Innovation or dividend payout: Evidence from China

Since 2001, the China Securities Regulatory Commission has implemented a series of policies to ensure that dividend payments constitute a prerequisite of equity financing, which is known as the semi-mandatory dividend policy. Using a sample of Chinese listed firms from 2007 to 2015, we demonstrate that firms with more R&D investments tend to pay more dividends. This can be explained by the semi-mandatory dividend policy and the equity dependence of R&D investments. R&D firms are more likely to have equity financing needs and they have strategic incentives to pay dividends in order to access external equity markets. Such pay-for-financing incentives are stronger for firms with lower cash holdings and higher internal financing deficit. We further demonstrate equity financing needs as the underlying mechanism for R&D investments to positively affect dividend payout. In addition, we show that such semi-mandatory dividend payments adversely affect firm value and sustainable growth.