Impact of Dividend Payment on Firms’ Leverage: Moderating Role of Firm Size

Abstract

This article investigates the impact of firms’ dividend payment decision on its capital structure. It also examines whether firm size moderates the relationship between dividend decision and capital structure. It relies on a large dataset of 4,116 listed firms over the period 2002–2019 in the Indian scenario comprising 37.21% firm-year observations as dividend payers and 62.79% firm-year observations as dividend non-payers. Fixed effect regression is used for analysis based on the results of the Hausman test for model specification. The study observes negative impact of dividend payment on firms’ leverage ratios. Ability of dividend payment to mitigate the free cash flow agency conflict together with the availability of substantial volume of retained earnings to meet the financing requirements internally are found to be possible explanations for lesser demand of debts in case of dividend paying firms. The study also finds heterogeneous impact of dividend payment on leverage ratios for small and large firms, thus confirming the moderating role of firm size. The higher level of free cash flow for dividend payers compared to non-payers in case of small firms is found to be the only possible explanation for such results. Financial managers may refer to the findings of the study as a guide while deciding their financing choices.