Determinants of Dividend Policy
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Literature Review On Determinants Of Dividend Policy
The roots of the literature of determinants of dividend policy relate to the linter (1956) who conducted a traditional study on how U.S. managers formulate dividend decisions. He developed a compressed mathematical model supported on survey of 28 well recognized industrial U.S. firms which is measured to be a finance standard. In the perception of him the dividend imbursement model of a firm is prejudiced by the existing year earnings and year before dividends and after that the work was polished by the Fama and Babiak (1968) theory test of a number of alternate models for clearing up dividend behavior chains Lintner's position that managers increase dividends only after they are rationally certain that they be able to lastingly continue them at the new level. And after the both Linter and Fama and Babiak many researcher study the linter model.
In Adaoglu (2000) has carry out the study on unsteadiness in the dividend policy (ISE) corporations, with content of emerging markets. By means of linter robust model on the sample of 916 dividend comments of non financial sector of listed firms on ISE. The practical investigation shows that the firms listed in ISE track unsteady cash dividend policy and the key factor for determining the sum of dividend is earning of the firms. And after this another study conducted in 2004 which not match with linters model which studied by Omet (2004), by means of the lintner's model checked the dividend performance of Jordan capital market by taking Dividend per share current year as depended variable and explanatory variables are Earning Per Share current year and DPS last years. The experimental analysis of the study on the section of 44 Jordian listed companies listed on Amman Securities Market (ASM). The experimental investigation explains that firms track stable dividend policies. Indeed the outcome gives the signal lagged dividend per share is further important then the current earnings per share (EPS) for determining the current dividend per share.
It has been experimented that during last 52 years the chain of empirical and theoretical studies has been completed. The summarize form of those empirical studies bring to a close three important things. Firstly, market value of the firm affected when the dividend payout increases. Secondly, the firm's value effected if the dividend decreases. Finally, the third suggest that dividend policy of the firm does not affect the firm value. However we can say that empirical proof on the determinants of dividend policy is unluckily very mixed. In addition there are many theories on why and when the firms pay dividends. In the present period, there are six very essential theories connecting to determinants of dividend polices applied in diverse economies.
The Bird In The Hand Theory which has been known by Gordon and Walter (1963), in which they find that investors always prefer cash in hand rather then a future promise of capital gain due to minimizing risk or lowering risk. There fore according to him investors wants stable dividend payout ratio rather than the capital gain earn from their share price premium which is more risky. Baker (1985) conducted the survey of management's views on Dividend policy in which managers believed that shareholders favored a stable flow of dividends, firms tended to make interrupted fractional adjustments toward a target payout ratio rather than impressive changes in payout. So, in the short run, dividends were smoothed in a try to avoid frequent changes. Study also shows that the main determinants of dividend is the same as linter defines in its paper and second results shows that dividend policy affects the share price of the firm. Anil and Kapoor (2008) conducted a study on Determinants of Dividend payout ratio in which results show that the Cash flow from operation is most important factor in Indian Information Technology sector is dividend payout ratio and they conclude that firms which have high liquidity position gives more dividend and which have low gives no dividend. Beta of the firm share price is also significant. Al-Malkawi (2007) profitability, age, and Size of the firm appear to be determinant aspect of corporate dividend policy in Jordan though profitability is high it means free cash flow increases so firm afford to high dividend payment or pay out ratio. Javid and Ahmed (2009) conduct the study where they study the dynamics and determinants of dividend payout policy of 320 non-financial listed firm of Karachi Stock Exchange throughout the time of 2001 to 2006. The results always support that Pakistani listed non-financial firms rely on both the change in dividends and change in net earnings which obviously show that the firms rely on both current EPS and past DPS to position their dividend payments. Though the study without a doubt shows that dividend tends to be more sensitive to current earnings than past dividends. Profitable firms with more steady net earnings can have enough money larger free cash flows and as a result they pay bigger dividends.
Catering theory given by Baker and Wurgler (2004) suggest to the managers to give incentives to the investor according to their needs and wants and this is the way to cater the investors by paying smooth dividends when the investors put stock price premium on payers and by not paying when investors prefer non payers. Megginson and Eije (2006), conduct the study by taking the unique sample of over 3400 listed firms in which United States concerns the tendency of European firms those are paying dividends turn down significantly more this period. From 91 to 62 percent of listed firms, whereas on the other hand the total dividend paid and dividend payments as propensity of total corporate profit increases dramatically. Dividend and earnings also directed sharply among European firms, and similar company uniqueness increase the both tendency to pay and the sum of dividend paid. The one of the very important factor which discovers increase in the retained earnings to total equity doesn't increase the payout ratio, but company age does. They also find that the effect of catering the dividend systematically which is nor conclusive evidence of continent and wide convergence in dividend policy. So they concluded which is opposing the catering theory and they also concluded that the age of the firm positive effect on dividend payout not the catering effect.
Bhattacharyya (1980) grow one more explanation for the dividend policy support on asymmetric information. Managers have confidential information concerning about the distributional maintain of the project cash flow and they signal this information to the market during their preference of dividends. In the signalling balance upper value of the support is signaled by higher dividend. In other words, the improved the news, the higher is the dividend. Heinkel (1978) regard as a set up where diverse firms have diverse return generating abilities. This information is broadcasted to the market by means of dividends, or regularly, from spending at less than the first best level. In the balance of Heinkel's model, the firm with smaller amount output invests up to its first best level and declares no dividend, while the firm with upper output invests less than its first best level of savings, and declares the differentiation among the amount raised and the sum invested as the dividend. The firm with higher productivity does something in this method in order to differentiate itself from the firm with smaller amount productivity. Dividends are still irrelevant in the wisdom that both firm types might raise an additional X dollars with a new number to pay an additional X dollars as a dividend with no signalling effect. The signalling charge in this model comes from Decreased investment from first best level. In compare, the signalling charge in Bhattacharyya (1979) comes from taxation and non symmetric charge of raising finances in the money market.
Bhattacharyya and Heinkel's work was followed by a number of additional papers which posited that dividends are used by managers to broadcast information to the money market. Notable works in signalling model of dividend policy is of John and Williams (1985) this signalling models characteristically the informational irregularity by bestowing the manager or the insider with information concerning some feature of the future cash flow. In the signalling equilibrium attained in this model, the higher the expected cash flow, the higher is the dividend and also defines that the dividends allay information asymmetric among managers and shareholders by delivering indoors information of firm future projections. Additionally, we can say that the dividend should be paid to shareholders according to the prices of stocks. Baker (1999) conducts the study match up to the views of 170 senior managers of regulated (utilities) and unregulated (manufacturing) US corporations listed on the NYSE concerning a number of dividend policy problems. Specially, the study examines respondents' views concerning four explanations for paying dividends and 20 factors control dividend policy. The results propose that all four explanations for paying dividends (signaling, bird- in- the- hand, tax preference, and agency costs) get some support, except the signaling explanation expected more support than the other explanations. The fact also suggests that the most important determinants of a company's dividend policy were the level of present and predictable future earnings and the outline or stability of past dividends. These factors have remained remarkably similar over time. In conclusion, regulated and unregulated companies rank factors pressure dividend policy more similarly to day than in the past. This finding may imitate the altering economic environment for utilities.
The main agent structure. According to this structure, dividends are used by shareholders as a tool to decrease over investment by managers. The managers manage the firm; so, they force spend cash in projects with depressing net present values, but which increase the individual value of the managers in some way. A dividend decreases this free cash flow and thus reduces the possibility for above investment. Jensen and Meckling (1976), give the agency theory is based on the conflict between Managers and shareholder. They also present an investigation concerning the impact of agency conflict between the managers and shareholders; the results of the study shows that the proportion of equity controlled by insider ownership should pressure the dividend policy. Easterbrook (1984) put forward that dividends are utilized to take away the free cash from the power of the managers and pay it off to shareholders. This makes sure that the managers will have to move toward the money market in order to meet the financial support needs for new projects. The need to move toward the money markets enforces a regulation on the managers, and thus decreases the cost of monitoring the managers. In addition, Easterbrook put forward that the very important to approach the money market also acts as a counter weight to the managers' own risk aversion .therefore we say that Easterbrook given the additional explanation concerning agency cost problem that there are two types of agency cost first is the cost monitoring and other on is cost of risk aversion on the part of directors or managers. Rozeff (1982) presented the optimal dividend model in which increased dividends lower the agency cost but also this model show that the transactional cost of external loan is increased. And further concluded that the optimal dividend payment minimize the average sum of both costs. Results of the study show that dividend affected by agency cost problem. D'Souza (1999) examined the agency cost and Dividend Policy and used the Institutional holdings as proxy for agency cost and the results of the study concluded that negatively relationship between agency cost with dividends payout. Thus the insider ownership is increase then dividend decreases. Wansley, Saxena and Collins (1996) conduct the study paper which clearly identifies the possible dissimilarities in dividend policy between regulated and unregulated firms and center on agency-cost and monitoring explanations for the importance of dividends. The reason of this paper is to study the role of insiders in formative dividend policy for unregulated firms, utilities, and financial-services firms. While utilities, and to a number of degrees, financial-services firms, have regulators who serve as the low-cost informants to market members, insiders participate a condensed role in formative dividend policy balanced to unregulated firms. A regression model is built up that deal with whether the function of regulators and insiders are proxy or balance for utilities and financial-services firms. The regression results disclose basic differences in the association between insider holdings and dividend policy for unregulated firms and utilities, but propose that the regulatory surroundings improve rather than mitigates -- the importance of the insiders” function for utilities. For financial-services firms, the results do not maintain the hypothesis that enlarged equity risk during fixed-rate deposit insurance enhances the role of insiders when formative dividend policy. DeAngelo et al (2004), conducted the study on dividend policy and agency cost. The study consists on why the firms pay dividends? If they didn't contain their assets and capital structure, would finally turn into unsustainable as the earnings of winning firms exceed their investment opportunities. The gives the investigation of 25 largest extensive position in 2002 dividend payers firms would have cash worth of $ 1.8 trillion which is 51% of T.A, up from $ 160 billion 6 % of assets and $ 1.3 trillion in surplus of their combined $ 600 billion in long term debt . They discover that their dividend expenditure barred significant agency problems. Al-malkawi (2007) study on determinants of dividend payout ratio in content only in Jordan and the results of the study suggest that the percentage of stocks in custody of insiders and state ownership significantly affect the quantity of dividends paid. The results give tough support for the agency costs hypothesis and are generally steady with the pecking order hypothesis. Javid and Ahmed (2009) further find the relationship of insider ownership and dividend payout policy with the content of Pakistani market and they concluded from their study that the inside ownership and market liquidity of the firm have negative and significant affect on dividend payout ratio of the firm.
Life Cycle Theory explanation given by the Lease et al (2000), Fama and French (2001), the firms should follow a life cycle and reflect management's assessment of the importance of market imperfection and factors including taxes to equity holders, agency cost asymmetric information, floating cost and transaction costs. Omet (2004) the tax imposition on dividend did not have the significant impact on the dividend behavior of the listed firms.
Miller and Modigliani (1961), which first planned dividend irrelevance. Fundamentally, their model is a one-period model under sureness. Given a firm's investment program, the dividend policy of the firm is unrelated to the firm worth, since a higher dividend would demand more sale of stock to lift up funds for the investment program. The critical hypothesis here is that the future market value will remain unchanged by present dividends. The disagreement rests on the assumptions that the investment program is determined separately and that every stockholder earns the equal return (i.e. the discount rate remains constant). Miller and Modigliani's dividend-irrelevance disagreement is elegant, but this does not make clear why companies, the public, investment analysts are so concerned in dividend announcements. Clearly, the observed interest in dividend announcement must be connected to some contravention of the Miller and Modigliani assumptions. Miller and Modigliani, while formulating their famous dividend irrelevance propositions, observed that in the existence of taxation, investors will form clienteles with exact preferences for particular levels of dividend yields. This exact preference for dividends may be resolute, inter alias, by the marginal tax rates faced by the shareholder. Changing the dividend level, according to Miller and Modigliani, leads only to a change in the clientele of shareholders for the firm.
Part of the dividend mystery arises starting from the reality that dividends are usually taxed at an upper rate compared to the income from capital gains. This has surely been historically correct although in current years we have noticed a shift to eliminate/reduce tax on dividends. We should, therefore, wait for investors to favor cash from capital gains over cash from dividends. Miller and Scholes (1978) provide a clever scheme to change dividend income to capital gains income. Their job provides a new basis for the dividend irrelevance position. Their disagreement is based upon a common income tax provision which allows interest expenses to be subtracted from income before applying tax. Miller and Scholes show that by have a loan of an suitable amount, the interest amount can be set off in opposition to the dividend income in a way that decreases the taxable income to zero. Miller and Scholes compete that the increases in risk due to borrowing can be answered by investing the on loan amount in a risk-free insurance contract, where the amount builds up at the risk-free rate. In this method, they argue, the tax shield on the interest expense can be used to defuse the tax incidence on the dividend income without sustaining any extra risk due to enlarged borrowing.
Rozeff (1982) in the study of determinants of dividend payout ratio where the examined taken variables are growth, Beta and agency cost where beta and growth future sales taken as a proxy for investment opportunity and results shows that investment policy affect the dividend policy negatively. D'Souza (1999), taken the factors the Market Risk, Investment Opportunities as the determinants of Dividend Policy and used the beta and previous growth market to book value locate as proxy for market risk and investment opportunities in that order. The paper without a doubt shows that negatively relationship between market risk with dividend payout. Though does not support the negative relationship between dividend payout policies and investment opportunities. And results clearly show the insignificant relationship between dividend policy and investment opportunities for international firms in sample.
Javid and Ahmed (2009) show the results from their study and conclude that the market capitalization and size of the firm have negative and significant affect on dividend payout ratio, thus the result shows clearly that the firm prefers to invest in their assets rather than dividends. If the firm pays dividend than it impacts on their investment policy and value of the firm effects.
DeAngelo et al (2004), the retention of the earnings would have given the managers control more than an additional $1.6 trillion with out contact to improved investment opportunities and without some monitoring. This logic suggests that firms with high retained earnings are particularly being fond of to pay dividends. In this vision firms pay high dividend when earned equity to total equity is elevated, and turn down when this ratio decline and when this ratio is zero or near to zero, it way firms don't have the earned equity. The as a final point found that the extremely significant relationship between the dividend policy and the earned equity to total equity ratio controlling for size of the firm, profitability, growth, leverage, cash balance and history of dividends.
Eriotis (2005), examined the effect of distributed earnings and size of the firms to its dividend policy of Greek firms. The author studied the Greek firms set their dividend policies not only by net distributed earnings, but also by change in dividend, the change from last year earnings and size of the firm. The empirical findings of the study suggest that distributed earnings and size of firms included as a signal about the firms dividend. The Greek firms also having the long term dividend payout ratio. Author used the two variables for determines the corporate dividend payout decisions, distributed earnings and size of the firm. The panel regression (Cross Section weights) were done and the results of the model give the significant estimations with the explanatory power (R2) 95.4%. The evidence of the model suggest that dividend at time (t) can be expressed as the long run target dividend payout represented by the both changes in dividend and in distributed earnings and its speed of adjustment towards distributed earnings and the last year dividend of the firm at (t). So the conclusion of the study is the Greek firms have a general dividend policy to distribute, each year dividend according to their target payout ratio, which is distributed earnings and size of the firm.
Stulz et al (2005) conducted the study on dividend policy and earned capital mixed by applying life cycle theory of dividends. The firms of the non-financial sector pay more dividends when retained earnings are large portion of total equity and falls to near zero when most equity is distributed rather then earned (retained earning). They observed significant association between decision to pay dividends and contributed capital mix. For controlling they used profitability, growth, firm size, dividend history, leverage and cash balance that also hold the dividend initiations and omission. The regression results shows that mix of earned or contributed capital has quantitatively greater impact than measure of profitability and growth opportunities.
Farinah and Foronda (2005) conducted the study on the relationship between the dividend and insider ownership in different legal systems and gives international evidence. The countries and firms included in the sample on the basis Anglo Saxon tradition and matching sample of firms from countries with civil law legal system. They hypothesised that due to different characteristics of both legal systems and the nature of agency conflicts in firms from those countries the relationship between dividend and ownership by insider will be considerably different between two set of companies. The found that the firms from Anglo Saxon tradition follow relationship between dividend and insider ownership the pattern of negative-positive-negative and in civil law countries relationship is positive-negative-positive. The result of the study consistent with hypothesis and give new inside into the role of dividend as mechanism in countries with different legal system and distinct agency cost problem.
Amidu and Abor (2006), conducted the study on determinants of dividend policy in Ghana. They choose the sample of 20 listed firms of Ghana Stock Exchange (GSE) which represent the 76% of the total GSE listed firms. They have taken the Payout Ratio as dependent variable and defined as dividend per share divided by earning per share. The included the explanatory variable profitability(prof), risk(risk), cash flows (cash), corporate tax(tax), institutional holdings(INSH), Sales Growth and Market to Book value(MTBV). By using the Panel data which involves the pooling of observations on a cross sectional of unit over several time periods and provides the results that are simply not measurable in pure cross-sections or exact time series studies. Because the panel time series is different from a regular time series or cross section regression equation and each variable use the double subscript in the data.
The study examines the determinants of dividend policy in Ghana. After the analysis they conclude that the more profitable firms pay more dividends. Because the result shows the positive relationship between profitability and dividend payout ratio, cash flows and corporate tax. Furthermore, they also conclude that when the firm's liquidity increases the firms pay more dividends. There is a negative relationship between payout ratio and risk, institutional holdings, growth and market to book value. The firms with the earning volatility find difficult to pay low and no dividends. The final conclusion of article is that dividend payout policy decision of listed firms in GSE is influenced by profitability, cash flow position, and growth scenario and investment opportunities of the firms.
Naceur et al (2006), conducted the study on the determinants and dynamics of dividend policy of Tunisian stock Exchange. They have selected the 48 firms (non financial) and examined that weather the managers of the listed firms is smooth their dividends or not.
They have attempted to explain that do the Tunisian firms follow stable dividend policy? Do dividend yield differ across the industry sector? What are the main factors that determine the dividend polices in Tunisia.
By using the Lintner's model in static and dynamic panel data regression they conclude that Tunisian firms more rely upon current earnings, past dividends to fix their dividend payments in that way dividend becomes to be more sensitive to current earnings rather then prior dividends. Any variability in the current earnings of the firms is directly having the impact on level of dividends. They found that Tunisian firms just like other emerging markets do not smoothing their dividend payments. Furthermore the target dividend payout ratio is too low ( 14% for full sample, 32% with dividend paying firms) the estimations has been done by applying General Method of Moment (GMM). Therefore low target dividend ratio and high speed of adjustment pointed out to low smooth and instability of dividend policies in Tunisia. The other part of the article gives the explanation regarding determinants of dividend policies in Tunisia. They conclude that high profitable firms with more stable earnings can manage the larger cash flows and because of this can pay larger dividends. Moreover the firms with fast growth distribute the larger dividends so as attract to investors. The ownership concentration does not have any impact on dividend payments. Because the Tunisian firms having very less agency conflicts and shareholders do not have choice to dividends in order to reduce managerial discretion and protect their interests. The liquidity of the firms has negatively impacted on dividend payments.
Reddy (2006), examined the dividend policy of Indian corporate firms, trend and determinants and make attempt to explain the observed behaviour of the firms listed on Bombay Stock Exchange(BSE) with the help of trade off theory and signalling theory hypothesis. The analysis of dividend trend shows that stock traded on New York Stock Exchange (NSE) and (BSE) indicates that the percentage of firms paying dividends has declined from 60.5% in 1990 to 32.1% in 2001 and there is only few firms paying dividend consistently. Furthermore the dividends paying firms are more profitable, large in size, and growth doesn't seem to discourage Indian firms from paying higher dividends. The corporate tax or tax preference theory doesn't appear to hold true in Indian context. Finally the dividend changes appear to signal contemporary and lagged earning performance rather than future earnings performance.
Megginson and Eije (2006), by using the unique database of over 3400 listed firms, they have examined evolution of dividend policy from 1989 to 2003 of fifteen countries that were member of European Union before May 2004. As for as United States concerns the tendency of European firms those are paying dividends decline dramatically over this period. From 91 to 62 percent of listed firms, while on the other hand the total dividend paid and dividend payments as tendency of total corporate profit increases significantly. Dividend and earnings also concentrating sharply among European firms, and similar company characteristics increase the both tendency to pay and the amount of dividend paid. The one of the very important factor which discovers increase in the retained earnings to total equity doesn't increase the payout ratio, but company age does. They also find that the effect of catering the dividend systematically which is nor conclusive evidence of continent and wide convergence in dividend policy.
Avazian et al (2006), conducted the study on United Stated listed firms at NYE and find that decision to smooth dividends depend at the part of public market access as proxies by the rating of bonds. In their study dividend smoothing is the optimal for firms raising debts in the public “uninformed” bond markets but not for firms in the private informed bank markets. In this logic the dividend decision is related to information asymmetric between the managers and the creditors of the firms.
Baker et al (2007), conducted the study on the perception of dividends by Canadian managers and taken the sample of 291 listed firms on Toronto Stock Exchange (TSE). The results of the studies regarding the factor influencing the dividend policy, matters involving with dividend policy and explanation of why firms pay dividend. According to the survey conducted for research of the managers of TSE, the most important factor for determinants of dividend is level of expected future earnings, stable earnings, pattern of past dividends and the level of current earnings. The evidence of the study suggests that mostly managers of TSE listed firms are still making the decision regarding the dividends consistent with survey results and behavioural model of lintner. The comparison with the survey results shows that overall rankings of determinants of dividend policies by managers of Canadian and US firms reveals high level of similarity. However the significant difference exists between the managers of TSE and New York Stock Exchange (NYE) on specific factors of influencing dividend policies. One of the major and very important factors of ownership concentration and corporate characteristics is high in the Canadian listed firms which perceive the other factors influencing the dividend policies relative to United States firms. The survey of the researchers regarding the Canadian firms' manager shows that TSE listed firms explained greater support for signalling and life cycle explained paying dividends than for the bird in hand theory, tax preferences and dividend clienteles, agency cost and catering explanations. Compare with the non dividend paying firms, Canadian dividend paying firms are significantly larger and more profitable, having greater cash flows, ownership structure and some growth opportunities.
Daniel et al (2007), conducted the study that do firms manage earnings to meet the dividend threshold? They found that firms are more likely to manage their earnings upward when their earnings would otherwise fall down of expected dividend levels. The earning management behaviour significantly impacts the likelihood of dividend cut. The firms made discretionally accruals because reported earnings to exceed the expected dividend levels are significantly less likely to cut dividends than those firms whose reported earnings fall down of expected level of dividends. They conclude that managers treat expected dividend levels as a vital earning threshold.
Jeong (2008) examined the dynamics of dividend policy in Korea during the investigation he found that how Korean listed companies set their dividend policies in different institutional environment and compare with develop markets like United States. The paper empirically test whether Korean firms follow stable dividend polices as develop countries where dividend smoothing is stylized fact. The paper also identifies the factors at the level of firm that influence the dividend smoothing. The empirical results of the paper shows that the Korean firms made dividend payments on the basis of firm's stock face value which is very close to the average interest rate of deposits. The change in dividends is less likely to reflect change in fundamentals of the firms. Rather than change in annual dividend payments are closely related to the interest rate of one year time deposit. To check the degree of dividend smoothing, the paper found that majority of listed Korean firms pay smooth dividends. But the speed of adjustment to the target payout ratio is faster than the develop countries capital markets. The dynamic dividend behaviour is less explained by lintner's model in the listed Korean firms.
On the other side of the paper examined the determinants of dividend smoothing, firm risk, size and growth factors play very important role in explaining the cross section of smoothing the dividend behaviour. However the association between the explanatory variables and the degree of smoothing dividend is different between the firms of United States and Korea. The growth is positively related to dividend smoothing as conclude by the pervious empirical studies. But one thing which is contrary to the theoretical predictions, the empirical results shows that larger and old firms pay dividend smoothly in Korea. The leverage and controlling shareholders ownership have insignificant effect on dividend smoothing. The results of the study shows that signalling and agency theories do not explain the dynamics of dividend polices in Korean listed firms. The study also finds that the more risky firms are smoother to pay their dividends. The result of ownership variable shows that the ownership plays a vital role to decide the firm's dynamic dividend policy in Korean listed firms.
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