Numerous literature studying
cognitive psychology argue that people tend to overestimate their abilities.
This provides a basis for the assumption that managerial psychological biases
affect corporate finance decisions. A particular and vital bias that is widely
studied is managerial overconfidence. While the existing literature focuses on
the effect of the overconfidence on investment appraisal, merger, capital
structure and other financing decisions (Heaton, 2002; Malmendier and Tate,
2005; Malmendier and Tate, 2005b; Malmendier and Tate 2008; Campbell et al.,
2011), the implications for dividends are little understood (Wu and Liu, 2008;
Desmukh et al., 2013).

Wu and Liu (2008) develop a
theoretical model examining the impact of managerial overconfidence on
corporate dividend policy. In their study Wu and Liu use Miller and Rock’s
(1985) model assuming no agency costs and that the manager’s goal is to
maximise firm’s value. According to them, overconfident CEO is a CEO who
overestimates own ability to maintain transitory earnings. According to this
study, overconfident CEOs pay higher dividends than rational CEOs, due to the
misleading assessment of earnings. On the other hand, other studies report
opposite results. Cordeiro (2009) states that overconfident CEOs or managers
believe in the assumption that their companies are undervalued. Thus, these
managers tend to overinvest. Cordeiro claims that overconfident CEOs are less
likely to pay dividends but managerial overconfidence does not affect the
amount of dividends. Deshmukh et al., (2013) constructed a dynamic model
examining dividend policy and overconfident managers, and empirically tested it
on the US firms using the period from 1980 to 1994. According to Deshmukh et
al., overconfident managers believe that external financing is more costly than
internal funds. Thus, overconfident CEOs overestimate the value of project
opportunities. Deshmukh et al. reveal that overconfident managers prefer to pay
fewer dividends than rational managers. This assumption is based on their
desire to invest in future projects. Deshmukh et al. managed to show this
effect empirically and also; they revealed that the effect is weaker in high
growth firms. The prediction of overconfident CEO’s tendency to pay fewer
dividends was supported by Ben-David et al. (2007). Ben-David et al. used a
survey-based approach to reveal that overconfident managers prefer to
repurchase shares instead of paying dividends.

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Campbell et al. (2011) argue
that investment rate and CEO optimism are closely related. According to the
Campbell et al. (2011), investment rate might act as a measure of the
overconfidence. Thus, this paper includes the analysis of the investment rate
effect on dividend policy.

The primary objective of this
paper is to analyse the factors affecting corporate dividend policy taking into
account both standard and behavioural finance theories. In a standard corporate
finance framework, the paper examines the effect of age and size (life-cycle
theory), ROA (signalling theory), debt and cash (agency theory) on dividend
policy. Also, three characteristics will be taken into account to test whether
they influence the amount of dividends. Namely, these characteristics will be
board size, investment rate and CEO overconfidence. 

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