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- Anu Riya K.J, Sreejith P.R, A. Ananth. A Research Paper on Impact of Dividend Policy Determinants of Listed Companies on Indian Capital Market. Journal of Finance and Accounting . Vol. 5, No. 2, 2017, pp 40-43. http://pubs.sciepub.com/jfa/5/2/2 ">Normal Style
- K.J, Anu Riya, Sreejith P.R, and A. Ananth. 'A Research Paper on Impact of Dividend Policy Determinants of Listed Companies on Indian Capital Market.' Journal of Finance and Accounting 5.2 (2017): 40-43. ">MLA Style
- K.J, A. R. , P.R, S. , & Ananth, A. (2017). A Research Paper on Impact of Dividend Policy Determinants of Listed Companies on Indian Capital Market. Journal of Finance and Accounting , 5 (2), 40-43. ">APA Style
- K.J, Anu Riya, Sreejith P.R, and A. Ananth. 'A Research Paper on Impact of Dividend Policy Determinants of Listed Companies on Indian Capital Market.' Journal of Finance and Accounting 5, no. 2 (2017): 40-43. ">Chicago Style
A Research Paper on Impact of Dividend Policy Determinants of Listed Companies on Indian Capital Market
The core purpose of financial management is the maximization of shareholders’ wealth with three core decisions that is, dividend, financing and investment decisions. In simple words dividend is the percentage of net profit of a company which is distributed among the shareholders. The research gap identified for this study is that, a comparison of different industries dividend policy impact on the Indian Capital Market and the samples are drawn from the National Stock Exchange (NSE) India. The main objective of this project is to study the influence of dividend policy on the market price of selected company’s scrip in NSE. The researcher has chosen Empirical study to prove the hypothesis and 15 companies balance sheet for 10 years (2007-2016) were collected from the respected companies websites and the following ratios have been calculated to test the hypothesis, Net profit ratio, Gross profit ratio, Earning per share, Dividend yield, Dividend payout ratio, Return on equity and the Market price of share. The analyses conducted, the parameter estimates were viewed within AMOS graphics and displayed the standardized parameter estimates. The regression analysis model revealed that the significant impact of the independent variables on the market price of share as well as impact of dividend policy determinants on the outcome variable market price.
Dividend policy is a guiding principle of a company to decide the portion of its earnings and its pay out to shareholders to show weather the company goes either for pay dividend to its owners or for retaining a share out of profits to plough back in the firm or at the end of each year and it is the company’s decision to how much to return to their stockholders in the form of dividends. In relation to this we talk of three types of dividends, ‘the stock dividend which increases the number of share outstanding and generally reduce the price per share, ‘the regular dividend which is paid in the form of regular intervals’ (quarterly, semi-annually, or annually) and ‘the special dividend which is paid in addition to the regular dividend.’
In addition the three main dividend policies that are used by the companies are; ‘residual dividend policy’, ‘stability dividend policy’ and ‘hybrid dividend policy’. These policies are chosen by the companies based on their growth opportunities. If the company has the great opportunity to grow to retain more on the above said and it is to reduce their dividend payout rate.
In the next level of our discussion, we move on to talk about the capital market where the company can raise the capital as well as the investors can invest in the company’s capital. Share price is one of the most important components that really influence investors to purchase the shares. The share price of the companies will always show volatility because of the impacts of some factors. The dividend policy is that impacts the stock market price of the company. But the real impact on the dividend policy in stock market is still ambiguous and remains unsolved. Hence this study analyses the real relationship between the dividend policy determinants and stock market price taking into account the variables like, Net profit ratio, Gross profit ratio, Earning per share, Dividend yield, Dividend payout ratio, Return on equity and the Market price of share are used for analyzing the impact level.
2. Literature Review
Adnan Ali, Farzand Ali Jan and Ilyas Sharif 1 have analyzed the effect of dividend policy on stock prices. They have taken 45 non-financial companies on KSE-100 index that have earned profits and paid dividend for a period of twelve year and they used Profit after tax, Earning per share and Return on Equity as the variables. Some of findings of this study were profit retention by firms will result in a decrease in the value of the stock market prices and dividend payout have positive impact on the share prices of respected stocks.
Khaled Hussainey, Chijoke Oscar Mgbame and Aruoriwo M. Chijoke‐Mgbame 16 conducted a study on “Dividend policy and share price volatility” with respect to UK stock market. The researchers used multiple regression analyses to analyze the relationship between the dependent variables and the share prices of the companies. The researchers found a positive relation between dividend yield and stock price changes, negative relation between dividend payout ratio and stock price changes and also firm's growth rate, debt level, size and earnings explain stock price changes and concluded that the dividend policy is relevant in determining share price changes.
Md. Abdullah Al- Hasan, Md. Asaduzzaman and Rashed al Karim 18 conducted a study on “The Effect of Dividend Policy on Share Price”. The study has mainly pointed at evaluating the effect of dividend policy on market price of share in the context of Bangladesh with the tools like Dividend policy, Market price per share, Earning per share Correlation and multiple regression models. The findings tell us that the effect of dividend policy on market price supports the relevant theory of dividend policy.
S.M. Tariq Zafar, D.S. Chaubey and S.M. Khalid 21 conducted a study on Dividend Policy and its Impact on the Shareholders Wealth. This study was based on the eleven selected Indian banks listed and actively traded in National Stock Exchange (NSE) during the period 2006 to 2010. The study gives an insight about the dividend and its legal implications and the relationship between shareholders wealth and the performance of the stock. The study concludes that dividend payouts have high influence on shareholders wealth and there is significant impact of dividend policy on the shareholder’s wealth in banking companies in India. They were used the Multiple regression technique to analyses the data and prove the hypothesis.
Yusniliyana Yusof, Suhaiza Ismail, 25 conducted a study to investigate the determinants of the dividend policy of public listed companies in Malaysia. The variables examined in this study include earnings, cash flows, free cash flows, debt level, growth, investment, size, largest shareholders, risk and lagged dividend. The results revealed that the five factors that are earnings, debt, size, investment and largest shareholder have a significant influence on dividend policy.
3. Research Problem
I M Pandey (11 th edition of Financial Management) evaluated the dividend policy determinants and its impact on market value of scrip. Many authors say, dividend policy has insignificant impact on the market value of the firm but the dividend policy determined based on the investment opportunities available for the company. The present study aims to find the impact of identified dividend policy determinants on the market price of the firm.
4. Objective of the Study
The objectives are;
• To study relationship between dividend policy determinants
• To find the impact of dividend policy determinants on the market price.
• To evaluate the dependency of dividend policy determinants on market price of various industries.
5. Research Methodology
The researcher has chosen the empirical study to test the impact of dividend policy determinants on Indian capital market. The present study involves a sample of 150 balance sheet and profit and loss account from three industries for the period of 2007 to 2016.The variables were empirically tested with the hierarchical regression on the companies from three industry such as pharmaceutical, Energy, and Media. Five companies from each industry were chosen thus a total of 15 companies were selected. The companies which include, Sun Pharma, Cipla, Glenmark Pharma, Dr.Reddys Laboratory, Lupin, Reliance, Gail,BPCL, ONGC, Tata Power, Network 18, Sun TV, PVR, ZEEL, and TV Today Network.
The analyses were conducted using the parameter estimates within AMOS graphics and it displayed the standardized parameter estimates. The regression analysis revealed that the factors of dividend policy such as Net profit ratio, Gross profit ratio, Earnings per share, Dividend yield, Dividend, Dividend pay-out ratio, and Return on equity influence the market price. The estimated p-value of the model can be used to test the hypothesis. If the values are significant at 5% significance level (i.e.) less than 0.05 then the alternate hypothesis are proved to be true, otherwise the null hypothesis is selected.
In hierarchical regression, the predictor variables are entered in sets of variables according to a pre-determined order that may infer some causal or potentially mediating relationships between the predictors and the dependent variable 10 . The logic involved in hypothesizing mediating relationships is that “the independent variable influences the mediator which, in turn, influences the outcome” 14 . However, an important pre-condition for examining correlational relationships is that the independent variable is significantly associated with the dependent variable prior to testing any model for mediating variables 14 .
As per the analysis, the P value of the Figure 1 , shows the impact level of independent variables on dependent variables. The Gross profit (0.023) and Net profit (0.010) ratios are significant to Earnings per share as the p value is less than 0.05. Earnings per share is insignificant to Dividend yield (0.669) and Dividend payout ratio (0.884) but it is significant to Dividend (0.012) and Return on equity (0.000). The independent variables like Return on equity, Dividend pay-out ratio, Dividend, Dividend Yield ratio are highly significant to the dependent variable Market price (0.000). Here the results reveals that the dividend highly influence the market price.
- Figure 1 . Structural Model – (Dividend-SEM Model)
Table 1. Regression Weights: (Default model)
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Table 2. Standardized Regression Weights: (Default model)
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Table 3. Squared Multiple Correlations: (Default model)
The R square value shows that the overall model explaining the market is about 50.4%, the dependent variables such as Net profit ratio and Gross profit ratio is impact the Earnings per share only by 6.8% and the other factor Earning per share is explaining Return on equity by 23%, Dividend by 4% and Dividend payout ratio and Dividend yield are very meager.
Table 4. Comparison of Industry values
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The above table shows the comparison of regression analysis of the pharma, Energy, and Media industry. The Dividend and Dividend yield are highly significant to Market price and also the Earnings per share is highly significant to Return on equity with respect to all three industries. In Energy and Media the Net profit ratio is highly significant to Earnings per share, but the pharma is slightly varying (.086). Gross profit ratio to Earnings per share of Energy sector has the significance and other two industries are shown insignificant. Earnings per share to Dividend, the Media sector is highly significant and other two are insignificant. Earnings per share to Dividend yield except Energy other two industries are significant and Earnings per share to Dividendpay-out ratioonly Energy have significance and other two are insignificant. The Return on equity to Market price, except Pharma other two industries are significant and Dividend pay-out ratio to Market price only Pharma sector has significance.
7. Managerial Implication
According to the study, the investors should consider more on Dividend, Dividend yield, and Return on equity before they invest in securities because these variables are highly significant to Market price. The overall model shows that more than 50% R square value which is the dependent variables has a clear impact on Market price. So the investors should consider these variables before they invest in any securities for a better return.
Some evidence suggests that investors are not concerned with a company's dividend policy since they can sell a portion of their portfolio of equities if they want cash. This evidence is called the “dividend irrelevance theory,” and it essentially indicates that an issuance of dividends should have no impact on stock price but the “relevance theory” said that the dividend policy have impact on stock price. Here the factors analyzed namely Net profit ratio, Gross profit ratio, Earnings per share, Dividend, Dividend yield, Return on equity, Dividend payout ratio to find the impact on Market price.
As mentioned early the dividend policy is the one of the factor that impacts the market price of the company in Indian Stock market. After this study researcher analyzed and proven the relevance theory that the Dividend policy determinants have a real impact on Market Price.
9. Scope of Future Research
The present study have chosen few companies in an industry. So the researcher can consider the entire companies for the study in an industry and also try to use the primary data.
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A Research Paper on Impact of Dividend Policy Determinants of Listed Companies on Indian Capital Market
The core purpose of financial management is the maximization of shareholders' wealth with three core decisions that is, dividend, financing and investment decisions. In simple words dividend is the percentage of net profit of a company which is distributed among the shareholders. The research gap identified for this study is that, a comparison of different industries dividend policy impact on the Indian Capital Market and the samples are drawn from the National Stock Exchange (NSE) India. The main objective of this project is to study the influence of dividend policy on the market price of selected company's scrip in NSE. The researcher has chosen Empirical study to prove the hypothesis and 15 companies balance sheet for 10 years (2007-2016) were collected from the respected companies websites and the following ratios have been calculated to test the hypothesis, Net profit ratio, Gross profit ratio, Earning per share, Dividend yield, Dividend payout ratio, Return on equity and the Market price of share. The analyses conducted, the parameter estimates were viewed within AMOS graphics and displayed the standardized parameter estimates. The regression analysis model revealed that the significant impact of the independent variables on the market price of share as well as impact of dividend policy determinants on the outcome variable market price.
Dividend policy (DP) of corporate sector is widely researched topic in finance however; it remains a debatable issue to study what factors determine the DP. The objective of the paper is to analyze the relationship between dividend policy (DP) and shareholders’ wealth (SW) of Fast Moving Consumer Goods (FMCG) sector in India. Out of 16 firms listed on National Stock Exchange (NSE) 13 firms that have been paying dividend consecutively for the recent past ten years are considered for analysis. In the light of the prior literature, key predictor variables such as earnings per share (EPS), dividends per share (DPS), and retained earnings per share (RPS) are considered for analyzing the relationship between DP and SW. The descriptive statistics reveals that the data form in to normal. The data are found to be homoskedastic and are free of autocorrelation. Augmented Dickey Fuller Test (ADF), White - Heteroskedasticity Test, Auto Correlation, Breuch-Godfrey Serial correlation LM test, Lagrange Multiplier (LM) for Autoregressive conditional heteroskedasticity (ARCH-LM), Johansen Cointegration and VAR Granger causality test / Block Exogeneity Wald Test are applied using Eviews 7 Econometrics software package for analysis. The Johansen Co-Integration test sets out that there exists a stationary; there is a long – run relationship between dividend per share (DPS) as well as INTERNATIONAL JOURNAL OF MANAGEMENT (IJM) ISSN 0976-6502 (Print) ISSN 0976-6510 (Online) Volume 6, Issue 1, January (2015), pp. 314-330 © IAEME: http://www.iaeme.com/IJM.asp Journal Impact Factor (2014): 7.2230 (Calculated by GISI) IJM © I A E M E International Journal of Management (IJM), ISSN 0976 – 6502(Print), ISSN 0976 - 6510(Online), Volume 6, Issue 1, January (2015), pp. 314-330 © IAEME 315 Ramachandran Azhagaiah & Sandanam Gejalakshmi, “The Relationship Between Dividend Policy and Shareholders’ Wealth: Evidence from FMCG Sector In India” – (ICAM 2015) retained earnings per share (RPS) and earnings per share (EPS). The VAR Granger causality test / Block Exogeneity Wald test shows a significant causality between dividend per share (DPS) and earnings per share (EPS); retained earnings per share (RPS) and earnings per share (EPS); retained earnings per share (RPS) and dividend per share (DPS); and earnings per share (EPS) and retained earnings per share (RPS).
Journal of Business Finance & Accounting
Muhammad Irfan Chani
Purpose: The volatility in stock prices is one of the most discussed topics in finance. Many studies have been conducted to find the factors which cause fluctuation in stock prices and different results have been found. In this study an attempt has been made to see the affect of dividend yield, dividend payout ratio, return on equity, earning per share and profit after tax on stock prices in Pakistan. For this purpose four non financial sectors (Sugar, Chemical, Food and personal care, Energy) have been selected. A sample of 63 companies listed at Karachi stock exchange was analyzed for the period of 2006-2011. Methodology: Ordinary least square regression model has been applied on panel data. Findings: The results indicate dividend yield and dividend payout ratio which are both measures of dividend policy have significant impact on stock price. Dividend yield is negatively related with stock price and dividend payout ratio is positively related with stock price which means that the...
Dividend policy of an organization and how it affects their performance has remained one of the hottest and keenly debated issues till date. In spite of growing bodies of literatures and empirical findings, there has not been any general acceptance or conclusion on the extent dividend policy may influence corporate performance. This study examined dividend policy and corporate performance. The study adopted multiple regression models to examine the selected companies namely Nigerian Breweries Plc, Zenith Bank Nigeria Plc and Guaranty Trust Bank Plc from 2011-2015. The result of the analysis showed that for Nigerian Breweries, profit after tax and return on asset are positively related to dividend while earnings per share has negative relationship with dividend. The result for Zenith Bank shows that earnings per share and return on asset are positively related to dividend while profit after tax has negative relationship with dividend. The result for Guaranty Trust Bank shows that profit after tax has positive relationship with dividend while earnings per share and return on asset are negatively related to dividend. From the findings, the study concludes by agreeing with most of the dividend relevant proponents that dividend matters to corporate performance even though with varying results that tends to support other theories such as dividend residual theory. It therefore recommends that managers must review the opinion of their core investors in deciding dividend policy that meets with their expectations.
IOSR Journal of Economics and Finance (IOSR-JEF)
Md. Bellal Hossain Raju
Commercial organizations in Bangladesh are experiencing rivalry among themselves because of economic struggle globally and attempting to remain competitive in these changeable economic surroundings. This paper intends to analyze the impact of dividend policy on the market price of stock in Bangladesh. The numbers of statistic community are 330 companies in Dhaka Stock Exchange. All 24 companies belong to Fuel, Power and Cement industry listed at DSEX index are included as the sample for a phase from 2000 to 2016. In this paper, Fixed Effect Model along with Random Effect Model have been used to estimate outcomes. Both Models are exercised on panel data for explaining the association between dividend payments and share prices after adjusting several variables including Earnings per Share, logarithm value of Profit after Tax, Growth of Asset and Dividend Payout Ratio. The study also checked both the Models and found Random Effect Model is more significant than Fixed Effect Model. Afterward, this paper applied the multicollinearity test to determine is there any correlation among the variables and found no multicollinearity. This paper found a weak form market exists in Bangladesh and investors choose stock dividend more than the cash dividend.
This study examined the impact of capital structure on dividend pay-out ratio. The data used for this study was extracted through secondary source from the annual financial report of Unilever Nigerian plc. The study employed the used of the multiple regression technique in order to examine the relationship between a dependent variable and the independent variables. The ordinary least square (OLS) method was used based on its BLUE (best, linear, unbiased, estimator) properties. The essence of this technique is its unique feature compared with other techniques of estimation of models. A system based program known as E-Views (Econometrics views) was used for the statistical analysis of the data. The study found that there is insignificant positive relationship between the leverage and dividend payout ratio. The study also found significant positive relationship between the earnings and dividend pay-out ratio. It recommended that firms should rely less on the use leverage and focus more on developing internal strategies to improve on the internal source of finance without affecting the dividend paid out status.
International Journal of Innovations in Business
This research investigates the determinant of dividend policy for a sample of non-financial companies in Jordan over the period 2005–2016. This study concentrates on some variables that effect the dividend pay-out ratio and the dividend yield such as: Company size, risk, investment opportunities, historical dividend, profitability and leverage. This study used the panel dataset of non-financial companies in Jordan. The results show that company size showed significant positive impact, which could solve the free cash flow problem, mature and large companies were paying more and consistent dividends. The return on equity was positive and significant, that firms with high profitability were paying larger consistent dividend pay-outs. The impact of historical dividends always positive and significant and signposts that firms trend of dividend payout rather than the random paying. Risk has a negative impact on the payout levels. The analysis was depending on some theories that affect the dividend policy such as: Dividends irrelevance theory, bird in hand theory, pecking order theory, agency problems and signaling theory.
The oil and gas sector has been the main stay of the Nigerian economy which has attracted lots of investors and consequently maximization of wealth in the form of dividend. This study therefore investigated the effect of dividend policy on the performance of listed oil and gas firms in Nigeria spanning from 2007-2016. Secondary data were sourced from 9 listed firms which formed the sample size of this study. The collected data were analysed using descriptive statistics, correlations matrix and pooled regression analysis. Also, residuals of result were subjected to various diagnostic tests such as Variance Inflation Factor and Heteroskedasticity. Findings from the analysis revealed that dividend payout ratio and retained earnings positively affects earnings per share of listed oil and gas firms in Nigeria while dividend yield had a significant but negative effect on earning per share. Based on this, the study therefore recommends that oil and gas firms willing to maximize shareholders wealth and firms value should endeavor to consistently increase their dividend payout ratio as this sends a signal that the firm is financially healthy.
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Dividend Policy Overview and Analysis Research Paper
Outline of the subject, introduction.
Many companies, all over the world pay a part of their earnings, as cash dividends. Corporations view the dividend decision as quite important, because it determines the amount of funds should flow to the investors and the amount of funds to be retained by the firm for reinvestment. Dividend policy of a company can also provide information to the stockholder concerning the performance of the firm. However, dividends cannot be viewed in isolation.
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Many companies currently utilize a higher percentage of their net income to share repurchases as well, and this percentage has increased over the period. Therefore, dividends and repurchases must be seen as alternative payouts competing for corporate cash flows. This paper deals with the practical aspects of dividends, taxation considerations, its impact on the stock prices and other relevant issues analyzed in past research.
Dividend – an Overview
The term “dividend” usually refers to a cash distribution of earnings by a company and dividend is distributed out of current or accumulated earnings. If a distribution is made from sources other than the current or accumulated earnings, the term “distribution” is used to denote such payouts. The most common type of dividend is in the form of cash dividend. Public companies usually pay regular cash dividends up to four times in a year. Making a cash dividend payment reduces the the corporate cash and retained earnings shown in the balance sheet. Another type of dividend is paid out in the form of shares of stock.
This dividend is referred to as a stock dividend. It cannot be considered as a true dividend as no cash leaves the firm. The decision to pay a dividend rests in the hands of the board of directors of the corporation. A dividend is distributable to shareholders of record on a specific date. When a dividend is declared, it becomes the liability of the firm and it cannot be easily rescinded by the corporation (Ross, Westerfield, & Jaffe, 2002). The amount of dividend is expressed as dollars per share (dividend per share), as percentage of the market price (dividend yield) or as a percentage of earnings per share (dividend payout).
There are several factors, which justify the payment of dividends by the companies. For instance, cash dividend payments underscore a good performance by the company and provide support to stock price. Dividends may attract institutional investors who would like to have some return in the form of dividends. A mix of individual and institutional investors would enable the firm to raise the capital requires at comparatively lower cost as it can reach a wider market. Stock prices usually increase with the declaration of a new or increased dividend. Dividends absorb excess cash flow and may reduce agency costs that arise from conflict between the management and shareholders (Ross, Westerfield, & Jaffe, 2002).
However, there are some issues, which discourage the payment of dividends. Since dividends are taxed as ordinary income, normally this form of payouts by the company is discouraged. Dividends can reduce the internal sources of financing. Dividends may force the firm to forego projects with positive net present values (NPVs) or rely on costly external debt financing. Once established dividend cuts are impossible to make without a consequent reduction in the stock price of the firm.
The dividend policy of a company normally depends on the cash requirements of the company for investing in different new projects or for expanding the existing business opportunities. The number of projects with positive net present values determines the dividend payout policy of the company. Firms with many projects with positive net present value relative to available cash flow should adopt a low dividend payout ratio and conversely, firms with a lesser number of positive NPVs relative to available cash flows would follow a liberal dividend payout policy. Since consistency in the dividend payouts over years have certain advantages, companies normally avoid changing the dividend payout policies (Ross, Westerfield, & Jaffe, 2002).
However, there is no formula for calculating the optimal dividend-to-earnings ratio. In addition, there is no formula for determining the optimal mix between repurchases and cash dividends. It can be argued that because of tax implications firms should always substitute stock repurchases in place of dividends. However, while the volume of repurchases has greatly increased over time, dividends do not appear to be on the way out.
The following sections of the paper present a review of the related literature and the empirical results of the studies that enrich the knowledge on the subject of dividend policy.
Review of the Related Literature
The objective of this chapter is to provide a deeper insight into various aspects of dividend payments by companies by reviewing past research on the subject.
Miller & Modigliani, (1961) provided the initial thinking on the modern theory of dividend policy. They postulated that since the investment policy of any firm is set ahead of time, the dividend policy is irrelevant. Studies by Allen & Michaely, (2002) have materials to offer extensive insight into the literature relating to dividend policy. Agency theory is one of the theories developed to describe the relationship between ownership and control of a firm and according to this theory, the purpose of dividend policy is to minimize agency costs representing costs arising out of the divergence of ownership and control.
Grossman & Hart, (1982), Easterbrook, (1984) and Jensen, (1986) are some of the earlier scholars who contributed to the development of theoretical frameworks on dividend policy. This review attempts to present an analysis of the views of different scholars on the impact of dividend policy on agency costs, shareholders’ rights, stock prices, and several other associated issues relative to dividend policy.
The article by Jensen (1986) revolves around the agency theory, which states that dividend payouts to shareholders will reduce the financial resources available at the disposal of the managers, and this will reduce the power of the managers. This necessitates the managers to watch the capital market closely as the firm may need new capital now and then. On the other hand financing, the new projects from the available internal cash accruals of the company would avoid this monitoring of the capital markets by the managers. It also reduces the uncertainty on the costs associated with the raising of funds from external sources.
The article describes the free cash flow as one, which is available in excess of the funds required to fund all new projects having positive NPVs. Jensen (1986) further states that the conflicts of interests between managers and shareholders intensify especially in the circumstances where the firm is in a position to generate substantial cash flows. Agency theory deals with the ways of motivating the managers to flush out the excess cash flow rather than investing it at below the cost of capital or wasting it on any inefficient operations of the firm.
Managers always find it advantageous to see that the firms grow beyond optimal size as such growth gives them enormous powers and increases the resources under their control. It has also a nexus with the enhanced compensation of the managers as growth in sales leads to enhanced compensation for managers (Murphy, 1985).
Jensen’s article develops a theory to deal with the benefits of debt on reducing agency costs (costs arising out of the divergence of ownership and control) pertaining to free cash flows, the manner in which debt can substitute dividends, and the reasons as to why diversification programs are more likely to fail financially than takeovers or expansions. It also attempts to explain the reasons for the abnormal performance of the stocks of bidders and some targets prior to the takeover.
Article by Easterbrook (1984) also deals with the agency-cost explanation of dividends. Easterbrook (1984) states the purpose of any dividend or other corporate policy is to minimize the sum of capital costs, agency costs, and taxation costs. The article attempts to find out whether dividends payout can be used as an instrument in aligning the interests of the managers with that of the shareholders.
One of the forms of agency costs is identified as the cost of monitoring of managers and this cost is found to be expensive for the individual shareholders. However, the individual shareholder, only in proportion to his/her, would gain any saving in these costs shareholding. Another source of agency costs Easterbrook (1984) discusses is the risk aversion on the part of the managers (Jensen & Meckling, 1976). Managers tend to tie up a substantial value of their personal wealth in the form of stocks in their respective companies and in case, if the company does not do well financially or becomes bankrupt the managers would lose their jobs as well as a major portion of the personal wealth tied up with the firm. Therefore, the managers would choose projects, which are rather safe even though they have a lower expected return than riskier ventures.
Therefore, the question is whether the distribution of the available cash resources with the company as dividends would reduce this agency cost. Managers can use a dividend policy to change the risk of the firm by altering the debt-equity ratio. The lower the debt-equity ratio the lower the risk becomes for the firm. Therefore, managers by adopting a stringent dividend policy may issue debts first, and then finance the projects by retained earnings reducing the distribution of surplus to the shareholders by way of dividends. Shareholders on the other hand would like to have enhanced dividends and would induce the managers to undertake more risks so that they do not part with the wealth to the bondholders (by issuing of debts by the managers).
Dividend and Share Prices
Changes in dividend policies of corporations do have an effect on their share prices in the stock market. The article by Michaely, Thaler, and Womack, (1995) investigates the reactions of the stock market in respect of the prices of shares of firms resorting to the initiation and omission of cash dividend payments (Healy & Palepu, 1988; Asquith & Mullins, 1983). It is the normal presumption that the prices of a firm’s stock frequently rise when either its current dividend is increased or stock repurchase is announced. Conversely, the price of a firm’s stock can fall significantly when its dividend is cut. This implies information content in payouts.
This study by Michaely et al (1995) finds that the magnitude of short-run price reactions of stocks is greater for the omission of dividend payouts. On the other hand, the price reactions for dividend initiation decisions are not that large as compared to the omissions. Similarly in the year following the announcements the prices continue to traverse in the same direction as that of the last year and in this case also the price changes following the omissions are sharper and more robust. The study based on the results of previous research attributes three reasons for expecting substantial excess returns in the year following the dividend announcements.
- Post-earnings announcement drift (Bernard & Thomas, 1989) which implies an underreaction of the market. In this case, it is postulated that since the initial reaction of the market for omission or initiation announcements is insufficient there will be subsequent drifts upwards or downwards depending on whether the firm made the announcement for initiation or omission respectively.
- Firms that show extreme rise or reduction over the last 3 to 5 years tend to display excess reactions, following the initiation or omission decisions of the firms (DeBondt & Thaler, 1985).
- The third reason is that any action in the direction of omission or initiation would have an impact on the composition of the stockholders owning the company. According to Black & Scholes, (1974) such changes can be expected in the type of stockholders owning the company because some classes of investors may not prefer to have cash dividends for taxation reasons, while others would prefer to have cash dividend payments (Shefrin & Statman, 1984). This is known as the “clientele effect”.
Frank and Jagannathan, (1998) examine the drop in stock prices in relation to the value of dividends. Normally it is theorized that stock prices drop by less than the value of the dividends and this drop occurs on ex-dividend dates. The effect has been attributed to the tax clientele effect, implying that such reduction in stock prices would follow in a market where there are regulations covering dividend taxes and capital gains. Elton & Gruber, (1970) have identified tax considerations on dividends affecting the share price movements. This study with the evidence from the Hong Kong stock market where there is no regulation on dividends or capital gains proves the theory that stock prices fall below the value of the dividends.
Therefore, the authors conclude that it is difficult to interpret the relationship between the amount of the dividend and the average ex-dividend day price drop. The possible reasons identified by Frank & Jagannathan (1998) are that there is a tendency for the investors to place a buy order as a group after the stock goes ex-dividend and to place group sell orders when the shares go cum-dividend. However, in the data analyzed there is no probability of these actions have taken place nor the bid-ask spreads have been observed.
Shiller, (1981) observes that the measures of stock price volatility during the past periods seem to be at a higher level of 5 to 13 times too high. This increase is attributable to the new information on future real dividends. The study witnesses a dramatic failure of the efficient markets model with the disproportionate increase in stock price volatility and the author opines that it would seem impossible to attribute the failure to issues like data errors, price index problems, or changes in taxation considerations.
Dividend versus Stock Repurchases
Corporate payout policy generally suggests that dividends and stock repurchases are equivalent ways of paying out cash flows by the firms (Brealey & Myers, 1996). Firms normally view dividends as a commitment to their stockholders and are quite hesitant to reduce an existing dividend. Repurchases do not represent a similar commitment. Thus, a firm with a permanent increase in cash flow is likely to increase its dividend. Conversely, a firm whose cash flow increases only temporarily is likely to repurchase shares of stock. This is the finding from the study conducted by Jagannathan, et al, (2000). The following table illustrates the volume of repurchases against dividends paid out during the years 1985-1996.
Table: Payout Measures and Payout Techniques.
The authors observe that stock repurchases and dividends are used at different times from one another by different firms. Stock purchases have been found to be very pro-cyclical. On the other hand, dividends appear to be increasing steadily over time. Repurchasing firms are found to have more volatile cash flows and distribution. The other finding of the study is that the firms tend to repurchase stocks following poor stock market performance and they tend to declare and pay higher dividends when the stock markets perform better. The flexibility inherent in the repurchase programs is one of the main reasons for being preferred to payment of cash dividends.
The finding of Jagannathan, et al, (2000) has been substantiated by Grullon & Michaely, (2002). Based on their study they observe that apart from becoming an important form of payout for the corporations in the United States, firms tend to finance the repurchases out of funds that otherwise would have been available for payment of increased dividends. They also found that young firms have a higher propensity to fund the repurchases at an increasing phase over the past and repurchases have become a preferred payout source for these firms. The study also shows although the tendency for larger firms is not to cut down the dividends, yet they show a higher propensity to use repurchases as a source of payout. The following graph shows the proportion of the firms that follow different payout methods over the period 1974-1988.
The general finding of the study is that firms have gradually substituted dividend payouts with stock repurchases. This finding is consistent with the finding of Fama & French, (2001) that even after controlling the firm characteristics firms have a lower propensity to pay dividends than in the past. However, according to Grullon & Michaely, (2002), in the period before 1983, regulatory measures have constrained the repurchasing decisions of the firms.
Baker, Mukherjee, & Powell, (2005) consider the different ways in which the investors receive the distribution from the corporations. Regular cash dividends, specially designated dividends (SDDs), and share repurchases have important implications for investors. The specially designated dividend payments have been one of the recent origins and are recurring for regular dividend increase firms (Lie, 2000).
The authors find that the main motive for adopting the repurchase route is to take the benefit of the perceived market’s undervaluation of shares. When the corporations are able to make strong earnings and higher cash flows they tend to increase the dividend payouts and the specially designated dividend payments. However, the investors have to treat the SDDs as a temporary phenomenon. The SDDs need to be interpreted, as indicating positive information about the current excess performance of the firm and it is not indicative of the long-term performance of the firm.
Ikenberry, Lakonishok, and Vermaelen, (1995) examined the long-run firm performance about the impact on open market share repurchase announcements made during the year 1980 to 1990. The study revealed that in respect of glamour shares where there is no undervaluation by the market is possible no positive drift in abnormal returns was observed. However, with respect to value stocks, the market erred in the initial response and the market does not react to the information conveyed through repurchase announcements.
The essence of signaling is that the manager sets the dividend policy of the company for the benefit of himself and for the benefits of all the shareholders in general. However, it is not enough if the manager sets the dividend policy in order to maximize the intrinsic value of the firm. He must also consider the effect of dividend policy on the current stock price even if the current stock price does not reflect true value. Dong, Robinson, & Veld, (2005) have analyzed the reasons for the investors’ preference for dividends through a questionnaire to a Dutch investor panel.
The findings of the study indicate that investors prefer to receive dividends partly due to the reason that the transaction costs of cashing in dividends are lower than the transaction costs entailed in selling the shares. The answers confirm the signaling theory of Miller & Rock, (1985) and Bhattacharya, (1979). The study also proves that the behavioral theory of Shefrin & Statman, (1984) would apply to stock dividends and not for cash dividends. Dong et al (2005) also prove that individual investors do not tend to consume a larger part of their dividends and the investors would like to receive stock dividends in the place of cash dividends.
Through the review of different articles on the subject of dividend policy, this chapter provided the opportunity to gain further knowledge in the area of dividend policy. Stock repurchases have been dealt with in detail in the chapter along with a detailed review of the impact of the dividend policy on the stock price movements.
On the empirical side, Jensen (1986) proves that an actual takeover is not required to enlarge the return of the resources to shareholders but through a thorough restructuring, the surplus funds available with the firm can be effectively distributed to the shareholders. He cites Arco restructuring provided gains to stockholders ranging from 20 to 35% of market value, which in monetary terms amount to $ 6.6 billion. The restructuring involved repurchase of from 25 to 35% of equity involving over $ 4 billion in cash outflows. With a view to reducing the cash resources available at the disposal of the managers, the company substantially increased the cash dividend, sale of assets, and major cutbacks in capital spending.
Since the article by Easterbrook (1984) deals with the theoretical aspects of dividend policy and its ability to control the agency costs there is not many empirical data used by him in the paper. However, he tries to explain the impact of the dividend policy on the agency costs by an illustration. Assuming that a firm has an initial capital of 100 out of which 50 represents debt and the balance 50 is equity.
The amount was invested in a venture and with the earnings; the firm has raised its holdings to 200. With this situation, the creditors of a firm enjoy a more than sufficient security at the cost of the residual claimants paying a rate of interest unwarranted by the healthy financial position of the firm. Therefore, the firm can decide to pay a dividend of 50 and issue new debts worth 50. In this situation, while the capital of the firm would continue to be 200 the debt-equity ratio would have been restored to the original position and the interest rate also becomes appropriate to the risk the creditors’ are carrying.
Table IX of the empirical details in the article from Michaely et al (1995) shows the abnormal trading volume around dividend initiation and omission announcements. Table IX is reproduced below to explain the clientele effect due to omission and initiation.
Table IX. Abnormal Trading Volume around Dividend Initiation and Omission Announcements
From the table, it can be observed that the relatively minor increase in the percentage of volume during the event window and the decline thereafter suggests that even if there are changes in the clientele they are not that dramatic.
Jagannathan, Stepehens, & Wieisbach, (2000) constructed a database consisting of an underestimate and an overestimate of actual repurchases for every Compustat firm for the period between 1985 and 1996 and observe that the repurchases have actually grown over the period. In the year 1996, the actual repurchase volume was between $ 44.3 billion and $ 63.3 billion and this volume suggests that the repurchases have been considered as an economically important source of payout by the corporations. However, this volume is considerably less than the $ 141.7 billion paid out as dividends in the year 1996.
Grullon & Michaely, (2002) found that the number of firms that have initiated stock repurchase programs has increased from 26.6% in the year 1972 to 84.2% in the year 2000. The position is illustrated by the following graph.
The study by Dong et al (2005), out of the 555 responses received against a questionnaire sent to 2,723 smaller investors, shows 60.5% of the respondents indicate a higher preference for receiving dividends showing a preference score of 5 or above. This corresponds to a score of 4.98 on a scale of 1 to 7 where 1 indicates “I do not want dividends and 7 indicates, “I want dividends” with 4 as neutral). Only 12.3% of the respondents replied with an answer of 3 or below. This result shows a strong confirmation of the signaling role of dividends.
The study by Baker, et al., (2005) presents the following information as the main reasons for the corporations deciding to pay Specially Designated Dividends.
Reasons for Paying Specially Designated Dividends.
Frank & Jagannathan (1998) observed that in the Hong Kong, stock market for the period studied the dividend was HK $ 0.12 and the average price drop was HK $ 0.06. The authors have empirically proved their stand through market microstructure-based arguments.
The study by Ikenberry, Lakonishok, & Vermaelen, (1995) found the average abnormal four-year buy-and-hold return measured after the initial announcement is 12.1 percent. In respect of value stocks, companies are more likely to repurchase shares because of undervaluation, the average abnormal return is 45.3%.
Implications and Avenues for Future Research
The introductory part prepared the ground for the research on the subject of dividend policy by providing sufficient information on the concept of distribution of cash surpluses by corporations. The paper also deals with the implications of the distribution of cash surpluses by corporations in different ways. This research paper on dividend policy helps in distinguishing between the implications of cash dividend payouts and stock repurchases as one of the methods of distribution of cash surpluses by the corporations. The influence of agency cost issues in dividend policy considerations has been elucidated.
The articles reviewed provided for the enhancement in the knowledge relating to various concepts on the dividend policies being followed by the corporations and their impact on the market prices of shares. The stock repurchase area has been extensively reviewed through the study of scholarly articles. The concept of dividend signaling has been reviewed to find the reasons why dividend has been preferred by some class of investors. The empirical results in the form of regression analysis, tables, t-statistical values, and graphs provided greater insight into the area of dividend policy.
This review provides opportunities for further research in the area of dividend policy to the extent that there is a possibility that the necessity of the managers to consider the effect of adding a potential project on the total volatility of the firm’s asset portfolio and the resultant impact on the firm’s optimal dividend policy. The link between dividend policy and cash flow volatility with respect to different industry settings is another potential avenue for further research. The impact of dividend announcements on the stock returns in respect of stocks being dealt with in any of the emerging stock markets would be an interesting study to assess the investor behavior in the respective emerging stock market.
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Economic Research-Ekonomska Istraživanja
Determinants of dividend payout decisions – the case of publicly quoted food industry enterprises operating in emerging markets
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2. theoretical background, 3. internal and market determinants of dividend policy, 4. different approaches to developed and emerging markets, 5. methodology, 7. discussion, 8. conclusions, 9. limitation of the study, 10. further research, disclosure statement, research article.
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The paper examines the factors influencing dividend payout decisions. Our analysis is based on unbalanced panel data with 799 observations of companies from 15 countries over a period of 14 years. The study develops eight research hypotheses and uses a modelling approach based on the random effects panel probit model. An important conclusion reached in our study is that a company’s financial situation in preceding year influences the dividend payout decision. In addition, the key significant determinants of dividend payout decision in the period covered by our study include free cash flow, growth, liquidity, profitability and size. These important research results are confirmed by other studies in the field. They are therefore essential for determining dividend policies. Individual effects across investigated enterprises also played an important role in the dividend policy.
- Dividend policy
- cash dividend
- emerging markets
- emerging European countries
- food industry
- panel Probit model
SUBJECT CLASSIFICATION CODES::
Dividend is a price that a company pays to investors for the capital invested by them in the company. For this reason, dividend payout decisions do not depend solely on financial results and cash flow distribution. Managers' decisions on dividend payments may be dictated by the hedging of funds in a situation of economic downturn, increased profit volatility, limited external financing or high future capital needs. Thus, the ‘dividend puzzle’ has been the object of an ongoing investigation. However, a study of the emerging markets could shed more light on the topic, contributing to the growing body of research on dividend policy (Glen, Karmokolias, Miller, & Shah, Citation 1995 ).
The issue of dividend payout in a given company, called the ‘dividend puzzle’, gives rise to several research problems that could be studied at various levels of detail. One of these problems relates to the companies’ financial condition. In this case, the importance of dividend payouts manifests itself in the value creation of publicly quoted enterprises or in the investors’ recommendations (Carleton, Chen, & Steiner, Citation 1998 ). The second issue linked to the dividend puzzle is the relationship between the company dividend policy and the operations, transfers and risk characteristics of the emerging markets.
The discussion on the ‘dividend puzzle’ in literature took the form of a ‘disappearing dividend puzzle’, which is still an important problem linked to the following issues: the trend to lower transaction costs for stock sales, the growing role of stock options for managers who prefer capital gains to dividends, the improvement in corporate governance technologies as compared with the lower value of the benefit of dividend payments in the management of agency problems between stockholders and managers (Fama & French, Citation 2001 ), and the level of earnings that affects managerial decisions on payout policy (Shapiro & Zhuang, Citation 2015 ). This approach builds on theories which seek to explain managerial motivation in a situation of a decreasing relevance of agency costs (Bahreini & Adaoglu, Citation 2018 ). Our model provides a comprehensive framework for the main determinants of payout decisions as part of the ‘dividend puzzle’ evaluation approach. In this regard, the study contributes to international business research that has established models and furnished crucial knowledge about the economy of the emerging markets, as the nature and characteristics of dividend policies differ between the developed and emerging countries.
The main purpose of this study is to identify the factors that influence the dividend payout decisions in relation to the companies’ financial situation among publicly listed food industry companies operating in emerging European markets. Understanding the dividend policy is crucial for further forecasts of possible dividend payouts. The panel data analysis was used to identify factors influencing the dividend policy of companies in different financial situations. The following variables were considered: net income, liquidity, growth, profitability, free cash flow, leverage, company size and the price per earnings (P/E) ratio. These data cover only internal analyses of the dividend policy. We examined the characteristics of dividend payers and non-payers which are common across the countries under study, by using international data from the food sector. The panel sample comprises 799 observations of a changing number of companies from 15 countries in the period 2003–2016. In our analysis, particular attention was paid to dividend payments in the developing economies. The availability of investment capital is, in fact, one of the essential (and necessary, if not sufficient) conditions for a given company’s further development. This issue is important in case of countries in transition (Skare & Sinković, Citation 2013 ), where financial liquidity is the key variable associated with dividend payout.
Our paper contributes to the relevant literature to intra-industry research with respect to dividend policy. Our paper adds new evidence to the literature on dividend policy by showing that there are different dividend responses with some of the effects occurring with a one-year delay with respect to intra-industry research. These results stand in contrast to the statement that dividend decisions in emerging markets are not predicated upon long-term payout targets. We tested the model according to two dimensions: the influence of the global financial crisis on the dividend payout decision process and the differences in the determinants of dividend payout in case of small and big companies. Our results might help investors gain a comprehensive understanding of the impacts of the dividend decision mechanism on the financial health of food sector companies.
The article is structured as follows. Section 1 deals with the theory of dividend policy decisions. Section 2 , which is based on a review of relevant literature, introduces the determinants of dividend payout decisions. Section 3 illustrates the study sample, sets out the methodology and defines the basic measures used in the selected panel model. Section 4 sums up the empirical results and the results of the robustness tests, while section 5 presents results and the general conclusions with limitations of the study and further research issue.
The corporate determinants of dividend policy have become a fixed element of the modern theories of finance. We can distinguish three principal theories that help illuminate the dividend policy, that is: information asymmetries, tax-adjusted theory and behavioural theories. The information asymmetries theory comprises signalling models, agency cost, and the free cash flow hypotheses (Amidu & Abor, Citation 2006 ). According to the agency costs theory, undistributed profit will be consumed in the company as an extra benefit or such retained earnings will be invested (Jensen & Meckling, Citation 1976 ). Second, capital markets are imperfect mostly because of unequal access to information: insiders are better informed about the firm’s future cash flows than investors are. In such a situation, dividend payouts might convey information about the firm’s future earnings (Allen & Michaely, Citation 2003 ).
The decision to pay out dividends may be influenced by investors if the shareholders wish that this should be the case. This view is supported by Frankfurter and Lane, who conclude that dividend payouts could increase the attractiveness of equity issue. In such a scenario, a dividend payout to a shareholder will enhance the future stability of the company. When understood in this way, dividend payouts could be a method of calming investors (Frankfurter & Lane, Citation 1992 ). The catering theory explains the demand-driven approach to dividend payouts by defining the role of the dividend policy as a tool for catering to investors’ desires.
The ‘dividend puzzle’ may have multiple underlying determinants. Most studies on this topic focus on investigating the determinants of dividend payments in developed economies.
Dividend policy depends on current or future earnings of the firm and the percentage share of retained earnings. According to DeAngelo, DeAngelo and Stulz, dividend payment correlates positively with the ratio of retained earnings to total equity (DeAngelo, DeAngelo, & Stulz, Citation 2006 ). Fama and Babiak ( Citation 1968 ) identify the impact of income from previous years on current dividends. This significant relation between dividends and past earnings was also confirmed by Benartzi, Michaely and Thaler ( Citation 1997 ). These findings are consistent with the signalling theory, according to which a significant increase in earnings in the current and previous years affects subsequent dividend payout decisions. Hence, we propose the following hypothesis:
H1: There is a positive correlation between dividend payment and net income value.
The level of profitability is a determining factor in dividend payouts. High ROE and ROA tend to correspond to high dividend payouts (Benavides, Berggrun, & Perafan, Citation 2016 ; DeAngelo, DeAngelo, & Skinner, Citation 1996 ; DeAngelo et al., Citation 2006 ; Denis & Osobov, Citation 2008 ; Fama & French, Citation 2001 ). The results of the study by Kaźmierska-Jóźwiak ( Citation 2015 ) indicate that there is a significant but negative relationship between profitability (ROE) and the dividend payout ratio. In the research sample, in the case of ROA there was a stronger correlation with dividend payouts than in the case of ROE, which could point to a specific capital structure correlation among listed companies operating in emerging markets. ROA serves as a proxy for the availability of internal funds, growth opportunities, the scale of agency problems and information asymmetry. This study recognises that the dividend payout correlates positively with profitability.
H2: There is a positive correlation between dividend payment and profitability (ROA).
3.3. Free cash flow
The free cash flow theory is based on the idea that managers rely on the dividend policy as a means of communication with the investors to signal income growth levels and future prospects of the company growth as well (Bena & Hanousek, Citation 2008 ). Firms that predict declining investment opportunities are more inclined to increase dividends (Grullon, Michaely, & Swaminathan, Citation 2002 ).
The dividend policy of a given company can be used as a monitoring tool to reduce free cash flows in order to decrease the agency costs associated with the separation of ownership and control in companies (Brunzell, Liljeblom, Löflund, & Vaihekoski, Citation 2014 ). We hypothesise that:
H3: There is a positive correlation between dividend payment and Free Cash Flow.
Dividend policy is strongly linked to fundamental firm characteristics such as growth opportunities (Denis & Stepanyan, Citation 2011 ). Growth in sales and in the market-to-book value is used as predictors of investment opportunities. However, in the effect of growth opportunities on the possibility of dividend payouts has been shown to be inconsistent. Allen and Michaely’s results and other researchers show that firms with a high degree of information asymmetry and high growth opportunities should avoid paying dividends (Allen & Michaely, Citation 2003 ; Chen & Steiner, Citation 1999 ; Jensen, Solberg, & Zorn, Citation 1992 ; Rozeff, Citation 1982 ). However, low-growth firms could pay out relatively high dividends in the situation of limited opportunities for profitable investment (Alli, Khan, & Ramirez, Citation 1993 ). Our hypothesis is:
H4: There is a positive correlation between dividend payment and company growth.
3.5. Company size
The size of the company matters, as in all countries dividends were paid by the biggest and most profitable firms (Denis & Osobov, Citation 2008 ). However, this factor is related to profitability, as bigger and more profitable firms are more likely to pay dividends (Consler & Lepak, Citation 2016 ; DeAngelo et al., Citation 2006 ). According to Authors, the size of a firm has a significant impact on the relation of retained earnings to total equity. This correlation was also evidenced in Fama and French’s study (Fama & French, Citation 2001 ). In this study, we hypothesise that larger food sector companies are more likely to pay dividends.
H5. There is a positive correlation between dividend payment and company size.
3.6. Financial leverage
In the long run, variation in dividends is significantly related to the capital structure of the firm (Belo, Collin-Dufresne & Goldstein, Citation 2015 ). The higher the leverage that the company relies on, the lower the likelihood that this company will pay dividends (Von Eije & Megginson, Citation 2008 ). Firms which increase dividend payouts by a large amount subsequently increase their leverage (Cooper & Lambertides, Citation 2018 ). A high level of debt could be related to the decision not to pay out dividends, which could be explained by the need to maintain higher levels of free cash to meet the creditors’ demands. Therefore, higher debt ratios are related to lower dividend payouts or lack of dividends (Chay & Suh, Citation 2009 ). Hence, our hypothesis is:
H6. There is a negative correlation between dividend payment and leverage.
The level of liquidity and the structure of current assets affect the decisions on dividend payments in a firm. High cash surpluses could translate into the distribution of retained earnings in the form of dividends to shareholders or into investments in the firm's capital stock as part of reinvestment in the firm (Alstadsaeter, Jacob, & Michaely, Citation 2017 ). Many studies provide evidence of the relationship between the current ratio, or the working capital level (as proxy for liquidity), and the possibility of dividend payouts (Ho, Citation 2003 ; Kaźmierska-Jóźwiak, Citation 2015 ). Companies which make a decision to disburse cash from profit retain a higher level of financial liquidity (Franc-Dąbrowska, Citation 2007 ). The positive correlation between dividend payouts and liquidity is supported by the signalling theory. In this study, we propose the following hypothesis:
H7: There is a positive correlation between dividend payment and liquidity.
3.8. Market risk
The market ratios explain the investors’ attitude to a given firm’s dividend policy. The value of price per earnings ratio can be interpreted as a risk measure. The increase of the P/E value may suggest an growth of future earnings expectations (Al-Malkawi, Citation 2008 ). In this manner, business risk is also used as an indicator of future profitability (DeAngelo et al. Citation 2006 ). Overall, this study recognises that dividend payout correlates positively with company value on the market, represented by stock price.
H8: There is a positive correlation between dividend payment and the P/E ratio.
3.9. Dividend payers and non-payers
According to the study by Baker et al. on developing markets, growth opportunities, low profitability and cash constraints are the main reasons not to pay dividends (Baker, Chang, Dutta, & Saadi, Citation 2012 ). According to Ferris, Sen and Unlu, the large proportion of non-payers can be explained by an increase in the percentage share of firms that have never paid dividends (Ferris, Sen, & Unlu, Citation 2009 ). Furthermore, firms that pay dividends are more attractive for investors, who choose to invest in these firms rather than in the non-dividend-paying ones (Goldstein et al., Citation 2015 ). Dividend payers tend to be mature firms, while young, high-growth firms do not usually pay dividends (Baker, Citation 2009 ).
3.10. Industry characteristics
The industry effect on the dividend policy verifies that industries with high-growth options pay fewer dividends (Gaver & Gaver, Citation 1993 ; Ho, Citation 2003 ; Smith & Watts, Citation 1992 ). The statement that dividend and investment decisions are not independent and that they are dependent on industry effects is advanced in a study by Michel and Shaked and Al-Malkawi (Al-Malkawi, Citation 2008 ; Michel, Citation 1979 ; Michel & Shaked, Citation 1986 ). Different firms have various possibilities of achieving high income and, thereby, high return. This information is transmitted to the market in the form of various signals that a dividend payout is likely to happen in the immediate future (Bhattacharyya, Citation 2007 ). Furthermore, Van Canegham and Aerts’ study, showed that firms paying dividends are more similar in their dividend payout strategy to firms from the same sector than to companies from other sectors (Van Caneghem & Aerts, Citation 2011 ).
The food industry produces primary products and responds to a relatively inflexible demand in at times turbulent economic conditions. In addition to the seasonality of the production process and the dependence on natural and political conditions, the unfavourable price developments in the long run or a relatively low profitability of investments can contribute to discouraging investment levels (Mądra-Sawicka Citation 2017 ; Pasek, Citation 2015 ).
The dividend policy of corporations which operate in emerging markets is significantly different from the widely studied dividend policy behaviour of corporations in developed economies (Adaoglu, Citation 2000 ). The results of relevant research are presented in Table 1
Table 1. comparison of dividend policies across developed and emerging economies., 5.1. sample, variables and data collection.
The study uses a firm-level panel data set comprising all publicly traded firms operating in emerging European food industry markets. We collected firm data (expressed in millions of USD) from consolidated and individual financial statements. The financial (end-of-year) data were collected from three sources. Our primary source is the Emis Intelligence database. Additional items were collected from Datastream. Finally, we also used data published by the stock exchanges.
We use a three-step level of selecting the data to enhance the data quality. In a first step, we select countries that are in EMIS Intelligence databased and were included in the MSCI Emerging Markets index of Thomson Reuters in Europe region. Then in the second-step the companies were selected according to databased industry classification. We identified firms by means of the sector variable that based on Worldscope Industry Classification Benchmark (ICB) codes. In the third-step the generated list contained the individual code for all firms and home country code of the company (identification code assigned by Datastream). We construct portfolios that contain the selected companies. The investigated period was limited by number of observation that enables to establish panel models. The sample was checked according to duplicated data. We eliminate these observations for which the price or market-capitalisation data was missing. The observations for firms that are cross-listed in more than one country were kept in a sample only in the country of incorporation.
The period under study covers the years 2003–2016. The verification of the data was performed by auditors and by the Authors by means of an expert method. A multidirectional verification of the calculations performed did not reveal any errors or raise any doubts as to the quality of the data.
We examined the characteristics of dividend payers and non-payers which are common across several countries by relying on the data for the food industry. The database has 799 observations of companies from the following 15 countries: Bosnia and Herzegovina, Bulgaria, the Czech Republic, Croatia, Hungary, Latvia, Lithuania, Macedonia, Poland, Russia, Romania, Serbia, Slovakia, Turkey and Ukraine. We add to the sample companies from Russia and Turkey to increase counterpoise and in research period between dividend payers and non-payers.
Table 2 presents the description of the variables used.
Table 2. Variable definitions.
A robustness test was carried out to verify the stability of results for different subsamples. The study period has been spanned into two sub-periods: 2003–2009 and 2010–2016. The first sub-period covers the years before the consequences of the global financial crisis could influence dividend payout decisions. The second sub-period is the longest possible time series that could be investigated after the financial crisis and due to the extensive – economic and temporal – consequences of that crisis.
To examine the determinants of dividend payments, we used a panel regression model with a binary dependent variable. Our results supplement those of Fama and French ( Citation 2001 ) and the models proposed by Denis and Osobov ( Citation 2008 ) which average the coefficients of the logit regression for annual cross-section data (Denis & Osobov, Citation 2008 ; Fama & French, Citation 2001 ). Other examples of longitudinal data analyses of dividend payout decisions were highlighted in several previous studies (Al-Malkawi, Citation 2008 ; Jabbouri, Citation 2016 ; Kim & Jang, Citation 2010 ).
We had the advantage of being able to use longitudinal data and test whether there were significant unobservable individual effects that influenced the dividend payment policy. Using cross-sectional time-series data gave us an opportunity to examine issues that could not be studied in one-dimension data sets. Every individual effect covered all the time-invariant characteristics of every object (firm), which influenced the dependent variable, but which was not explicitly comprised in the vector of explanatory variables (usually because it was not observable).
6.1. Descriptive statistics
Table 3 presents the statistics of the variables examined. Some of them show a fairly high level of variability. However, as further analyzes (model tests) have shown, outliers carry a large dose of information on the phenomena investigated. It is therefore not necessary to eliminate them from this particular study. On the other hand, questionable cases of dividend payments were explained or not considered in the study.
Table 3. Descriptive statistics of selected variables for whole sample.
Detailed information about the number of enterprises from individual countries is provided in Appendix 1 . The fewest companies analyzed in our study operated in Bosnia and Herzegovina, the Czech Republic, Slovakia and Ukraine, while most observations pertained to firms operating in Poland and Turkey.
There was a variation in the number of observations of dividend-paying and non-dividend paying companies across individual countries. It turned out that there is only a small majority of companies being non-payers (detailed data are provided in Appendices 2 and 3 ).
Comparing the mean characteristics (see: Appendix 4 ) for dividend payers and non-payers it was confirmed that the mean values of SIZE, FCF, GRO and NI were statistically significantly different between analyzed groups. In case of LEV , LIQ, PE and PROF we did not find a statistically significant difference in the means.
6.2. Fixed effects logit model and the random effects Probit model
Table 4. estimation results for logit fe model and probit re model..
Based on the F test for the linear approximation Footnote 3 of the fixed effects model, we can reject the null hypothesis that all individual effects equal zero ( p -value = 0.000). Also, according to the Breusch and Pagan Lagrangian Multiplier test for the linear approximation of random effects, the evidence is strongly in favour of an individual-specific effect ( p -value = 0.000). Therefore, individual effects should be included in the model. The Hausman specification test indicates that the random effects estimator is preferable ( p -value = 0.25) to the fixed effects model. Moreover, in the case of the random effects model, the interclass correlation coefficient indicates that more than 85% of variance is due to differences across the panel, which confirms that individual effects across firms play an important role in dividend payout decisions.
Subsequently, we tried to examine if there were any significant lags in the relationships between the explanatory variables and the decision on dividend payout. Successive models were estimated according to the from-general-to-specific principle. Finally, we have obtained the following probit model with random effects (the results are presented in Table 5 ):
Table 5. Random effects probit regression Footnote 4 .
Table 6. marginal effects at the average, assuming that the random effect for that observation's panel is zero., 6.3. robustness of the results.
The objective of this section is to verify whether the results obtained in the previous section are robust for different model specifications. We have investigated the stability of the results in two dimensions. Based on a literature review we distinguish two periods that includes financial crisis effect and company SIZE as a factor that matters thus the bigger and more profitable firms are more willing to pay dividends.
6.3.1. Effect of the financial crisis on dividend payout policy
Abreu and Gulamhussen (2013) suggest that the agency cost theory influenced the dividend payouts decision both before and during the financial crisis. It can be confirmed that the global financial crisis, which spread all over the world at the turn of 2008/2009, has changed the financial conditions of firms operating on the emerging markets. Given the deterioration of the conditions in which companies operate, it may be supposed that the dividend payment policy may also have changed. In order to compare the results for the pre-crisis and post-crisis model, the model was estimated for two subsamples for which the stability of the parameters was verified. The results are set out in Table 7 .
Table 7. Estimation results for probit RE model for before crisis and after crisis subsamples.
The analysis of the results confirmed the previous results related to FCF, GRO and SIZE . In the case of the pre-crisis period, only the PROF values are not significant; in the post-crisis period, both PROF and LIQ lose their significant impact on dividend payment decisions. This confirms that the financial measures after the crisis lost their influence on dividend payment policies. These results indirectly support the conclusion that after the financial crisis bigger companies and companies with more growth potential decided to signal their favourable market position by paying dividends. Company size, the rate of growth and the FCF values continued to be the most reliable indicators of the financially stable condition of the food sector companies.
6.3.2. Effect of company size on dividend payout policy
Related studies, such as Coulton and Ruddock ( Citation 2011 ), DeAngelo, DeAngelo and Stulz ( Citation 2006 ) and Fama and French ( Citation 2001 ), formed the background for this check. The hypothesis that ‘Large’ firms have different dividend payout policies than smaller firms has been verified. Listed companies operating on emerging markets differ according to size, therefore the full sample was divided according to their revenues value into two groups, named ‘Small’ (the size of the company was smaller than the median size of all companies) and ‘Large’ (the size of the company was bigger than median size of all companies). The investigated sample of companies significantly differed according to their SIZE which could be one of the consequences of emerging markets characteristics. The results of the estimations performed for the two subsamples are presented in Table 8 .
Table 8. Estimation results for probit RE model for two subsamples of companies according to SIZE measure: Small and Large.
The analysis of the results confirmed that bigger firms noticed the influence of all the estimated variables for the whole sample, apart from LIQ , which is an essential factor mostly for ‘Small’ companies that do not have flexible access to short-term debt. In the case of ‘Small’ firms only two variables – LIQ and SIZE – had a significant impact on dividend payout policy.
We find that the core findings of the estimated model are consistent after the verification of the panel model results.
The research hypotheses regarding the relationship between dividend payments and leverage, P/E ratio and net income have not been confirmed.
We have estimated a random effects probit panel model which confirms the significant influence of free cash flow, company growth, liquidity, profitability ratio and the logarithm of the size on the decision concerning dividend payments. The higher the values of these variables, the greater the probability of dividend payments. There are significant unobservable individual firm-specific effects that determine the dividend policy.
We also investigated the robustness of the results for the outlier observations that were included in the sample. The removal of outlier observations did not change the overall results, which is why we can suppose that the significantly higher values of individual observations are the result of the same data-generating process as underlies all other observations.
The results indicate that highly profitable firms with more stable earnings can afford larger free cash flows, which increases the likelihood of dividend payouts. A similar conclusion was also reached by Naceuer et.al. and Kim and Jang (Kim & Jang, Citation 2010 ; Naceur, Goaied, & Belanes, Citation 2006 ). The results of Kaźmierska-Jóźwiak’s research (2015) substantiate the conclusion that it is necessary to further investigate the correlation between dividend payout and profitably. Furthermore, high-growth firms are more likely to resort to dividend payout when these conditions are fulfilled (Denis & Osobov, Citation 2008 ; Fama & French, Citation 2001 ).
In order to perform a robustness check, we repeated the analysis using different subsamples. The empirical results show that food industry companies apply an unstable dividend policy and that liquidity is the main factor which determines dividend payout decisions in the case of smaller firms. The analysis corroborates the results obtained by Kuo, Philip, and Zhang ( Citation 2013 ) and Jabbouri (2016), and stresses the same factors enhancing the forecast of dividend payout that could boost market activity of a company and attract more potential investors. After the financial crisis period, the main factors that influence dividend payout decisions are growth, size and free cash flow, which is consistent with Aivazian, Booth and Cleary ( Citation 2003 ), Denis and Osobov ( Citation 2008 ) and Mahdzan, Zainudin and Shahri ( Citation 2016 ). The model for the whole period and our robustness tests point to the same correlation between the variables studied.
Limitations of the interpretations of the study results are mainly the consequence of the limited number of sample observations and the irregularity of decisions on dividend payout in the sector under study. The risk of obtaining unstable results was mitigated by data quality verification, which was performed as a three-step process.
The interpretation of the results may be burdened with some limitations. First of all, the risk of unstable results of estimated binary choice model on panel data may be an effect of the characteristics of the investigated sample size and data quality. The decisions on dividend payout are irregular. Moreover, this irregularity increases in the case of emerging markets and food industry, which can be seen in the unbalanced panel data. However, we can assume that the panel data are incomplete due to randomly missing observations. In this case standard procedures are appropriate (Baltagi, Citation 2005 ). Moreover, the stability of the results was widely verified for different subsamples and the verification of data quality was performed. It should also be underlined that the estimated binary-choice model points to significant factors which may influence the decision on dividend payout, but it does not specify the value of the dividend (a two-stage decision process). One more problem with the interpretation of the model results may arise in the case of endogeneity of the explanatory variables. It was assumed that in the course of the dividend policy process, the financial indicators do not depend simultaneously on the positive or negative decision concerning the dividend payout. They may, however, depend on the value of the dividend payout with a lag of one or more years.
Our study results could be usefully supplemented by further research. With the increasing pace of financial operations and the growing flow of information, it is necessary to consider other factors that may affect the decrease in dividend payment levels. These could include behavioural determinants or macroeconomic variables that make it possible to predict a financial crisis or a bull market in a global perspective. Further research may investigate dividend payment policies in companies operating in other sectors by use of tobit panel model.
Source: Own computations.
Source: own computations in STATA 15.
Where: superscript t − 1 indicates one-year lag of the variable.
Related Research Data
No potential conflict of interest was reported by the author(s).
1 Dividend payment policy refers to the payout policy that a firm follows in determining the size and the pattern of cash distributions to shareholders (Baker et al., Citation 2012 ; Jabbouri, Citation 2016 ).
2 In all the results presented in this study, the p-value z is a two-tail p-value based on the hypothesis that each coefficient is different from zero.
3 Wooldridge ( Citation 2005 ) suggests that linear models are usually good approximations of non-linear binary-choice models, it was also supported by Greene ( Citation 2012 ) (Greene, Citation 2012 ; Wooldridge, Citation 2005 ).
4 Due to an insufficient number of observations, it was impossible to estimate the logit FE model (the conditional fixed-effects logistic estimator requires only objects for which at least one observation of the binary variable is different from others; in the sample, 72 groups (423 observations) were dropped because of all positive or all negative outcomes).
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Number of companies depending on the country listed market
Number of observations depending on the country listed market
Descriptive statistics of selected variables in group of dividend payers and non-payers
The results of the two-sample t tests on the equality of means.
The null hypothesis is that the mean values of variables are equal for dividend payers and dividend non-payers
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Dividend Policy: What It Is and How the 3 Types Work
James Chen, CMT is an expert trader, investment adviser, and global market strategist.
Gordon Scott has been an active investor and technical analyst or 20+ years. He is a Chartered Market Technician (CMT).
Investopedia / Crea Taylor
What Is a Dividend Policy?
A dividend policy is the policy a company uses to structure its dividend payout to shareholders. Some researchers suggest the dividend policy is irrelevant, in theory, because investors can sell a portion of their shares or portfolio if they need funds. This is the dividend irrelevance theory , which infers that dividend payouts minimally affect a stock's price.
- Dividends are often part of a company's strategy. However, they are under no obligation to repay shareholders using dividends.
- Stable, constant, and residual are the three types of dividend policy.
- Even though investors know companies are not required to pay dividends, many consider it a bellwether of that specific company's financial health.
What Is A Dividend?
How a dividend policy works.
Despite the suggestion that the dividend policy is irrelevant, it is income for shareholders. Company leaders are often the largest shareholders and have the most to gain from a generous dividend policy.
Most companies view a dividend policy as an integral part of their corporate strategy. Management must decide on the dividend amount, timing, and various other factors that influence dividend payments. There are three types of dividend policies—a stable dividend policy, a constant dividend policy, and a residual dividend policy.
Types of Dividend Policies
Stable dividend policy.
A stable dividend policy is the easiest and most commonly used. The goal of the policy is a steady and predictable dividend payout each year, which is what most investors seek. Whether earnings are up or down, investors receive a dividend.
The goal is to align the dividend policy with the long-term growth of the company rather than with quarterly earnings volatility. This approach gives the shareholder more certainty concerning the amount and timing of the dividend.
Constant Dividend Policy
The primary drawback of the stable dividend policy is that investors may not see a dividend increase in boom years. Under the constant dividend policy, a company pays a percentage of its earnings as dividends every year. In this way, investors experience the full volatility of company earnings.
If earnings are up, investors get a larger dividend ; if earnings are down, investors may not receive a dividend. The primary drawback to the method is the volatility of earnings and dividends. It is difficult to plan financially when dividend income is highly volatile.
Residual Dividend Policy
Residual dividend policy is also highly volatile, but some investors see it as the only acceptable dividend policy. With a residual dividend policy, the company pays out what dividends remain after the company has paid for capital expenditures (CAPEX) and working capital .
This approach is volatile, but it makes the most sense in terms of business operations. Investors do not want to invest in a company that justifies its increased debt with the need to pay dividends.
Example of a Dividend Policy
Kinder Morgan (KMI) shocked the investment world when in 2015 they cut their dividend payout by 75%, a move that saw their share price tank. However, many investors found the company on solid footing and making sound financial decisions for their future. In this case, a company cutting their dividend actually worked in their favor, and six months after the cut, Kinder Morgan saw its share price rise almost 25%. In early 2019, the company again raised its dividend payout by 25%, a move that helped to reinvigorate investor confidence in the energy company.
Kinder Morgan. " Dividend History ." Accessed Sept. 26, 2020.
Yahoo! Finance. " Kinder Morgan, Inc. Stock Price ." Accessed Sept. 26, 2020.
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Determinants of Dividend Policy in Indian Companies: A Panel Data Analysis
Proceedings of 10th International Conference on Digital Strategies for Organizational Success
18 Pages Posted: 3 Jan 2019 Last revised: 3 Feb 2019
Prestige Institute of Management
Date Written: January 6, 2019
This article examined the determinants of the dividend policy of Automobiles companies and pharmaceuticals companies listed on Auto index and Pharma Index of the sectoral indices of national stock exchange in India. The study covers the tenure of ten years starting from 2006-2007 to 2015-2016. Static panel data model has been used for the analysis. From the literature review we identified the variables like profitability measure as Return on equity, Liquidity or cash flow, leverage (debt equity ratio), investment opportunities, dividend distribution tax, retained earnings, size of the company and sales growth of the company which affect the dividend decision of the company. The result of panel regression concludes that in automobiles sector Liquidity/Cash Flow, dividend distribution tax, investment opportunities and retained earnings are the significant factor which influence the dividend payout ratio where as in Pharmaceuticals sector profitability, debt equity ratio, sales growth and retained earnings are the significant factor for deciding dividend payout ratio.
Keywords: Dividend Policy, Automobiles sector, Pharmaceuticals sector and Panel Regression
Suggested Citation: Suggested Citation
Navita Nathani (Contact Author)
Prestige institute of management ( email ).
Airport Road, Opposite Deendayal Nagar Gwalior, MP 474 020 India
Jiwaji University ( email )
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The method used by a company to pay out dividends
What is a Dividend Policy?
A company’s dividend policy dictates the amount of dividends paid out by the company to its shareholders and the frequency with which the dividends are paid out. When a company makes a profit, they need to make a decision on what to do with it. They can either retain the profits in the company (retained earnings on the balance sheet ), or they can distribute the money to shareholders in the form of dividends.
What is a Dividend?
A dividend is the share of profits that is distributed to shareholders in the company and the return that shareholders receive for their investment in the company. The company’s management must use the profits to satisfy its various stakeholders, but equity shareholders are given first preference as they face the highest amount of risk in the company. A few examples of dividends include:
1. Cash dividend
A dividend that is paid out in cash and will reduce the cash reserves of a company.
2. Bonus shares
Bonus shares refer to shares in the company are distributed to shareholders at no cost. It is usually done in addition to a cash dividend, not in place of it.
Examples of Dividend Policies
The dividend policy used by a company can affect the value of the enterprise. The policy chosen must align with the company’s goals and maximize its value for its shareholders. While the shareholders are the owners of the company, it is the board of directors who make the call on whether profits will be distributed or retained.
The directors need to take a lot of factors into consideration when making this decision, such as the growth prospects of the company and future projects. There are various dividend policies a company can follow such as:
1. Regular dividend policy
Under the regular dividend policy, the company pays out dividends to its shareholders every year. If the company makes abnormal profits (very high profits), the excess profits will not be distributed to the shareholders but are withheld by the company as retained earnings. If the company makes a loss, the shareholders will still be paid a dividend under the policy.
The regular dividend policy is used by companies with a steady cash flow and stable earnings. Companies that pay out dividends this way are considered low-risk investments because while the dividend payments are regular, they may not be very high.
2. Stable dividend policy
Under the stable dividend policy, the percentage of profits paid out as dividends is fixed. For example, if a company sets the payout rate at 6%, it is the percentage of profits that will be paid out regardless of the amount of profits earned for the financial year.
Whether a company makes $1 million or $100,000, a fixed dividend will be paid out. Investing in a company that follows such a policy is risky for investors as the amount of dividends fluctuates with the level of profits. Shareholders face a lot of uncertainty as they are not sure of the exact dividend they will receive.
3. Irregular dividend policy
Under the irregular dividend policy, the company is under no obligation to pay its shareholders and the board of directors can decide what to do with the profits. If they a make an abnormal profit in a certain year, they can decide to distribute it to the shareholders or not pay out any dividends at all and instead keep the profits for business expansion and future projects.
The irregular dividend policy is used by companies that do not enjoy a steady cash flow or lack liquidity . Investors who invest in a company that follows the policy face very high risks as there is a possibility of not receiving any dividends during the f inancial year .
4. No dividend policy
Under the no dividend policy, the company doesn’t distribute dividends to shareholders. It is because any profits earned is retained and reinvested into the business for future growth. Companies that don’t give out dividends are constantly growing and expanding, and shareholders invest in them because the value of the company stock appreciates. For the investor, the share price appreciation is more valuable than a dividend payout.
The dividends and dividend policy of a company are important factors that many investors consider when deciding what stocks to invest in. Dividends can help investors earn a high return on their investment, and a company’s dividend payment policy is a reflection of its financial performance.
Thank you for reading CFI’s guide to the different Dividend Policies. To keep learning and advancing your career, the following resources will be helpful:
- Capital Gains Yield
- Dividend Discount Model
- Important Dividend Dates
- Retained Earnings
- See all equities resources
- Share this article
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Introduction The term ‘dividend policy’ refers to “the practice that management follows in making dividend payout decisions or, in other words, the size and pattern of cash distributions over time to shareholders” (Lease et al., 2000, p.29). This issue of dividend policy is one that has engaged managers since the birth of the modern commercial corporation. Surprisingly then dividend policy remains one of the most contested issues in finance. Dividend policy is concerned with financial policies regarding paying
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Theories for Dividend Policy and Factors Affecting Dividend Payout A Review of the Literature Prepared for, 11038 Corporate Finance 307 School of Economics and Finance Curtin Business School Curtin University Miri Sarawak Campus Abstract The main objective of this literature review is to highlight the major theories for dividend policy that have been discussed and argued by many researchers over the years. It is aim to helping firms’ management to set their dividend policy and provide
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1. Introduction to Dividend Policy
Dividend refers to that part of net profits of a company which is distributed among shareholders as a return on their investment in the company. Dividend is paid on preference as well as equity shares of the company.
On preference shares, dividend is paid at a predetermined fixed rate. But the decision of dividend on equity shares is taken for each year separately. A company should adopt a consistent approach to the dividend decisions on equity shares rather than taking decisions each year on a purely adhoc basis. A settled approach for the payment of dividend is known as dividend policy.
Therefore, dividend policy means the broad approach according to which every year it is determined how much of the net profits are to be distributed as dividend and how much are to be retained in the business.
Thus, the dividend policy divides the net profits or earnings after taxes into two parts:
(1) Earnings to be distributed as dividend
(2) Earnings retained in the business
Since dividends are distributed out of the profits, there exists an inverse relationship between dividends distributed and retained earnings in the business. If larger net profits are distributed as dividends, retained earnings would be less and on the contrary, if lesser profits are distributed as dividends, the retained earnings would be larger.
The retained earnings are the most easily accessible significant source of finance for the firm. A firm which declares larger dividends will have to use external sources of financing to finance its investment opportunities.
Thus, a firm will have to choose between the portion of profits distributed as dividends and the portion ploughed back into the business. The choice is called the dividend policy and it will have its effect on both the long-term financing and the wealth of shareholders.
2. Types of Dividend
Dividends can be classified in various forms. Dividends paid in the ordinary course of business are known as Profit dividends, while dividends paid out of capital are known as Liquidation dividends.
Dividends may also be classified on the basis of medium in which they are paid:
A company may pay dividend in different forms as follows:
1. Equity Dividend:
The dividend paid on equity shares is called Equity Dividend. The rate of equity dividend is set (recommended) by the board of directors of a business firm and approved by their shareholders.
2. Preference Dividend:
Preference dividend is paid on Preference Shares. At the time of issue of such shares, the rate of dividend is mentioned which remains fixed in nature. This dividend on preference shares is paid before equity dividend. The board of directors of a business firm does not put any recommendation towards preference dividend viz. rate, payment mode etc.
3. Interim Dividend:
Interim dividend is paid by a company for the current year before the accounts for that period have been closed. Such dividend is paid when the company has heavy earnings during the year.
4. Regular Dividend:
Payment of dividend at the usual rate is termed as regular dividend. The investors such as retired persons, widows and other economically weaker people prefer to get regular dividends.
5. Cash Dividend:
A cash dividend is a usual method of paying dividends. Payment of dividend in cash results in outflow of funds and reduces the company’s net worth, though the shareholders get an opportunity to invest the cash in any manner they desire. This is why the ordinary shareholders prefer to receive dividends in cash.
But the firm must have adequate liquid resources at its disposal or provide for such resources so that its liquidity position is not adversely affected on account of cash dividends.
6. Stock Dividend:
Stock dividend means the issue of bonus shares to the existing shareholders. If a company does not have liquid resources it is better to declare stock dividend. Stock dividend amounts to capitalization of earnings and distribution of profits among the existing shareholders without affecting the cash position of the firm.
7. Scrip or Bond Dividend:
A scrip dividend promises to pay the shareholders at a future specific date. In case a company does not have sufficient funds to pay dividends in cash, it may issue notes or bonds for amounts due to the shareholders. The objective of scrip dividend is to postpone the immediate payment of cash. A scrip dividend bears interest and is accepted as a collateral security.
8. Property Dividend:
Property dividends are paid in the form of some assets other than cash. They are distributed under exceptional circumstances and are not popular in India.
9. Composite Dividend:
When dividend is paid partly in cash and partly in the form of property then it is known as composite dividend.
10. Optional Dividend:
Instead of paying a composite dividend, if the company gives option to its shareholders either for cash dividend or for property dividend then it is called option dividend.
11. Extra or Special Dividend:
Special dividend is an abnormal and non-recurring form of dividend, when the management of a company does not want to make frequent changes in the regular rate of dividend but company is having good amount of profits or undistributed reserves then they can declare extra or special dividend.
3. Types of Dividend Policies
An organization considers many factors before deciding its dividend policy.
The explanation of various types of dividend policy is as follows:
1. Stable Dividend Policy:
Refers to the policy in which an organization pays regular dividends to its shareholders. The stable dividend policy is also known as constant-payout-ratio.
2. Long-Term Dividend Policy:
Refers to the policy in which dividend is paid to the shareholders in the long run. If an organization follows long-term dividend policy, then it would not distribute dividend among its shareholders regularly and consistently, even in case of huge profit.
The organization retains the earnings to be used in future for its growth and expansion programs. Investors looking for short-term gains do not favor the long-term dividend policy. This policy is preferred by those shareholders who have interest in long-term capital gains.
3. Regular and Extra Dividend Policy:
Refers to the dividend policy, which pays a fixed amount of dividend on a regular basis, and an additional amount of dividend, if the organization earns abnormal profit. This policy encourages the prospective investors to invest in the organization and helps in raising capital in the future.
4. Irregular Dividend Policy:
Refers to the policy in which the dividend payout ratio keeps on fluctuating. In the irregular dividend policy, dividend per share depends on profit of the organization. If the profit is high, the organization would pay a high dividend per share.
However, if the profit is low, the organization would pay less or no dividend to the shareholders. The irregular dividend policy is favorable for an organization, which has unstable income. Although, shareholders do not approve this policy very much, as it does not provide any certain income.
5. Regular Stock Dividend Policy:
Refers to the policy in which an organization gives dividend in the form of stock instead of cash. If an organization needs liquidity then it may adopt regular stock dividend policy and issue bonus shares to its shareholders.
However, regular stock dividend policy is not considered a very good strategy because it adversely affects share prices and credit standing of the organization. Moreover, shareholders are more interested in getting cash instead of shares.
4. Essentials of a Sound Dividend Policy
Following are the essentials of a sound dividend policy of a company:
Stability in dividend distribution implies regularity in payment of dividend. If a company pays a high dividend in a year but fails to pay any dividend next year, then it cannot be said as good. On the other hand, if a company pays a dividend each year even though at a medium rate, its shareholders will remain satisfied and its shares will not be subjected to high speculation.
2. Gradually Rising Dividends:
The management of the company should always try to make some increase in the dividend rate each year, though this increase will depend on the increase in income of the company. If there are huge profits in any year than in that year the company should distribute additional or special dividends.
3. Distribution of Cash Dividend:
Dividends should be paid in cash. But, if the amounts of reserves and funds in the company become very high, then stock dividend may also be declared. But the distribution of stock dividend should remain within reasonable limits otherwise the company may become victim of over-capitalization.
4. Moderate Start:
In the beginning years of a company’s incorporation, dividends should be declared at lower rates for some years so that the company’s financial position may become sound. Afterwards with the growth and progress of the company, dividend rates may be increased gradually.
5. Other Factors:
Dividends should be paid out of earned profits only. If there is carry forward of past losses, then dividend should not be declared till these are set off. Though, the dividend is usually paid only once in a year in order to keep the shareholders in high spirits, interim dividends should also be declared.
5. Dividend Theories
Theories of Dividend:
1. MM Theory:
According to MM approach, the dividend policy of a firm has no effect on the value of the firm.
This approach is based on certain assumptions which are as follows:
(a) There are perfect capital markets and investors are rational.
(b) Information is freely available and there are numerous transactions.
(c) An investor cannot influence prices.
(d) Flotation costs are nil.
(e) There are no taxes.
(f) The firm has a fixed investment policy.
(g) Risk of uncertainty does not exist.
Mathematical Proof of MM Approach:
E.g., – A company has a P/E (Price/Earnings) ratio of 10. The amount of share Capital is Rs. 50,00,000 dividend into shares of Rs. 100 each. The company expects a declaration of dividend of Rs. 8 per share. On the assumption that the company pays dividend, its net income is Rs. 5,00,000 and it makes new investments of Rs. 10,00,000 during the period proven under the MM assumption that the value of the firm remains unchanged when.
(a) Dividends are paid; and
(b) Dividends are not paid
2. Walter’s Model:
Walter’s Dividend model measures the effect of dividend on common stock value by making a comparison of the actual and normal capitalisation rates i.e. –
As per Walter’s model the rate of return on investment and cost of capital determine the price of share. If r > k, the price per share increases as dividend payout ratio decreases. If r > k the price per share increases as dividend payout ratio increases. The dividend pay-out ratio has no effect on the price of the share if r = k.
Under the circumstance, the optimal pay-out ratio (i) for a growth firm (r > k) is nil (ii) declining firm (r > k) is 100 percent and (iii) for a normal firm (r = k) is irrelevant.
3. Gordon’s Model:
According to Gordon’s Model, the value of the share is given by the following equation:
6. Significance of Dividend Policy
Theoretically, the objective of the dividend policy should be to maximise the shareholder’s return so that the value of his investment is maximised. Shareholder’s return is composed of – the dividends and the capital gains. Dividend policy has a direct impact on these two components of return.
The term dividend policy involves two ratios namely the Payout ratio and the Retention ratio. The Payout ratio is the dividend which is calculated as the percentage of the earnings, for example, the total earnings are Rs. 1,00,000 and the company distributes or pays 20% of its earnings to the shareholders then the Payout ratio is 20% and the Retention ratio is calculated as 100% minus the payout ratio, i.e. in the above example the Retention ratio is 100% – 20% = 80%.
A company could adopt a high payout policy or a low payout policy. A high payout policy means more current dividends and less retained earnings, which may consequently result in slower growth and lower market price per share.
A low payout policy means less current dividends and more retained earnings, which may result in higher growth, higher capital gains and higher market price per share. Capital gains are future earnings while dividends are current earnings.
Paying dividends involves outflow of cash. The cash available for the payment of dividends is affected by the firm’s investment and financing decisions. If a company decides to incur large capital expenditure, it would have less cash available for the payment of dividends. Thus, the investment decision affects the dividend decision.
7. Factors Determining Dividend Policy
The major factors affecting the dividend policy of a firm are listed below:
1. Company’s Own Policy:
The Company’s own dividend policy regarding the stability of dividend affects the dividend decisions.
Where the earnings are more stable the company may decide to pay a constant dividend. Where the earnings are not stable i.e., fluctuating, then, the company may decide to pay a huge amount of dividend when earnings are more or no dividend in case of less earnings.
2. Availability of Divisible Profits:
The dividend policy of a concern depends upon the divisible profits available. If there are no divisible profits, there is no question of declaration of dividend. If there are large divisible profits, there can be more dividend distribution and more retention of funds.
3. Liquidity of the Company:
Liquidity of the company also affects the dividend decisions. Liquidity indicates the cash available to make the payment of dividend.
If a company has sufficient liquidity to pay a dividend, it can declare a higher dividend.
4. Effect of Current Market Prices:
Dividend decisions affect the market price of the shares. As per Walter’s model, dividend is relevant while determining the market price of a share.
5. Past Dividend Rates:
Every company takes past dividends as a base and takes decisions to enhance the dividend in the future. If a company pays 60% dividend in the last year, should maintain the same rate or enhance the rate during the current year.
6. Contractual Restrictions:
The term lending financial institutions impose restrictions on dividend decisions. They fix the maximum ceiling on the rate of dividend or the amount of dividend and also on the retained earnings.
7. Legal Restrictions:
The Companies Act specifies that every company is required to transfer a certain amount to general reserve based on the rate of dividend declared. If any shortage after declaration of dividend will impose restriction on their companies for declaration of dividend.
8. Equity Capitalisation Rate:
Cost of capital is an important factor to decide the dividend payment. If a company is raising capital at a cheaper rate of interest, then the company can declare a higher rate of dividend.
9. Composition of Shareholders:
The composition of shareholders also determines dividend policy. The shareholders of closely held company may be interested in capital gains rather than on dividends. Hence, a low dividend should be paid. But shareholders of widely held companies may be interested in higher dividends. Such companies may decide to pay a higher rate of dividend.
10. Availability of External Sources of Fund:
The availability of external sources of funds are needed for capitalisation purposes. The companies with greater accessibility to external sources may decide to pay higher dividends because they can retain less earnings for reinvestment. In case of new companies having less access to the external market may declare and pay lesser dividends and to retain more earnings.
11. Re-Investment Opportunities of the Company:
Availability of profitable investment opportunities to the company also decides the payment of dividend, if a company has more profitable reinvesting opportunity, then it can declare a lower rate of dividend. In other words, if a company cannot reinvest its earnings, then it can declare a higher rate of dividend.
The dividend tax has a greater impact on the dividend policy. If the dividend is taxable in the hands of individual shareholders, then the companies declare bonus issues, rather than cash dividend. At present the dividend distribution tax on a dividend is taxable in the hands of the company.
13. Bonus Issue:
The bonus issue in the past years increases the capital base in the current year, hence dividend policy determined on the basis of bonus issue. A company has to pay a dividend compulsorily in the year of bonus issue because a bonus issue cannot be in lieu of cash dividend.
14. Future Plan for Growth and Expansion:
A Company which will plan for future growth and expansion requires a huge fund. As merger and acquisition need a huge outflow of cash, a moderate dividend can be expected from such a company.
15. Effect of Inflation:
Inflation affects dividend decisions. During inflation the value of closing stock and the figures of net profits are overstated. During inflation, it is necessary to retain earnings so as to enable the company to have sufficient funds to replace capital assets. Hence, the companies pay lower cash dividends.
Financial Management , Dividend Policy
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