Dividend Policy in Regulated Firms

We study the impact of different regulatory contracts of electricity companies on their dividend policy. Using a panel of 106 publicly traded European electric utilities in the period 1986-2011 we link dividend pay-out and smoothing ratios to the implementation of different regulatory mechanisms (cost plus vs. incentive regulation) and also to firm ownership. After controlling for the potential endogeneity of the regulatory mechanism, our results show that electric utilities subject to incentive regulation smooth their dividends less than firms subject to cost plus regulation but also present higher target payout ratios; thus suggesting that incentive regulation leads firms to a dividend policy more responsive to earnings variability and more consistent with efficiency-enhancing pressures. This suggests that when managers are more sensitive to competition-like efficiency pressures following the adoption of incentive regulation, they are more inclined to cut dividends when necessary. These results seem to apply in particular to incentive regulated firms when they are privately controlled.