Leverage in Pyramids When Debt Leads To Higher Dividends.pdf

Leverage in Pyramids: When Debt Leads * To Higher Dividends Abe de Jong† Douglas V. DeJong‡ Ulrich Hege§ Gerard Mertens** March 2010 Abstract This paper explores the use of leverage in pyramids and its relationship to dividend policy. The use of leverage in holding companies widens the disparity between control rights and cash flow rights. We postulate that it also leads to more generous dividend payouts since dividends are needed to service debt in the holding companies. We analyze a comprehensive sample of French pyramidal structures. Consistent with our hypothesis, we find that dividend payouts increase in the disproportionality between control and cash flow rights that is explained by holding company debt. By contrast, disproportionality generated by holding company equity leads to lower payouts. Servicing debt in the holding companies of a pyramidal structure is the primary motive for dividends, as opposed to alternative explanations such as investments or dividend preferences. Finally, the combination of high leverage in holding companies and high dividends negatively affects firm value, consistent with the hypothesis of tunneling by dominant owners. Keywords: pyramids, payout policy, leverage, ownership structure, control wedge, disproportionality of control and cash flow rights. JEL classification: G32, G34, G35. * The authors appreciate the helpful comments from Henrik Cronqvist, Ingolf Dittmann, Edith Ginglinger, Erick Lie, Giovanna Nicodano, Urs Peyer, Daniel