Marc Deloof University of Antwerp Annelies Roggeman University of Antwerp Wouter Van Overfelt

1. Who’s afraid of universal banks? Bank affiliations and corporate dividend policy in pre-World War I Belgium Marc Deloof University of Antwerp Annelies Roggeman University of Antwerp Wouter Van Overfelt University of Antwerp

2. Universal Bank Interlocks of Belgian non-Financial Companies Listed on the Brussels Stock Exchange in 1905

3. Universal banks • Regarding the economic effects of universal banks, there are basically two different views • View 1: universal banks are good • They are efficient institutions that overcome problems of asymmetric information • Universal bank relations are characterized by a multitude of links which allow the bank to reuse costly information and to build up technical expertise • View 2: universal banks are bad • Universal bank relations with affiliated companies give rise to conflicts of interest • Universal bank relations allow the bank to loot the company at the expense of other investors, especially in an environment characterized by weak institutions and poor investor protection

4. Research question • In this paper, we focus on corporate dividend policy • Dividend play a central role in the relationship between insiders and outside investors • Dividends limit the scope for insiders to expropriate value from outside investors, because they reduce the inside cash in the firm, and they guarantee a pro-rata payout to all shareholders • How did universal bank affiliation affect dividend policy of 428 Belgian companies listed on the Brussels Stock Exchange in 1905-1909?

5. The setting • Why is Pre-World War I Belgium an interesting setting to investigate this research question? • By modern standards and even by contemporary standards, investors in Belgium were poorly protected, and they faced severe information problems (cf. Théate, 1905) • Nevertheless, Belgium combined an active stock market with a strongly developed banking sector • According to Rajan & Zingales (JFE, 2003), more than the U.S., the U.K., Germany and Japan • A limited number of universal banks played a central role in Belgian finance

6. The setting • Moreover … • There were no dividend taxes → tax based dividend theories are irrelevant • The late 19th and early 20th centuries are widely regarded as the first great era of globalization, and it has been argued that there are close parallels with world finance today

7. Related research on the same sample • Van Overfelt, Annaert, De Ceuster & Deloof (WP, 2007) • Universal bank affiliation was positively related to firm performance • Deloof & Van Overfelt (JBFA, 2008) • Universal bank affiliation was negatively related to debt ratios • Van Overfelt, Deloof & Vanstraelen (WP, 2008) • Universal bank affiliation was positively related to corporate financial disclosure

8. The certification hypothesis • The role of dividends • In the period considered, capital markets in the U.S., the U.K., Germany and Belgium were flourishing, even though investor protection was weak • When investor protection is weak, dividends may be a substitute for weak legal protection • By paying high dividends, companies can establish a reputation for moderation in expropriating shareholders

9. The certification hypothesis • Certification by universal banks • In the period considered, (universal) banks played a central role in establishing a reputation of honesty and reliability • In the U.S.: e.g. Carosso (1970)), De Long (1991), Ramirez (JF, 1995), Baskin and Mirante (1997) • In Germany: e.g. Fohlin (2006), Franks, Mayer and Wagner (2006) • In Belgium: universal banks contributed most of the money for the financing of new securities, either by investing in the securities themselves, or by selling the securitites to the public (Durviaux, 1947)

10. The certification hypothesis • Certification by universal banks • Universal banks pressured companies to pay sufficiently high dividends in order to create trust among investors • Firms affiliated with a universal bank paid higher dividends than stand-alone firms

11. The certification hypothesis • We also expect a positive relation between dividends and investment opportunities • companies with better investment opportunities have a stronger incentive to establish a good reputation • If universal banks played a central role in establishing a reputation of honesty and reliability, and dividends signaled good investment opportunities, the positive relationship between dividends and investment opportunities may have been stronger for affiliated companies than for stand-alone companies.

12. Alternative hypotheses • Monitoring by universal banks • Monitoring by the bank reduces the likelihood that managers will behave in opportunistic behavior • Affiliated companies have less need to pay high dividends and are less reluctant to cut or omit dividends • Cf. Goergen et al. (JCF, 2005) for Germany and Dewenter and Warther (JF, 1998) for Japan

13. Alternative hypotheses • Conflicts of interest • The bank may use its power to protect its interests as a lender, or even to expropriate value from the shareholders • The universal bank may protect its interests as a lender by limiting dividends of affiliated companies. • The universal bank may abuse its power to expropriate value from shareholders (cf. La Porta et al., JF, 2000; Faccio et al., AER, 2001) • If affiliated companies pay lower dividends, this provides more room for expropriation by the bank

14. Sample • Full sample (all sectors) • 663 stocks issued by 428 Belgian listed companies on the Brussels Stock Exchange: • Stockmarket data from the SCOB database • Subsample (coal mining, trams, railways and textiles) • 151 stocks issued by 109 companies in the four largest sectors: • Handcollected financial statement data from the ‘Annexes au Moniteur Belge:’

15. Dividend measures • Dividends per stock • Dividend Cut (dummy) • Dividend Payer (dummy) • Dividends per company • Dividend Payout Ratio • Dividend/Total Assets

16. Measures of bank affiliation • Bank Interlocks • An executive board member of a universal bank is on the executive or supervisory board of a particular company • Five universal banks considered: (i) Société Générale, (ii) Banque de Bruxelles, (iii) Banque Internationale de Bruxelles, (iv) Banque d’Outremer, (v) Crédit Général Liègeois • Equity Stakes • Industrial portfolio of the universal banks • Not necessarely a better indicator than bank interlocks; universal banks provided all kind of services to the companies (provision of loans,underwriting new securities,…)

18. Determinants of dividend policy • Control variables • ‘Market-to-book’: measure for investment opportunities • Cash Flow/Total Assets • Ln(Total Assets) • Firm Age • Debt/Total Assets • Industry dummies • Year dummies

19. Univariate results for the full sample • Dividend policy affiliated companies significantly different from stand-alone companies • Affiliated companies: more likely to pay dividends, less likely to cut or omit dividends, keep dividends more constant • Affiliated companies pay higher dividends • These results are consistent with the ‘certification’ hypothesis

20. The Effect of Stock Return Performance on the Decision to Cut Dividends (full sample)

23. Alternative explanations • Universal banks as outside investors • Universal banks may basically have been outside investors, demanding high dividends in order to force companies to go to the capital market for external financing and be subject to monitoring by the external market • Companies in which the bank has an equity stake will pay higher dividends • Companies which have a bank director but in which the bank does not have an equity stake will not pay higher dividends

25. Alternative explanations • Fear of universal banks • Affiliated companies may need to put more effort in “seducing” investors, because investors fear expropriation by universal banks. • From this point of view, it can be expected that dividends will be positively related to the degree of bank control: the stronger the control of the bank over the company, the more investors should fear expropriation by the bank.

27. Conclusions • Our results are generally consistent with the hypothesis that companies affiliated to a universal bank used dividends as a tool to convince investors of their honesty and reliability • Companies with several bank directors and companies in which the bank had an equity stake tended to pay lower dividends. We therefore cannot reject the hypothesis that banks extracted rents from companies they controlled.