Dividend Payout Policy Behaviour in Pakistan
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Published: Thu, 15 Mar 2018
Dividend policy in the firm has been the major matter for recognizing how managers set dividend ratio and change dividend given to stockholders. The existing literature on dividend payout ratios provides firms with no generally accepted prescription for the level of dividend payment that will maximize share value. Black (1976) in his study concluded with this question is that what the corporation should do about dividend policy. It has been argued that dividend policy has no cause on either the price of a firm’s share or its cost of capital. Thus, extensive studies were done to find out various factors affecting dividend payout ratio of firm. The setting of corporate dividend policy remains a troublesome issue and involves ocean deep judgment by decision makers.
The behavior of dividend policy is the most debatable issue in the corporate finance and still keeps its important position both in developed and emerging markets. Many researchers try to uncover the issue regarding the dividend behavior or dynamics and determinants of dividend policy but still do not have satisfactory details for the observed dividend behavior of firms. (Black, 1976; Allen and Michaely, 2003; Brealey and Myers, 2005). One of the well known explanations of dividend behavior is the smoothing of firm’s dividends vice versa earnings and growth. Linter (1956) found that firms in the United States adjust their dividends smoothly to maintain a target long run payout ratio. Numerous studies appeared after this work and facts suggested that the dividend policy of the companies varies from country to country due to various institutions and capital market differences.
The study examined the relationship between determinants of dividend payout ratios from the context of a developing country like Pakistan. The primary objective of this thesis is to find out whether numerous factors influence the dividend payout ratio of Sugar Sector in Pakistan.
The purpose of this study is to examine the dynamics and factors affecting dividend policy of sugar firms in Pakistan. After that it explored how Pakistani firms set their dynamic dividend policies in a different institutional environment than that of developed markets. This study examined whether Pakistani firms follow stable dividend policies as in developed markets or they are going to retain their earnings. The paper also identified the areas of firm level factors that influence the degree of dividend smoothing. This paper indicated that importance of institutional features towards the dynamic of dividend policy and also critical out the advantages of examining the dividend policy in different institutional environments. The outcomes of the thesis provided meaningful and handy information in the role of institutional factors which creates dividend policy at firm’s level. More than a few studies become visible after this work and evidence suggest that the dividend policy of the companies varies from country to country due to various institutions and capital market differences.
The Pakistan’s capital market and the economy have several important features for examining the dynamics of dividend policy. Firstly Pakistan is moving towards the development and improving the economy position in the world since the 1980. Pakistan capital markets are much better than before. Many studies conclude that firms are likely to pay constant dividend during the high growth period and it is interesting to find that how dynamic dividend policy is determined in growing economy like Pakistan. In fact, in Pakistan the many major investors are still disagreed with dividends and consider stock prices positive reception as the major part of stock returns therefore, it is assumed that investor attitude towards dividends is expected to have an impact on the way in which firms set their dividend policy in Pakistan.
Sugar Industry in Pakistan
The sugar industry plays an important role in the economy of the Pakistan. It is the second largest industry after textiles. The Pakistan sugar industry is the second largest agro based industry consists of 78 sugar mills with per year crushing capacity of 6.1 million tones. Sugarcane farming and sugar manufacturing contributed significantly to the national exchequer in the form of a range of taxes. Sugar manufacturing and its by-products have contributed appreciably towards the foreign exchange funds through import replacement. In Sugar industry 75000 people working over there, including engineers, technologists, and financial experts, skilled, management expert’s semiskilled and unskilled workers. It contributed around four billion rupees under the head of excise duty and other charges to the Government are also dominant implication.
The annual 2008-2009 sugarcane production is estimated at 51.5 MMT, a reduce of 19 percent over the preceding year due to both a decline in area harvested. Milling policies and practices, coupled with attractive prices for alternative/competing crops and inadequate irrigation supplies are most important factors limiting crop growth in the country.
In the year 2009-10 sugarcane production is estimate at 53.6 MMT, an increase of 4 percent over the previous year due to an expected increase in area and yield. A scarcity of cane supply during the present crushing season lead to an increase in cane prices. These circumstances benefitted who received prices higher than the analytic prices announced by the Government. The development is expected to contribute to a boost in sugarcane region and output in the following year. The previous year was higher production of rice and sunflower lead to lower prices received by farmers, so encouraging the go back to sugarcane.
Purpose of the Study
In Pakistan there were few firms which paid dividend to stockholders constantly. For this explore, the listed sugar firms of Karachi Stock Exchange (KSE) were not able to pay their dividends and which factors are influencing or determining the dividend policy in Pakistan. In this thesis it examined the number of firm’s various factors and their function in dividends policy. The liquidity of the stock market, is the profitable firms are paying dividends in Pakistan, is the firms with greater investment opportunities pay less dividends in Pakistan, is the dividends and debts are substitutes and the degree of leverage is negatively associated with dividends payments and finally examined the firms with greater cash flows pay lesser dividend in Pakistan.
Objective of thesis has to find out the relationship between dividend policy and operating cash flow, EBIT, Sales and Debt to Equity Ratio. It is very important for investors to examine the factors of dividend policy that whether they have been impact on the sugar sector of Pakistan or not.
H1: There is association between CFO and dividend payout ratio.
H2: There is association between Debt to Equity and dividend payout ratio.
H3: There is association between Revenue and dividend payout ratio.
H4: There is association between EBIT and dividend payout ratio
This thesis is composed of five chapters. The first part of a thesis is introduction (Chapter I).Then after it evaluates and discusses the literature review in (Chapter II), in this chapter it examined the dividend payout policy of Pakistan and the main factors that influenced on it, theories, models put forward by many well-known authors is examined various studies. In (chapter III), it explained research methods and sample in detail. (In chapter IV),examined the dividend payout policy and the main indicators that affect the dividend payout policy of listed firms on the Karachi Stock Exchange 100 over the period 2003-2008 and present the interpretation of results. Finally in Chapter V, researcher present and discuss the main contributions and conclusion, implication and recommendation of this thesis.
Naceur (2006) found that the high profitable firms with more stable earnings can manage the larger cash flows and because of this they 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. In Indian case Reddy (2006) showed that the dividends paying firms are more profitable, large in size, and growing. The corporate tax or tax preference theory does not appear to hold true in Indian context. Amidu and Abor (2006) found that the dividend payout policy is influenced by profitability, cash flow position, and growth scenario and investment opportunities of the firms.
Lease (2000) the firms be supposed to pursue a life cycle and imitate management’s evaluation of the importance of market imperfection and factors including taxes to equity holders, floating cost, agency cost, transaction costs asymmetric information.
Linter (1956) studied and developed a compact mathematical model based on survey of 28 well established industrial U.S. firms which is well thought-out to be a finance classic. According to him the dividend payment pattern of a firm is influenced by the current year earnings and previous year dividends.
Linter’s (1956) study of dividend policy found that a company’s net income is the determinant of dividend changes, which in his sample are largely dividend increases since he primarily surveys healthy firms.’ If one can extrapolate this finding to dividend decreases, it implies that low bottom line earnings drive dividend reductions.
Jensen (1986) argued that debt is an effective substitute mechanism for dividends in this respect. By issuing debt instead of equity, managers give bondholders the right to take the firm into bankruptcy court if managers do not maintain their promise to make the interest and principal payments. This substitutability between debt and dividends as alternative mechanisms for reducing the agency costs of FCF implies that firms that use low debt ratios will tend to follow a policy of high- dividend payout.
Alli (1993) the liquidity or cash flows position is also an important determinant of dividend payouts. A poor liquidity position means less generous dividends due to shortage of cash. It reveals that dividend payments depend more on cash flows, which reflect the company’s ability to pay dividends, than on current earnings, which are less heavily influenced by accounting practices. They claim current earnings do no really reflect the firm’s ability to pay dividends.
Farzad Farsio and Amanda Geary (1983) in their research the relationship between Dividends and Earnings say that dividends have no explanatory power to forecast future earnings. They presented four cases for possible effects of earnings on future dividends and show that there should be no significant relationship between dividends and future earnings in the long run. The contribution of this study is that it provides financial managers and investors with evidence that it would be a mistake to base investment decisions on inferences about dividend/earnings relationships that rely on some certain short-term periods.
John and Kalay (1982) Debt agreement to minimize dividend payments are necessary to prevent bondholder wealth transfers to shareholders. An additional way dividend payout ratio affects agency costs is the reduction of agency cost through increased monitoring by capital market.
Analysis shows the positive association among profitability and dividend payout ratio, corporate tax and cash flows. The study also suggests that when the liquidity of companies increases the companies disburse more dividends. The companies with dynamic profitability find out hard to disburse dividends. Last but not least, conclusion of the study shows that cash flow, profitability, growth and investment opportunities influence the dividend payout policy.
Amidu and Abor (2006) conducted and 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(profit), 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.
Jensen (1986) concluded that funds remaining after financing all positive net present value projects cause conflicts of interest between managers and shareholders. Dividends and debt interest payment decrease the free Dividend payout ratios in Ghana cash flow available to managers to invest in marginal net present value projects and manager perquisite consumption.
Crutchley and Hansen (1989) examined the hypothesis that financial leverage, dividends and managerial ownership are jointly determined by firms’ attempts to minimize the total agency costs of debt and equity. Chaplinsky and Niehaus (1992) examine whether managerial ownership share and financial leverage common determinants. In addition to the agency costs of debt and equity, they also assess whether these decisions are governed by the tax advantage of debt, the costs of issuing securities and the demand for risk sharing by insiders.
Avazian (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 payment is the optimal for firms raising debts in the public Unknown 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.
Pruitt and Gitman (1991) found that risk (year-to-year variability of earnings) also important factor firm’s dividend payout ratio. A company that has constant earnings is often able to forecast approximately what its future earnings will be. Company is therefore more likely to pay out a higher percentage of its earnings than a firm with unpredictable earnings.
The liquidity or cash flow from operation is an important factor of dividend payouts policy. A less liquidity position means less generous dividend due to shortage of cash. He exposed that dividend payments depend more on cash flows, which reflect the company’s ability to pay dividends, than on current earnings, which are less heavily influenced by accounting practices. They claim current earnings do not really reflect the firm’s ability to pay dividends. (Alli, 1993)
Green (1993) questioned the irrelevance argument and investigated the relationship between the dividends and investment and financing decisions. Their study showed that dividend payout ratio is not totally decided after a firm’s investment and financing decisions have been made. Dividend decision is taken along investment and financing decisions. Higgins (1981) indicated a shortest link between growths and financing needs, speedily growing firms have external financing needs because working capital needs usually exceed the cash flows from new sales.
Daniel (2007) conducted the study that 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 behavior 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.
Higgins (1972) and McCabe (1979) the leverage (Lev) also influenced the dividend behavior of the firm, if the level of the leverage is high that mean the firm is high risky in the cash flows. The negative effect of leverage on dividends payments is documented in the literature, finds that the firms with higher leverage pay lower dividends in order to evade the cost of raising external capital of the firm.
Lintner (1956) founded that past dividends of the companies and current earnings are the key determinants of current dividends and managers prefer to maintain stable dividends and make cyclic adjustments toward a target payout ratio.
Arditti (1976) carried out research in order to evaluated dividend policy with respect to taxes and uncertainty. The purpose of this paper has been to tackle the distressing dilemma of the zero dividend solution by clearly incorporating Modigliani & Miller original proposal that dividends have an information aspect that is of potential worth to investors. The analysis of ambiguity they have offered is only one of many possible hypotheses which can account for the experimental fact that companies naturally do not take on intense dividend policies.
Arnott and Asness (2003) suggested that a higher payout policy may result in lesser future growth, based their research on it founded that higher total dividend payout ratios were associated with greater future earnings growth.
Modigliani and Miller (1985) carried out research to evaluate dividend Policy under asymmetric information. The Standard finance model of the firm’s dividend/investment/financing decisions gives manager more appropriate information regarding the firm’s current earnings. The purpose of research is to replace the assumption built by Miller and Modigliani that the outside investors and inside managers have the same information about companies profit and future income with the assumption that inside managers know more than outside investors about the actual situation of firm’s current earnings.
James A. Gentry (1990) informed about free cash flow analysis, showed that the financial position of a company depends upon its ability to generate net operating cash flows that are sufficient to cover up a hierarchy of cash outflows. The profiles generated from a large sample of companies show that relative cash flow components vary across company size and across industry groups. The researcher hopes that these profiles will serve as benchmarks for comparing cash flow components and encourage financial analysts to use cash flow analysis.
Miller and Modigliani (1961) suggest that in perfect markets, dividend do not affect firms’ value. Shareholders are not concerned to receiving their cash flows as dividend or in shape of capital gain, as for as firm’s doesn’t change the investment policies. In this type of situation firm’s dividend payout ratio effect their residual free cash flows and the result is when the free cash flow is positive firms decide to pay dividend and if negative firm’s decide to issue shares. They also conclude that change in dividend may be conveying the information to the market about firm’s future earnings.
Jensen and Meckling (1976) the agency theory is based on the argument between managers and stockholder and the percentage of equity controlled by insider ownership should influence the dividend policy. Easterbrook (1984) gives further explanation regarding agency cost problem and says that there are two forms of agency costs; one is the cost monitoring and other is cost of risk aversion on the part of directors or managers.
The firm size (SIZE) defined as natural logarithm of total assets is probable to have a positive effect on dividend payouts as large more diversified firm are likely to have very low chance of bankruptcy and can sustain higher level of debt.
In investigating the determinants of dividend policy of Tunisian stock Exchange, found that the high profitable firms with more stable earnings can manage the larger cash flows and because of this they pay larger dividends. (Naceur, 2006)
Baker (2007) reports that Canadian dividend paying firms are significantly larger and more profitable, having greater cash flows, ownership structure and some growth opportunities.
The liquidity or cash flows position is also an important determinant of dividend payouts. A poor liquidity position means less generous dividends due to shortage of cash. Alli et.al (1993) reveal that dividend payments depend more on cash flows, which reflect the company’s ability to pay dividends, than on current earnings, which are less heavily influenced by accounting practices. They claim current earnings do no really reflect the firm’s ability to pay dividends.
Megginson and Eije (2006) examined that the dividend paying tendency of fifteen European firms decline dramatically over this period 1989 to 2003. The increase in the retained earnings to total equity doesn’t increase the payout ratio, but company age does.
The empirical study of Canadian dividend-paying firms found that they try to maintain stable dividends per share, are reluctant to decrease the payout level, and smoothly adjust the level of payout based on level of expected future earnings. (Adjaoud, 1986)
Easterbrook (1984) argues that increasing dividends raises the probability that additional capital will have to be raised externally on a periodic basis and consequently, the firm will be subject to constant monitoring by experts and outside suppliers in the capital market.
Green (1993) questioned the irrelevance argument and investigated the relationship between the dividends and investment and financing decisions. Their study showed that dividend payout levels are not totally decided after a firm’s investment and financing decisions have been made. Dividend decision is taken along investment and financing decisions.
Partington (1983) revealed that firm’s use of target payout ratios, firm’s motives for paying dividends and level to which dividends are determined are independent of investment policy.
Lipson (1998) conducted study to examine the factors that derives dividend initiations and earnings surprises, look at the performance of newly firms that started dividends with those that did not. Earnings increases following the dividend initiation and earnings revelations for initiation firms are more constructive than for those non initiating firms. In an economy that charges taxes on investment income, dividends are obviously a disadvantageous means of transferring wealth to shareholders. To validate dividend costs, two clarifications are typically given: dividends are used to solve agency problems inside the firm, or dividends are used to communicate information to the market.
H. Kent Baker, Gail E. Farrelly (1983) in their study dividend policy say that the major determinants of dividend payments today appear strikingly similar to Linter’s behavioral model developed during the mid-1950. In particular, respondents were highly concerned with dividend continuity. Second, the respondents seem to believe that dividend policy affects share value, as evidenced by the importance attached to dividend policy in maintaining or increasing stock price. Although the survey does not uncover the exact reasons for their belief in dividend relevance, it does provide evidence that the respondents are generally aware of signaling and clientele effects. Finally, the opinions of the respondents from the utilities differ markedly from those of the other two industries.
Smith and Watts (1992) examined the relationship among managerial compensation, corporate financing and dividend policy. It concluded that a company dividend policy is affected by its corporate policy choices. Jensen, Solberg and Zorn (1992) connected the interaction between financial strategy (dividend payout and leverage) and internal ownership to informational asymmetries between internal and external investors. They found that corporate financial decisions and insider ownership are interdependent.
Lintner (1956) suggested that the company long run dividend payout ratios and put their attention more on dividend changes than on dividend levels. It also founds that dividend changes pursue shifts in long run sustainable earnings and managers are uncertain to make dividend changes that may later need to be reversed. Managers try to stabilize dividends and avoid dividend cuts. It developed a part adjustment model to describe the dividend decision process that explained eighty five percent of year to year dividend changes. Gordon (1959) determined that an increase in the dividend policy raise stock price value and decrease the cost of equity, but practical support for this position is weak.
Bemstein (1996) maintained that dividend policy makes no difference because it has no effect on either stock prices or the cost of equity. According to Gordon (1959) a higher payout ratio will reduce the required rate of return (cost of capital), and hence increase the value of the firm.
Miller and Rock (1985) dividends contain this private information and therefore can be used as a sign device to influence share price. An announcement of dividend increase is taken as good news and accordingly the share price reacts favorably, and vice versa. Only good-quality firms can send signals to the market through dividends and poor-quality firms cannot mimic these because of the dissipative signaling costs. According to Easterbrook (1984) the agency costs forecasted that dividend policy can diminish the problems linked with information asymmetry. Dividends may also serve as a mechanism to reduce cash flow under management control, and thus help to mitigate the agency problems. Reducing funds under management discretion may result in force them in the capital markets frequently, thus putting them under the scrutiny of capital suppliers. The tax-preference theory posits that low dividend payout ratios lower the required rate of return and increase the market valuation of a firm’s stocks. Because of the relative tax disadvantage of dividends compared to capital gains investors require a higher before-tax risk adjusted return on stocks with higher dividend yields.
Higgins (1972) indicated that a direct connection between growth and financing needs: growing firms have outside financing requirements because working capital needs normally go beyond the incremental cash flows from new sales. It showed those payouts ratios are negatively related to firms’ need top fund finance growth opportunities. (Higgins, 1972)
Dependent variable in this study is dividend payout ratio which is defined as the percentage of earnings disbursed as dividends. While the independent variables include of profit (EBIT), sales, debt equity ratio and cash flow from operation. These four variables are used as predictors in order to conclude that how much each of the variables affects the dividend payout of sugar firms listed on the Karachi Stock Exchange over the period of eight years (2001-2008).
DP = α + β1 EBIT + β2 SALES + β3 CFO + β4 DER+ ε
DP is the annual dividend paid by firms during the period, while α is Alpha constant in the model. Whereas β (beta) shows the times of the variable in the model and ε represents the error term. Variables include in the model are Earning before interest and tax, Sales per year, Cash flow from operation and Debt equity ratio.
Dividend payout ratio:
The dividend policy is the one of the very important issue of corporate finance. It developed the dividend model which becomes very famous and known as Linter Partial Adjustment Model. According to the Linter (1956) in his research each firms i has target dividend payout ratio. By using the target payout ratio it calculated the target dividend at time (Dit*) as percentage of net earnings of the firms i at the time t (Eit), i.e Dit*= ri. Eit.
In this study researcher used dividend payout ratio as dependent variable. It is calculated by percentage of net earnings of the firms paid at the end of period. The set of determinants of dividend payout ratio consist of following variables. CFO (cash flow), Sales, EBIT (earning) and Debt to Equity Ratio (leverage).
There are four independent variables are used in this thesis to find out their impact on the dependent variable as dividend payout.
Operating Cash Flow:
The liquidity or cash flows position is also an important determinant of dividend payouts. A poor liquidity position means less giving dividends due to shortage of cash. Alli (1993) reveal that dividend payments depend more on cash flows, which reflect the company’s ability to pay dividends, than on current earnings, which are less heavily influenced by accounting practices. They claim current earnings do no really reflect the firm’s ability to pay dividends.
The market liquidity is defined as annual value of stock traded divided by the stock market capitalization. Market liquidity is one of very important factor that can influence the decision or behavior of the dividend policy. Belanes (2007) there is a negative relationship between the market liquidity and dividend yield in Tunisian Stock exchange.
OCF= EBIT +Depreciation-Taxes
H1: There is positive impact of CFO on dividend payout ratio.
Debt to Equity Ratio (leverage):
The leverage has been used as proxy of Debt to equity ratio and variable in this study. Because debt to equity is very important variable for the determinants of dividend policy, if the level of the leverage is high its mean the firm is more risky in the cash flows. The effect of negative leverage on dividends payments is already documented .Higgins (1972) and McCabe (1979) suggested that long term debt had negative impact on the amount of dividend paid. Rozeff (1982) found that the firms with higher leverage paid lower dividends in order to avoid the cost of raising external capital of the firm. When reorganization results in a debt-equity swap, the firm becomes an all-equity firm. Since there are no tax benefits or the possibility of bankruptcy in the future, the total value of the firm is exactly the asset value.
Debt to Equity ratio =Total debt / Total equity
H2: There is association of Debt to Equity on dividend payout ratio.
According to the assumption the high growth firms are smooth to pay their dividends to shareholders. The sales growth has been used as proxy of Growth in the empirical analysis of the study. The sales growth has been use as percentage change in sales annually of the growth. But in thesis, Sale is calculated by multiplying the price at which goods or services are sold by the number of units or amount sold. In this study sales consist of total a sale that is included local sales and export.
H3: There is association of Annual Revenue on dividend payout ratio.
EBIT (Earnings before interest and taxes):
Profits have been as the important indicator of the firm’s to pay dividends. Linter (1956) conducted a classic study on how U.S. managers make dividend decisions. He developed a compact mathematical model based on survey of 28 well established industrial U.S. firms which is considered to be a finance classic. According to him the dividend payment pattern of a firm is influenced by the present year earnings and preceding year dividends. Baker, Farrelly and Edelman (1986) review of New York stock exchange companies and concluded that the main factor of dividend policy are predictable level of future earnings and of past dividends. Pruitt and Gitman (1991) showed that present and precedent year profits are main factors influencing dividend policy. Firm’s profitability is argued to be an important factor in determining dividend policy. It can be argued that pro
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