor in the Department of Finance, College of Business at the University of Texas at San Antonio, San Antonio, TX.
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  • The authors would like to thank Palani-Rajan Kadapakkam, Kathy Kahle, Mike Long, David Reeb, Dan Rogers, Lucas Roth, an anonymous referee, and seminar participants at Virginia Tech, the University of California-Riverside, and the 2008 Southern Finance Association Meetings for comments and suggestions. We are also indebted to Roberta Romano for providing her coding of state director liability laws. Mansi acknowledges partial funding from Virginia Tech's summer support. The remaining errors are the sole responsibility of the authors.


We hypothesize that firms that face limitations on debt may use increased dividend payments to mitigate the free cash flow problem. Limitations on debt are implicit in state laws that restrict the firm from making payouts when the asset-to-liability ratio is low. We find that: 1) firms incorporated in states with stricter payout restrictions pay more dividends, 2) the probability of paying dividends or repurchasing shares decreases as firms approach a binding payout constraint, and 3) bonding with dividends is less prevalent with increased managerial equity holdings. In addition, antitakeover and director liability laws have a less consistent effect on payout policy.