PROJECT REPORT

ON

Study Of Dividend Policy Adopted By Companies

MS : 100 SUBMITTED IN PARTIAL FULFILLMENT FOR THE DEGREE OF

MASTER OF BUSINESS ADMINISTRATION

(2013)
SUBMITTED BY MAYUREE ENROLLMENT NO 091327327 STUDY CENTRE : 2728

ACKNOWLEDGEMENT
No task whatever big or small can be completed without proper guidance and encouragement. It gives me a great pleasure to express my deep sense of gratitude and reverence to every person who created a congenial atmosphere for successful completion of this training. A research report course module of MBA; plays a major role in shaping ones career to at most perfection. I Here make a special reference to our FACULTY AT MEERUT COLLEGE who gives me tremendous support and gave me an opportunity to carry out this project report.
My guide Miss Gunjan Garg has helped me out when ever their helps were required in my project. Starting with the analysis of Balance sheet till the end they were always very helpful. Last but not least, I owe everything in this life to my parents who are a content source of inspiration & pillars of support. I am sincerely thankful to the above people who were very kind and co-operative with us when ever we needed them.

TABLE OF CONTENTS S. no. 1. 2. 3. 4. 5. 6. 7. 8. 9. 10. 11. 12. Contents Introduction Review of the literature Research objectives Research Methodology Lintner Model: Analysis and findings Factor Analysis and Regression results on Extracted Factors Quadratic Polynomial Regression Analysis & Findings Event study: Analysis & Findings Conclusion Chapter plan Selected References Annexure Page no. 4-9 9-14 14-15 15-23 23-24 24-28 28-30 30-32 32-35 35-36 36-38 (III-XX)

EXECUTIVE SUMMARY

Dividend policy decision is one of the three decisions of financial management because it affects the financial structure, the flow of funds, corporate liquidating and investors attitudes. The main aspect of dividend policy is to determine the amount of earning to be distributed the shareholder and the amount to be retained in the firm. Divined policy involves the decision to pay out earning versus retaining them for reinvestment in the firm. The relationship between dividend and the value of the share is not clear cut. The financial manager must understand the various conflicting factors which influence the dividend policy before deciding the allocation of its companys earnings into dividends and retain earnings.

This study focuses on the dividend practice and its influence in prospect of Nepal of A class listed companies in Nepal. The empirical testing has been proved that exday stock price tend to fall by significantly less than the dividend. They interpret the result as consistent with a clientele effect where investors in high tax brackets show a preference for capital gains over dividends and vice versa.

The number of cash dividend paying companies listed at NEPSE is seen almost the same in context of total listed companies since last five fiscal year except 2004/05 in which it comprise of 20.80 percent of total listed companies. It is also seen that there is the low degree of positive correlation between the total number of listed companies and the number of cash dividend paying listed companies. Most of the finance company is not being capable of declaring cash dividend to their 5

shareholders. This study also wrap up that there is no significant difference between the average MPS before and after the cash dividend payment of commercial banks, development banks and finance company.

After such critical entrenchment level, however, when insider ownership increases are associated with additional entrenchment related agency costs, dividend policy may become a compensating monitoring force and accordingly a positive relationship with insider ownership would be observed.

DIVIDEND SIGNALING: A theory that suggests company announcements of an increase in dividend payouts act as an indicator of the firm possessing strong future prospects. The rationale behind dividend signaling models stems from game theory. A manager who has good investment opportunities is more likely to "signal" than one who doesn't because it is in his or her best interest to do so.

ABNORMAL RETURNS: A term used to describe the returns generated by a given security or portfolio over a period of time that is different from the expected rate of return. The expected rate of return is the estimated return based on an asset pricing model, using a long run historical average or multiple valuations.

FACTOR ANALYSIS: Factor analysis is a statistical procedure used to uncover relationships among many variables. This allows numerous intercorrelated variables to be condensed into fewer dimensions, called factors.

PANEL DATA: Panel data is data from a (usually small) number of observations over time on a (usually large) number of cross-sectional units like individuals, households, firms, or governments.

MULTIPLE REGRESSION ANALYSIS: Statistical procedure that attempts to assess the relationship between a dependent variable and two or more independent variables. Example: Sales of a popular soft drink (the dependent variable) is a function of various factors, such as its price, advertising, taste, and the prices of its major competitors (the independent variables)

1. INTRODUCTION

Dividend policy has been an issue of interest in financial literature since Joint Stock Companies came into existence. Dividends are commonly defined as the distribution of earnings (past or present) in real assets among the shareholders of the firm in proportion to their ownership. [15] Dividend policy connotes to the payout policy, which managers pursue in deciding the size and pattern of cash distribution to shareholders over time. Managements primary goal is shareholders wealth maximization, which translates into maximizing the value of the company as measured by the price of the companys common stock. This goal can be achieved by giving the shareholders a fair payment on their investments. However, the impact of firms dividend policy on shareholders wealth is still unresolved

The area of corporate dividend policy has attracted attention of management scholars and economists culminating into theoretical modelling and empirical examination. Thus, dividend policy is one of the most complex aspects in finance. Three decades ago, Black (1976) in his study on dividend wrote, The harder we look at the dividend picture the more it seems like a puzzle, with pieces that just dont fit together.[10].Why shareholders like dividends and why they reward managers who pay regular increasing dividends is still unanswered.

According to Brealey and Myers (2002) dividend policy has been kept as the top ten puzzles in finance. [34].The most pertinent question to be answered here is that how much cash should firms give back to their shareholders? Should corporations pay their 9

shareholders through dividends or by repurchasing their shares, which is the least costly form of payout from tax perspective? Firms must take these important decisions period after period (some must be repeated and some need to be revaluated each period on regular basis.)

Dividend policy can be of two types: managed and residual. In residual dividend policy the amount of dividend is simply the cash left after the firm makes desirable investments using NPV rule. In this case the amount of dividend is going to be highly variable and often zero. If the manager believes dividend policy is important to their investors and it positively influences share price valuation, they will adopt managed dividend policy. The optimal dividend policy is the one that maximizes the companys stock price, which leads to maximization of shareholders wealth. Whether or not dividend decisions can contribute to the value of firm is a debatable issue.

Firms generally adopt dividend policies that suit the stage of life cycle they are in. For instance, high- growth firms with larger cash flows and fewer projects tend to pay more of their earnings out as dividends. The dividend policies of firms may follow several interesting patterns adding further to the complexity of such decisions. First, dividends tend to lag behind earnings, that is, increases in earnings are followed by increases in

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dividends and decreases in earnings sometimes by dividend cuts. Second, dividends are sticky because firms are typically reluctant to change dividends; in particular, firms avoid cutting dividends even when earnings drop. Third, dividends tend to follow a much smoother path than do earnings. Finally, there are distinct differences in dividend policy over the life cycle of a firm, resulting from changes in growth rates, cash flows, and project investments in hand. Especially the companies that are vulnerable to macroeconomic vicissitudes, such as those in cyclical industries, are less likely to be tempted to set a relatively low maintainable regular dividend so as to avoid the dreaded consequences of a reduced dividend in a particularly bad year.

Shareholders wealth is represented in the market price of the companys common stock, which, in turn, is the function of the companys investment, financing and dividend decisions. Among the most crucial decisions to be taken for efficient performance and attainment of objectives in any organization are the decisions relating to dividend. Dividend decisions are recognised as centrally important because of increasingly significant role of the finances in the firms overall growth strategy. The objective of the finance manager should be to find out an optimal dividend policy that will enhance value of the firm. It is often argued that the share prices of a firm tend to be reduced whenever there is a reduction in the dividend payments. Announcements of dividend increases generate abnormal positive security returns, and announcements of dividend decreases generate abnormal negative security returns.A drop in share prices occur because dividends have a signalling effect. According to the signalling effect mangers have private and superior information about future prospects and choose a dividend level to signal that 11

private information. Such a calculation, on the part of the management of the firm may lead to a stable dividend payout ratio.

Dividend policy1 of a firm has implication for investors, mangers and lenders and other stakeholders (more specifically the claimholders). For investors, dividends whether declared today or accumulated and provided at a later date are not only a means of regular income2, but also an important input in valuation of a firm3. Similarly, managers flexibility to invest in projects is also dependent on the amount of dividend that they can offer to shareholders as more dividends may mean fewer funds available for investment. Lenders may also have interest in the amount of dividend a firm declares, as more the dividend paid less would be the amount available for servicing and redemption of their claims. The dividend payments present an example of the classic agency situation as its impact is borne by various claimholders. Accordingly dividend policy can be used as a mechanism to reduce agency costs.The payment of dividends reduces the discretionary funds available to managers for perquisite consumption and investment opportunities and require managers to seek financing in capital markets. This monitoring by the external

Brealey (1992) poses that dividend policy decisions as what is the effect of a change in cash dividends,

given the firms capital budgeting and borrowing decisions? In other words, he looks at the dividend policy in isolation and not as by products of other corporate financial decisions.
2

Linter (1956) finds that firms pay regular and predictable dividends to investors where as the earnings of

corporate firms could be erratic. This implies that shareholders prefer smoothened dividend income.
3

Bernstein (1976) observes that given the concocted earnings estimate provides by firms, the low

dividend payout induces reinvestment risk and earnings risk for the investors.

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capital markets may encourage the mangers to be more disciplined and act in owners best interest.

Companies generally prefer a stable dividend payout ratio because the shareholders expect it and reveal a preference for it. Shareholders may want a stable rate of dividend payment for a variety of reasons. Risk averse shareholders would be willing to invest only in those companies which pay high current returns on shares. The class of investors, which includes pensioners and other small savers, are partly or fully dependent on dividend to meet their day-to-day needs. Similarly, educational institutions and

charity firms prefer stable dividends, because they will not be able to carry on their current operations otherwise. Such investors would therefore, prefer companies, which pay a regular dividend every year. This clustering of stockholders in companies with dividend policies that match their preference is called clientele effect.

1 Background of the Study

After the restoration of democracy in 1990 A.D., Nepal has implemented liberal economic policy. As a result, many more companies are established in different sectors such as industrial, tourism, transportation, trade and mostly in financial sector who contribute to build up economy of the country. Nepal is a country trying to develop its economy through global trend and cooperation with developed countries. The development of an economy requires expansion of productive activities, which in turn is the result of the capital formation, which is the capital stock of the country. The change in the capital stock of the country is known as investment. Investment is key factor for capital formation. Investment promotes economic growth and contributes to a nations wealth. Investor desire to earn some return from the investment, without any return there is no any investment. Investment will block, if there is no return. The total expected return include two components one is capital gain and other is dividend. In the capital market, all firms operate in order to generate earnings. Shareholders make investment in equity capital with the expectation of making earning in the form of dividend or capital gains. Thus, shareholders wealth can increase through either dividend or capital gain. Once the company earns a profit, it should decide on what to do with the profit. It could be continued to retain the profit within the company, or it could pay out the profit to the owners of the company in the form of dividend. Dividends are payment made to stockholders from a firms earning in return to their investment. Dividend policy is to determine the amount of earnings to be distributed to shareholders and the amount to be retained or reinvestment in the

firm. The objective of a dividend policy should be to maximize shareholders wealth position. Retained earnings are used for making investment in favorable investment opportunities, which in turn help to increase the growth rate of the firm. What and how much it is desirable to pay dividend is always a controversial topic because shareholders expect higher dividend from corporation, but corporation ensure towards setting aside funds for maximizing the overall shareholders wealth. Management is therefore concerned with the activities of corporation that affect the well being of shareholders. That well being can be partially measured by the dividend received, but a more accurate measure is the market value of stock. But stockholders think dividend yield is less risky than capital gain. Dividends are payments made by a corporation to its shareholders. It is the portion of corporate profits paid out to stockholders. When a corporation earns a profit or surplus, that money can be put to two uses: it can either be re-invested in the business i.e. retained earnings, or it can be paid to the shareholders as a dividend. Many corporations retain a portion of their earnings and pay the remainder as a dividend. The most widely accepted objective of a firm is to maximize the value of the firm and to maximize shareholder wealth. In general, there are three types of financial decisions which might influence the value of a firm: investment decisions, financial decisions and dividend decisions. These three decisions are interdependent in a number of ways. The investments made by a firm determine the future earnings and future potential dividends; and dividend policy influences the amount of equity capital in a firms capital structure and further influences the cost of capital. In making these interrelated decisions, the goal is to maximize shareholder wealth. Dividends are decided upon and declared by board of directors. A firms profits after-tax can either be used for dividends payment or retained in the firm to increase shareholders' fund. This may involve comparing the cost of paying dividend with
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the cost of retaining earnings. Generally, whichever component has a lower cost that is where the profit after-tax will flow. However, there is a need to strike for a balance because it is a zero sum decision.1 Although firms do not have obligations to declare dividends on common stock, they are normally reluctant to change their dividend rate policy every year as the firms strive to meet stockholders expectation, build a good image among investors and to signal that the firm has stable earnings to the public. The theory of dividend and its effect on the value of the firm is perhaps one of the most important yet puzzling theories in the field of finance. Academics have developed many theoretical models describing the factors that managers should consider when making dividend policy decisions. By dividend policy, we mean the payout policy that managers follow in deciding the size and pattern of cash distributions to shareholders over time. Miller and Modigliani (1961) argue that given perfect capital markets, the dividend decision does not affect firms value and is, therefore, irrelevant. However, most financial practitioners and many academicians believe otherwise. They offered many theories about how dividends affect firms value and how managers should make dividend policy decisions. Over time, the number of factors identified in the literature as being important to consider in making dividend decisions increased substantially. There are plenty of potential determinants for the dividend decisions. The more prominent determinants include protection against liquidity, after-tax earnings of the firm, liquidity and cash flow consideration, stockholders' expectation/preference, future earnings, past dividend practices, return on investment, industry norms, legal constraints, growth prospects, inflation and interest rate. (Foong, Zakaria and Tan, 2007, p.98)

The development of an economy requires expansion of productive activities, which in turn is the result of the capital formation, which is the capital stock of the country. The change in the capital stock of the country is known as investment. Investment is key factor for capital formation. Investment promotes economic growth and contributes to a nations wealth. Investor desire to earn some return from the

investment, without any return there is no any investment. Investment will block, if there is no return. The total expected return include two components one is capital gain and other is dividend. In the capital market, all firms operate in order to generate earnings. Shareholders make investment in equity capital with the expectation of making earning in the form of dividend or capital gains. Thus, shareholders wealth can increase through either dividend or capital gain. Once the company earns a profit, it should decide on what to do with the profit. It could be continued to retain the profit within the company, or it could pay out the profit to the owners of the company in the form of dividend. Dividends are payment made to stockholders from a firms earning in return to their investment. Dividend policy is to determine the amount of earnings to be distributed to shareholders and the amount to be retained or reinvestment in the firm. The objective of a dividend policy should be to maximize shareholders wealth position. Retained earnings are used for making investment in favorable investment opportunities, which in turn help to increase the growth rate of the firm. What and how much it is desirable to pay dividend is always a controversial topic because shareholders expect higher dividend from corporation, but corporation ensure towards setting aside funds for maximizing the overall shareholders wealth. Management is therefore concerned with the activities of corporation that affect the well being of shareholders. That well being can be partially measured by the dividend received, but a more accurate measure is the market value of stock. But stockholders think dividend yield is less risky than capital gain. In Nepal only few companies are paying dividend and the other companies are not stable in the payment of dividend. There are some companies who have never paid dividend to their investors throughout their historical background. It has been noticed that company who has risen dividend generally experience on increase its stock price and that a company dont pay dividend or lowers its has a falling stock price trend. It seems to suggest that dividend so matter, is affecting the stock price
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of the company but several researchers argue the fact that dividend affect stock price, rather it is the information declaration of dividend that affect the stock price. It is fact that dividend work as a simple sufficient signal of managements interpretation of the firms recent performance and its future prospects.

1.2 The Problem Statement

Dividend policy is an integral part of financial management decision of a business firm. Dividend refers to that portion of a firms net earning which are paid out to the shareholders. Whether dividends have an influential on the value of the firm is the most critical question in dividend policy. If dividends are irrelevant, the firm should retain earnings for investment opportunities. If there are not sufficient investment opportunities providing expected returns in excess of the required return, the unused funds should be paid out as dividends. Dividend is the most inspiring factor for the investment on shares of the company is thus desirable from the stockholder's point of view. In one hand the payment of dividend makes the investors happy. But in the other hand the payment of dividend decreases the internal financing required for making investment in golden opportunities. This will hamper the growth of the firm, which in turn affects the value of the stock.

Earnings are also treated as financing sources of the firms. The firm retains the earning; its impact can be seen in many factors such as decreased leverage ratio, expansion of activities and increase in profit in succeeding years. Whereas if firm pays dividend, it may need to raise capital through capital that will affect on risk characteristics of the firm. Therefore there are many dimensions to be considered on dividend theories, policies and practices. Shareholders make investment in equity capital with the expectation of making earnings. Dividend is kind of earning that the shareholders expect form their
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investment. But, the dividend decision is still a fundamental as well as controversial area of managerial finance. The effect of dividend on market price of stock is the subject matter of the study. There are many empirical studies on dividend and stock price behavior. For example, few of them are Linter (1956), Miller and Modigliani (1961), Durand and May (1960), Friend and Puckett (1964), Fama and Babiak (1968), Elton and Gruber (1970), Frank and Jagannathan (1998), Uddin (2003), Foong, Zakaria and Tan (2007). However, conclusive relationship exists between the amount paid out in dividend and the market price of the share. There is still a considerable controversy concerning the relation between dividend and stock price.

Theoretically, the share price should fall down after the book closure by an amount to the amount of cash dividend, in case the company is going to distribute cash dividend. For example, if the share price of ABC Company on one day before the book closure was Rs. 1000 and the company had declared Rs.70 per share as cash dividend, which was to be formalized in the coming AGM. The price per share in the first transaction after the book closure should be around Rs. 930.

1.3 Purpose of the Study

The major objective of the study is to determine the trend and practices of dividend payment by the Nepalese A class listed companies of Nepal from fiscal year 2003/04 to 2008/09 however the specific objective is are as follows.

To examine the impact of dividend policy on market price of stock of A class listed companies of Nepal.

To explore the prevailing practices and effort made in dividend policy among the companies.

To identify the regularity and uniformity of dividend paying financial institutions.

1.4 Significance of the Study

In the capital market the investor can earn return in two ways, one is dividend and another is capital gain. The term dividend is defined as a return from investment in equity shares. So dividend is important factor for investor while investing in equity shares. This study helpful to investor to take rational decision like where to invest, how to invest, what portfolio should be made to obtain maximum profit from their investment? When a new company floats shares through capital market, large numbers of people gathers to apply for owner's certificate. It indicates people's expectation on higher return of investment in shares. In Nepalese context, most of investors are investing in the stock without adequate knowledge of the company and performance and dividend policies. This study helps to aware the Nepalese investors. This study is useful for the firms perspective too. They know the investor objectives from this study. There are basically two types of objective one is receiving dividend and another is receiving capital gain. Knowing the objective of investor they can develop their plans and policies accordingly. Basically this study is conducted to help the investor while investing in share capital. So that they can make correct decision at right time about the influence of dividend in market price of share and make investment.

1.2 RELEVANCE OF THE STUDY

Previous empirical studies have focused mainly on developed economies The study undertaken looks at the issue from emerging markets perspective by focusing exclusively on Indian Information Technology, FMCG and Service sector respectively. The major objective of this research is to empirically examine rationale for stable dividend payments by finding the applicability of Lintner Model in Indian scenario. The present research work also seeks to examine and identify the relative importance of some of known determinants of dividend policy in Indian context. The research work also has made an endeavor to bring to light the influence of ownership groups of a company on dividend payout behavior of a firm. This research tries to unfold the relationship between the shareholders wealth and the dividend payout and analyse whether the dividend payout announcements affects the wealth of the shareholders.

Given the diversity in corporate objectives and environments, it is conceivable to have divergent dividend policies that are specific to firms, Industries, markets or regions. Through the research an attempt has been made to suggest how dividend policy can be set at micro level. Finance mangers would be able to examine how the various market frictions such as asymmetric information, agency costs, taxes, and transaction costs affect their firms, as well as their current claimholders, to arrive at reasonable dividend policies. Previous research studies have focused on dividend payment pattern and policies of developed markets, which may not hold true for emerging markets like India. In Indian Context, few studies have analysed the dividend behavior of corporate firms and focused on Indian cotton textile Industry and Manufacturing sector. However, it is still not apparent what the dividend payment pattern of firms in India is. Very few studies have
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analyzed the dividend behavior of corporate firms in the Indian context. To date, most studies have paid attention on influence of cash flows or earnings on the dividend payment of a firm.

Further, for the dividend policy makers of the Indian IT, FMCG & Service Industry, the study may prove to be useful for re-sketching their dividend policy keeping in view the analysis, results and discussions presented. Through the research one can have better

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understanding of the factors that should systematically affect firms payout decisions. It also gives insight into what kind of ownership structure is beneficial for the shareholders.

1.3 SHAREHOLDERS VALUE CREATION AND ITS LINKAGE WITH DIVIDEND POLICY DECISIONS

It has been recognized by various research studies that a dividend policy could make significant impact on corporate future value when established and carefully followed. The goal of wealth maximisation is widely accepted goal of the business as it reconciles the varied,often conflicting ,interest of the stakeholders.

The interest in shareholders value is gaining momentum as a result of several recent developments: The threat of corporate takeovers by those seeking undervalued, under managed assets

Impressive endorsements by corporate leaders who have adopted the approach

The growing recognition that traditional accounting measures such as EPS and ROI are not reliably linked to the value of the companys shares

Reporting of returns to shareholders along with other measures of performance in business press.

A growing recognition that executives longterm compensation needs to be more

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closely tied to returns to shareholders. The shareholders value approach estimates the economic value of an investment (e.g shares of a company, strategies, mergers and acquisitions, capital expenditure) by discounting forecasted cash flows by the cost of capital. These cash flows, in turn, serve as the foundation for shareholder returns from dividends and share price appreciation.

A going concern must strive to enhance its cash generating ability. The ability of a company to distribute cash to its various constituencies depends on its ability to generate cash from operating its business and on its ability to obtain any additional funds needed from external sources. Debt and equity financing are two basic external sources. Borrowing power and the market value of the shares both depend on a companys cash generating ability. The market value of the shares directly impacts the second source of financing, that is, equity financing. For a given level of funds required, the higher the share price, the less dilution will be borne by current shareholders. Therefore, managements financial power to deal effectively with corporate claimants also comes from increasing the value of the shares. This increase in value of shares can be brought about by rewarding shareholder with returns from dividends and capital gains.

The most famous statement about the relationship between dividend policy and corporate value claimed that, in the presence of perfect markets, given a firm's investment policy, the dividend payout policy it chooses to follow will affect neither the current price of its shares nor the total return to its shareholders However, "market imperfections as differential tax rates, information asymmetries between insiders and outsiders, conflicts of

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interest between managers and shareholders, transaction costs, flotation costs, and irrational investor behavior might make the dividend decision relevant

The relevance of dividend policy to corporate value is due to market imperfections. Shareholders can receive the return on their investment either in the form of dividends or in the form of capital gains. Dividends constitute an almost immediate cash payment without requiring any selling of shares. On the contrary, capital gains or losses are defined as the difference between the sell and buy price of shares. Friction costs are one of the market imperfections and are further distinguished in transaction costs, floatation costs and taxes. Another market imperfection is that of information asymmetries between the insiders (e.g. managers) and the outsiders (e.g. investors). Agency conflicts, stemming from the different objectives of company's stakeholders, form the third market imperfection. Finally, there are some other issues that are related to dividend policy and cannot be placed among the previously mentioned imperfections.

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2. REVIEW OF THE LITERATURE

The research aims at analysing information asymmetry, agent conflicts, signalling effect and corporate dividend policy determinants. This section on literature review is focussed on various models and theories that are relevant to our study. The review of the literature is organised into various schools of thoughts on dividend policy which are discussed as follows:

2.1 DIVIDEND IRRELEVANCE PROPOSITION: MODIGLIANI &MILLER APPROACH (1961)

In 1961, two noble laureates, Merton Miller and Franco Modigiliani (M&M) showed that under certain simplifying assumptions, a firms dividend policy does not affect its value. The basic premise of their argument is that firm value is determined by choosing optimal investments. The net payout is the difference between earnings and investments, and simply a residual. Because the net payout comprises dividends and share repurchases, a firm can adjust its dividends to any level with an offsetting change in share outstanding. From the perspective of investors, dividends policy is irrelevant, because any desired stream of payments can be replicated by appropriate purchases and sales of equity. Thus, investors will not pay a premium for any particular dividend policy. [2]

M&M concluded that given firms optimal investment policy, the firms choice of dividend policy has no impact on shareholders wealth. In other words, all dividend policies are equivalent. The most important insight of Miller and Modiglianis analysis is that it identifies the situations in which dividend policy can affect the firm value. It could matter, 14

not because dividends are safer than capital gains, as was traditionally argued, but because one of the assumptions underlying the result is violated. The propositions rest on the following four assumptions: 1. Information is costless and available to everyone equally. 2. No distorting taxes exist 3. Flotation and transportation costs are non- existent

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4. Non contracting or agency cost exists

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2.2 DIVIDEND POLICY AND AGENCY PROBLEMS

The level of dividend payments is in part determined by shareholders preference as implemented by their management representatives. However, the impact of dividend payments is borne by a variety of claim holders, including debt holders, managers, and supplier. The agency relationship exists between

The shareholders versus debt holders conflict, and

The shareholder versus management conflict

Shareholders are the sole receipts of dividends, prefer to have large dividend payments, all else being equal; conversely, creditors prefer to restrict dividend payments to maximize the firms resources that are available to repay their claims. The empirical evidence discussed is consistent with the view that dividends transfer assets from the corporate pool to the exclusive ownership of the shareholders, which negatively affects the safety of claims of debt holders.

In terms of shareholder- manger relationships, all else being equal, managers, whose compensation (pecuniary and otherwise) is tied to firm profitability and size, are interested in low dividend payout levels. A low dividend payout maximizes the size of the assets under management control, maximizes management flexibility in choosing investments,

and reduces the need to turn to capital markets to finance investments. Shareholders,
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desiring managerial the need to turn to capital markets to finance investments. Shareholders, desiring managerial efficiency in investment decisions, prefer to leave little discretionary cash in managements hands and to force mangers to turn to capital markets to fund investments. These markets provide monitoring services that discipline managers. Accordingly, shareholders can use dividend policy to encourage managers to look after their owners best interests; higher payouts provide more monitoring by the capital markets and more managerial discipline.

La Porta, Lopez- de Silannes , Shleifer , and Vishny (2000) [20], have argued that a legal environment provides strong protection to shareholders enables them to force companies to disgorge cash. The implication is that effective monitoring by shareholders in UK, where legal protection is strong, should be associated with higher dividend payments. Studies for the UK where empirical evidence on the relationship between dividends and ownership structures is rather limited show that there is a negative relationship between inside ownership and dividends (Short ,Zhang and Keasey,2002, Renneboog and Trojanowski,2005, Farinha, 2003).However , evidence regarding financial institutions is not only limited but also contradictory: Short ,Zhang and Keasey report a positive relationship between dividends and shareholding by financial institutions while Renneboog and Trojanowski find a negative.

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Some of the important Research studies on agency conflicts are Berle and Means (1932), Easterbrook analysis (1984), the Jensen & Meckling (1986) [18], Lang and Linzenberger (1989), Jensen, Solberg and Zorn (1992) Agrawal and Jayaraman (1994) [1], Yoon and Starks (1995), Denis, Denis, and Sarin (1997) Heaton (2002)

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Dividend policy refers to the issue of how much of the total profit a firm should pay to its stockholders and how much to retain for investment so that the combined present and future benefits maximize the wealth of stockholders. The dividend policy, however, not only specifies the amount of dividend, but also form of dividend, payment procedure etc. Dividend policy according to the application could be categorized as follows:

a. Stable dividend policy

When the firm constantly pays a fix amount of dividend and maintains it for all times to come regardless of fluctuations in the level of its earnings, it is called a stable dividend policy. This policy is considered as a desirable policy by the management of companies. Most of the shareholders also prefer stable dividends because all other things remaining same, stable dividends have a positive impact on the market price of the share. By stability, we mean maintaining their positions in relation to a trend live preferably one that is upward sloping. Three of the common used dividend policies are:

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i) Constant dividend per share

Constant dividend policy is based on the payment of a fixed rupee dividend in each period. A number of companies follow the policy of paying fixed amount per share as dividend every period, without considering the fluctuation in the earnings of the company. The policy does not imply that the dividend per share or dividend rate will never be increased. When the company reaches new level of earnings and expects to maintain it the annual dividend per share may be increased. Investors who have dividends as the only source of their income prefer the constant dividend policy.

ii) Constant payout ratio

The ratio of dividend to earning is known as payout ratio. When fixed percentage of earnings is paid as dividend in every period, the policy is called constant payout ratio. Since earnings fluctuate, following this policy necessarily means that the rupee amount of dividends will fluctuate. It ensures that dividends are paid when profits are earned, and avoided when it incurs losses.

iii) Low regular plus extra policy

The policy of paying a low regular dividend plus extras in a compromise between a stable dividend (or stable growth rate) and a constant payout rate. Such a policy gives the firm flexibility, yet investors can count on receiving at least a minimum dividend. It is often followed by firms with relatively volatile earnings from year to year. The low regular dividend can usually be maintained even when earnings decline and extra dividends can be paid when excess funds are available.

b. No immediate dividend policy

If the company does not declare dividend unless the company earn large income is called no immediate dividend policy. In other words, if there is not any hurry about dividend payment and if it could be paid only when the company earns more profit

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is known as no immediate dividend policy. This policy is usually pursued the following circumstances:

When the firm is new and rapidly growing concern, which needs large amount of funds to finance its expansion program,

When the firms excess to capital market is difficult, When availability of funds is costlier, When stockholders have agreed to accept higher return in future.

In fact, this policy should follow by issue of bonus shares.

c. Regular stock dividend policy

If the company regularly pays dividends to its shareholders in stock instead of cash, then it is called regular stock dividend policy. Regular stock dividend policy is ale designated as bonus shares. Such policy should follow under the following circumstances:

When the firm needs cash generated by earning to cover its modernization and expansion of projects.

When the firm is lacking in cash despite high earning, this is particularly true when the firms sales is affected through credit and entire sales proceeds are tied in receivables.

d. Irregular dividend policy

It is the policy in which, the firm does not pay any fixed amount of dividend every year or dividend varied in correspondence with change in level of earning, i.e. higher earnings means higher dividend and vice-versa. The firm with unstable earnings also adopts this policy, when there are investable opportunities the company retains more and when there is not any investable opportunities, the company distributes the earning as dividend or there is not regularity of dividend payment therefore it is the most used type of dividend policy in the Nepalese context at present.
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e. Irregular dividend policy

This policy is based on the premise that investors prefer to have a firm retain and reinvest earnings rather than pay out them in dividends if the rate of return the firm can earn on reinvested earnings exceeds the rate of return investors can obtain for themselves on other investments of comparable risk. Further, it is less expensive for the firm to use retained earnings than is to issue new common stock.

2.3 Factors affecting Dividend Policy

2.3.1 Legal Requirements

The legal rules provide that the dividends must be paid from earnings either form the current years earnings or from past years earnings as reflected in the balance sheet account retained earnings. State laws emphasize three rules: a) Capital impairment Rules

The firm cannot pay dividend out of its paid up capital. If it does so there would be reduction in the capital that would affect the creditors of a corporation. b) Insolvency Rule

This rules state that cash dividend should be prohibited, if the company is insolvent. Insolvency in the legal services defined as the situation when the recorded value of liabilities exceeds the recorded value of assets. Similarly in the technical sense, it is the firms inability to pay its current debtors. c) Net profit rule

This rule provides that dividend can be paid form past and present earnings.

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2.3.2 Liquidity position

The cash or liquidity position of the firm influences its ability to pay dividends. A firm may have sufficient retained earnings, but if they are invested in fixed assets, cash may not be available to make dividend payment. Thus, the company must have adequate cash available as well as retained earning to pay dividends.

2.3.3 Access to the capital markets

A large, well-established firm with a record of profitability and stability of earnings has easy access to capital markets and other forms of external financing. A small, new or venturesome firm, however, is riskier for potential investors. Its ability to raise equity or debt funds from capital markets is restricted, and it must retain more earnings to finance its operations. A well-established firm is thus likely to have a higher dividend payout ratio than a new or small firm.

2.3.4 Need to repay debt

Firms may have the policy to retire its past debts by means of retained earning. If such alternative are being adopted then such firm will retain more and pays less dividend.

2.3.5 Restrictions in debt contracts

Debt contracts, particularly when long-term debt is involved, frequently restrict a firms ability to pay cash dividends. Such restrictions, which are designed to protect the position of the lender, usually state that (I) future dividends can be paid only out of earnings generated after the signing of the loan agreement (i.e. they can not paid out of past retained earnings) and (ii) that dividends cannot be paid when net working capital is below a specified amount. Similarly, preferred stock agreements generally state that no cash dividends can be paid on the common stock until all accrued preferred dividends have been paid.

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2.3.6 Growth rate of firm

A rapidly growing concern will have constant needs of long-term funds to seize favorable opportunities for which it has to retain more and pays less dividend.

2.3.7 Control
Another important variable is the effect of alternative sources of financing on the control situation of the firm. As a matter of policy, some corporations expand only to the extent of their internal earnings. This policy is defended on the ground that raising funds by selling additional common stock dilutes the control of the dominant group in that company. At the same time, selling debt increases the risks of fluctuating earnings to the present owners of the company. Reliance on internal financing in order to maintain control reduces the dividend payout.

2.3.8 Stability of earnings

A firm that has relatively stable earnings is often able to predict approximately what its earnings will be. Such a firm is therefore more likely to pay out a higher percentage of its earnings than a firm with fluctuating earnings. The unstable firm is not certain that in subsequent years earning will be realized, so it is likely to retain a high proportion of current earnings. A lower dividend will be easier to maintain if earning fall off in the future.

2.3.9 Tax position of shareholders

The tax position of a corporations owners greatly influences the desire for dividends. For e.g. a corporation owned by largely taxpayers in high income tax brackets tend toward lower dividend payout where as corporations owned by small investors tend toward higher dividend payout.

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2.4 Payment Procedure followed by Companies

The actual payment procedure is of some importance, and the following is an outline of the payment sequence.

1.

Declaration date: This is the day on which board of directors declares the dividend. At this time they set the amount of the dividend to be paid, the holder-of-record date and payment date.

2.

Holder-of-record date: This is the date the company opens the ownership books to determine who will receive the dividend; the stockholders of record on this date receive the dividend. In that date, the company closes its stock transfer books and make up a list of the shareholders as of that day.

3.

Ex-dividend date: The date when the right to the dividend leaves the stock is called the ex-dividend date. In this case, the ex-dividend date is four days before holder of record date. Therefore if someone wants to receive the dividend, he/she must buy the stock four days before the holder of record day.

4.

Payment date: This is the day when dividend checks are actually mailed to the holders of record. (Weston and Copeland, 1992, p. 658)

2.5 Ex- dividend Day Tests

The ex-dividend test involved the ex-dividend behavior of common stock prices. Investors buying the stock before ex-dividend date are entitles to the dividend declared; purchases on or after the ex-dividend date are not entitled to the dividend. In one of the earliest published studies on the ex-dividend stock price anomaly is that of Campbell and Beranek (1955) who reversed the general view that stock prices drop by the full dividend amount on ex-days. Using data from the NYSE stocks, they observed that the ex-dividend price drop was 90% of the dividend
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amount. Durand and May (1960) conducted another seminal work examining the ex-dividend day behavior of American Telephone and Telegraph stock (ATandT) for a time series of 43 consecutive dividends. They found that the average price change from the cum-dividend day to the ex-dividend day was $2.16, or about 4 percent less than the $2.25 dividend. Elton and Gruber (1970) were the first researchers that offered a reasonable explanation for the ex-dividend stock price anomaly. Using a one-year sample with 4,148 dividends, Elton and Gruber (1970) confirmed that ex-day stock prices tend to fall by significantly less than the dividend and developed a model explaining the effect known as the long-term trading hypothesis or the tax-effect hypothesis. Elton and Gruber showed that when dividends are taxed at a higher rate than capital gains, the stock price must drop by less than the dividend for investors to be indifferent between (i) selling the stock cum-dividend and (ii) holding the stock, receiving the dividend, and selling ex-dividend. Hence, in case that an investor decides to sell on the cum-dividend day he receives the cum-dividend price (Pc) and he pays tax at the capital gains rate (tg) on the excess of the cum-dividend price over to the price at which the share was bought (Po). On the other hand, if he decides to sell ex-dividend, he receives a dividend and the ex-dividend price (Pe) but he pays tax on the dividend at the dividend tax rate (td) and he pays tax on the excess of the ex-dividend price (Pe) over to the price at which the share was bought at the capital gains tax rate (tg). The above relationship is given by: Pc (Pc-Po)tg = Pe (Pe - Po) tg + D (1- td) (1) Rearranging Equation (1) we get:
Pc Pe 1 td = D 1 tg

Elton and Gruber (1970) argued that the statistic1 (Pc -Pe )/ D (or P/D) must then reflect the marginal tax rates of the marginal stockholders and one should be able to infer these tax rates by observing the above ratio.

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Elton and Gruber (1970) sorted their sample into deciles by the dividend yield and computed the mean P/D for each group. They found that NP/D generally increase with the dividend yield, suggesting that investors in lower tax brackets prefer stocks with higher dividend yields, while higher-bracket investors prefer lower-yield stocks. Thus, Elton and Gruber (1970) confirmed the existence of the dividend clientele effect as firstly proposed by Miller and Modigliani (1961).

Frank and Jagannathan (1998) examined the ex-dividend day stock price behavior in the Hong Kong market, where neither dividends nor capital gains were taxed and unlike in the NYSE, in the Hong Kong Stock Market (HKSE) there were no market makers until 1993. They found that stock prices dropped on the ex-dividend day by half the dividend amount. Frank and Jagannathan argued that the unexpected price drop on the ex-dividend day was the result of transactions on the cum-dividend day occurring at the bid price, while transactions on the ex-dividend day took place at the asked price. That is, since for the average investor it is a burden to receive the dividend and then go through the process of collecting it, most investors prefer not to receive it. Market makers, instead, find themselves in a better position to collect the dividend, so they buy the stock on the cum-dividend day. As a consequence, on the cum-dividend day most trades occur at the bid price, while on the ex-dividend day most trades occurred at the asked price. (Dasilas, 2007, p.1-8) Similarly other many studies have been made in this matter. In a number of these studies, the evidence is consistent with the previous, namely, that stock prices decline on the ex-dividend day but less than the amount of the dividend. (Bhattarai, 2007, p.393)

2.6 Quality Rating of Companies in Nepal

Nepalese capital market is still lacking an independent quality rating agency. But, NEPSE, the sole secondary market of Nepal, categorizes the listed companies into
28

two categories: Category A and Category B, on different criteria. According to the NEPSE criteria, only those companies are included in A categories that have:
Paid-up capital exceeding Rs. 20 million Reported profit for the last three consecutive fiscal years Have at least 1,000 shareholders Shares of the company should be trading in the stock exchange for a price

above the face value

The company should have submitted the annual report to NEPSE within six

months of the end of the fiscal year. Organizations not falling under these criteria are kept in B category. If not fulfilled the criteria for long-term by the financial institutions they are de-listed by the NEPSE. (Bhattarai, 2006, p. 298)

2.7 Legal Provision Regarding Dividend Practice in Nepal

Company Ordinance, 2005 makes some legal provision for dividend payment in Nepal. These provisions may be seemed as under: Dividends and subsections of this section are as follows

Section 46: Shareholder and Debenture-holder Register Book Subsection (1)

Every company should establish shareholder and debenture-holder register book as prescribed by law at company registrar office.

Subsection (2)
1. Following description should be clearly mentioned in the shareholders register book:
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a) Shareholders full name and address. b) No. of shares holding by shareholder. c) Total amount paid by shareholder and remaining balance if any. d) Registered date of shareholders certificate. e) Cancellation date of shareholders certificate. f) Ownership right on share after the death of the registered shareholder.

Section 182: Dividend Subsection (1)

Expect in the following circumstances, dividend shall be distributed among the shareholders within 45 days from the date of decision to distribute them,

a) In case any law forbids the distribution of dividends. b) In case of right to dividend is disputed. c) In case dividends cannot be distributed within the time limit mentioned above owing to circumstance beyond anyones control and without any fault on the part of the company.

Subsection (2)
Government owned companies either fully or partly cant issue dividend without permission of government and also necessary direction in the matter of dividend.

Subsection (3)
In case dividends are not distributed with the time limit mentioned in subsection (1), adding interest at prescribed rate.

Subsection (4)
Only the person whose name stands registered in the register of existing share holders at the time of declaring the dividend shall be entitled to it.

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Subsection (5)
The Company cant issue any form/amount as dividend expected separate reserve amount for the distribution of dividend.

Subsection (6)
The Company should deduct the operating cost, deprecation amount, payable, adjustment for previous years losses by-law before distributing dividend from profit.

Subsection (7)
Under this section company can distribute interim dividend if it is provisioned in rules and if the dividend is verified by audit report and attested by the BOD.

Subsection (8)
Except the amount declared from AGM, the company cannot distribute dividend from fund affecting the companys reserve.

Subsection (9)
If the shareholder does not come to take the dividend within the five F/Y from the declaration date, the amount would be safe guarded according to section 186 of company act.

Subsection (10)
If any shareholder comes to take the dividend amount according to section 183 within 1 month of before the expiry date, the notice should be published publicly in national daily.

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Subsection (11)
After the dividend declared form AGM, the company should establish separate book of account within 45 days and distribute to the shareholders and the amount should not be used for other purpose by the company.

2.8 Review of the International Studies

Linter (1956) conducted a study, which is focused in the behavioral aspect of dividend policy. He investigated dividend pattern of 28 different companies of America and found that, firm generally predetermines the desired payout and tries to achieve it and rarely considers other factors. The model developed firm is his research is as follows: DIV*t= pEPSt .. (i) and, DIVt- DIVt-1=a+b (DIV*t- DIVt-1) +e1. (ii) Or, DIVt=a+b DIV*t+ (a+b) DIVt-1 +e1 (iii) Where, DIV*t = Firms desired payment EPS p a b = Earning per share = Targeted payout ratio = Constant relating to dividend growth = Adjustment factor relating to the previous periods dividend and new desired level or dividend where b<1.

Major finding of this study are as follows:

Firms generally prefer desired proportion of earning to be paid as dividend. Investment opportunities are not considered for modifying the pattern of dividend behavior.

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Firm generally have target payout ratios in view while determining change in dividend per share.

Walter (1957) has proposed a model for share valuation which supports the view that the dividend policy of the firm has impact on share valuation. His works shows clearly the importance of the relationship between the firms internal rate of return on investments (r) and its cost of capital (k) in determining the dividend policy that will maximize the wealth of shareholders. Walterss model is based on the following assumptions (Chandra, 1999, p.302)

Retained earnings represent the only source of financing for the firm. The return on the firms investment remains constant. The cost of the capital for the firm remains constant. The firm has an infinite life.

Walters formula to determine the market price per share is as follows. DPS r(EPS DPS)/k DPS +r(EPS DPS)/k = = k k k

P= Where P DPS EPS r k = = = = =

Market price per share Dividend per share Earning per share Internal rate of return on investments Cost of capital

In Walters model the optimum dividend policy depends on the relationship between the firms internal rate of return on investment (r) and its cost of capital (k). Walters view of the optimum dividend payout ratio can be summarize as follows:

33

Growth Firm r>k Firm having r>k may be referred as growth firm. The optimum payout ratio for a growth firm is 0. The market price per share increases as payout ratio decreases. Normal Firm r=k Firm having r=k may be referred as normal firm. There is no unique optimum payout ratio for a normal firm. One dividend policy is a good as the other. The market price per share is not affected by the payout ratio when r=k. The payout ratio for a normal firm is irrelevant. Declining Firm r<k Firm having r<k may be referred as declining firm. The optimum payout ratio for a declining firm is 100%. The market price per share increases as payout ratio increases. Thus, in Walters Model the dividend policy of the firm depends on the availability of investment opportunities and the relationship between the firms internal rate of return (r) and its cost of capital (k). The firm should use earning to finance investment if r>k, should distribute all earnings when r<k and would remain indifferent when r=k. Modigliani and Millers (1961) model (M-M) dividend policy of the firm is irrelevant. It doesnt affect the wealth of the shareholder. They argue that the value of the firm depends on the firms earning, which result from its investment policy. The literature suggests that dividend payments should have no impact on shareholders value in the absence of taxes and market imperfections. Hence, companies should invest excess funds in the positive net present value projects instead of paying out them to the shareholders.

34

Modigliani and Millers model hypothesis of irrelevance is based ion the following assumptions. (Pandey, 2002, p.756)

The firm operates in perfect capital markets where investors behave rationally, information is freely available to all and transaction and floatation cost do not exist. Perfect capital markets also imply that no investor is large enough to affect the market price of share.

Taxes do not exist or there is no difference in the tax rate applicable to the capital gains and dividends. This means that investors value a rupee of dividend as much as a rupee of capital gains.

The firm has a fixed investment policy. Risk of uncertainty does not exist i.e. investors are able to forecast future prices and dividend with certainty and one discount rate is appropriate for all securities and all time periods. Thus, r=k=kt for all t.

Modigliani and Millers Model provide falling model to prove their theory.

Market Value of Share

The market value of share at the beginning of the period is equal to the present of dividend paid at the end of the period plus the market price of the share at the end of the periods. Symbolically, P0 = Where D1 +P1 1+ k (i)

P0 D1 P1 k

= = = =

Market price of share at the beginning of the period Dividend of the share at the end of the period Market price per share at the end of the period Cost of the equity capital

35

No External Financing
If no external financing exist the market value of firm can be computed by multiplying both sides by number of outstanding shares as follows: n (D1 +P1 ) 1+ k

V= nP0= Where V n = = Total value of the firm

(ii)

Number of shares outstanding

New Shares
If retain earning is not sufficient to finance the investment opportunities, issuing new shares is the other alternatives. Assuming that m is the number of newly issued equity share at the price of P1 the value of firm at time 0 will be: nD1 + (n + m )P1 mP1 1+ k

nPo = Where nPo n nD1 m (n+m)P1 mP1 k

(iii)

= Total market value of outstanding shares at time 0 = Number of outstanding shares at time 0 = Total dividends in year 1 payable on equity shares outstanding at time 0 = Number of outstanding shares at time 1 at price P1 = Total market value of all outstanding shares at time 1 = Market value of shares issued at time 1 = Discount rate

Total numbers of shares

A firm can pay dividends and raise funds to undertake the optimum investment policy. The firm finances all investment opportunities either by issue of new shares or retained earnings or both. Thus the amount of new shares issues will be: mP1 = I1 (E nD1)
36

(iv)

Where I1 E = = Total investment at time 1 Total net profit of the firm Retained earning

E-nD1 =

Substituting equation (iv) to equation (iii) we get

nP0=

(n + m )P1 I1 + E
1+ k

A firm, which pays dividends, will have to raise funds externally to finance its investment plans. Modigliani and Millers argument, that dividend policy does not affect the wealth of the shareholders, implies that when firm pays dividends, its advantage is offset by external financing. This means that the terminal value of the share decline when dividends are paid .Thus, the wealth of shareholders dividend plus terminal price remains unchanged. As a result, the present value per share after dividends and external financing is equal to the present value per share before the payment of dividends. Thus the shareholders are indifferent between payments of dividends and retention of earnings. Gordon (1962) develops own very popular model explicitly relating the market value of the firm to dividend policy. Gordon made a study on the dividend policy and market price of the stock and concluded that the dividend policy of a firm influences the market value of stock. He explained the investors preferred present dividend rather that future capital gains. He further explained that the dividend policy has direct relation with the value of stock even if the internal rate of return is equal to the required rate of return. Gordons model is based on the following assumptions:

The firm is an all equity firm.

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No external financing is available. Consequently retain earning would be used to financial expansion. The internal rate of return (r) of the firm is constant. This ignores the diminishing marginal efficiency of the investment.

The appropriate discount rate (k) for the firm remains constant. The firm and its stream of earning are perpetual. The tax does not exist. The relation ratio (b) ones decide upon, is constant. Thus the growth rate g=br, each constant forever. k>br =g. if this condition is not fulfilled, we cant get a meaningful value for the share.

According to Gordons Dividend Capitalization Model the market value of a share is equal to the present value of an infinite stream of dividend to be received by the share. Thus: P0 =

(1 + k )

D1

(1 + k )

D2

.............. +

(1 + k )n1

Dn

Gordon has further developed the following equation for the computation of the market value of stock. EPS (1 b) P = (Ke br) Where P EPS b ke 1-b br = = = = = = market price per share earning per share retention ratio cost of capital payout ratio growth rate

Gordons relevant theory is a popular theory of dividend as investors prefer current dividends earnings rather than expected higher future income so as to eliminate the
38

risk associated with future capital gain. Gordon stressed that the higher payout increases the dividend yield and hence increases the value of stock. But the assumption of this model is also far from the reality. (Pandey, 2002, p.751) Friend and Puckett (1964) conducted a study on the relationship between dividend policy and price of stock by running regression analysis on the data taken from 110 firms from five industries in the year 1956 to 1958. Industries taken as samples were chemicals, electric utilities, food, steels, and electronics. These industries were selected to permit a distinction made between the results for growth and nongrowth industries and to provide a basis for comparison with the results by other authors for earlier years. They also considered cyclical and non-cyclical industries in their study. The study period covered a boom year for the economy when stock prices leveled off after rise (1956) and a depressed for the economy when stock prices, however rose strongly (1958). They used dividends, retained earnings and price earning ratio as independent variable in their regression model of price function and dividends as supply function. Earnings, previous years dividend and price earning ratio are independent variable in the dividend function. Symbolically, their price function and dividend supply function are as follows: Their study based on the following assumption:

Dividends react with year-to-year fluctuation in earnings. Price doesnt contain speculative components. Earnings fluctuation may not sum zero over the sample.

The regression results based on the equation of: Pt= a + b Dt + CRt+dh(E/P)t-1 shows the customary strong dividend and relatively weak retained earning in three of the five industries, i.e. chemicals, foods and steels. They again tested other regression equation by addition of lagged earning price ratio to the above equation and result the following equation: Pt= a + bDt + CRt+d(E/P)t-1
39

Where,

Pt= Per share price at time t Dt= Dividends at time t Rt= Retain earning at time t (E/P)t-1= Legged earning price ratio Dividend supply function Dt= e + fEt +gDt-1 +d(E/P)t-1 Where, Et= Earning per share at time t Dt-1= Last year dividend They found that more than 80% of the variation in the stock price could be explained by three independent variables. Dividends have predominant influence of stock price in the same three out of five industries but they found the difference between the dividend and retained earnings coefficient are not quite so marked as in the first set of regression. They also found that the dividend and retained earning coefficient are closer to each other for all industries in the both the years except for steels in 1956 and the correlations are higher again except for steels. They also calculate the dividend supply equation (Dt= e + fEt +gDt-1 +d(E/P)t-1) and derived price equation for four-industry group in 1958. The derived price equation showed that there were no significant changes from those obtained in the single equation approach as explained above. They argued that the stock price or more accurately the price-earning ratio does not seem to have a significant effect on dividend payout. On the other hand they noted that the retained earnings effect increased relatively in the three of the four cases tested. Further their result suggested, price effects on dividend supply are probably not a serious source of bias on the customary deviation of dividend and retained earnings effects of short-term income movement are sufficiently great. Further they used lagged price as a variable instead of lagged earning price ratio and showed that more than 90 percent of variation in stock prices can be explained by three independent variables and
40

retained earnings received greater relative weight than dividends in most of the cases. The only exception was steels and food in 1958. They considered chemicals, electronics, and utilities as growth industries in these groups and the retained earnings effect was larger than the dividends effect for both the years covered. For the other two industries, namely food and steels, there was no significant systematic difference between the retained earnings and dividends coefficient. Similarly, they tested the regression equation, Pt = a + bD, + cR, by using normalized earnings again, which they obtained by subtracting dividends from normalized earnings. This process of normalized earnings was based on the period 1950 to 1961. They again added prior years normalized earning price variable and compared the results and found that there was significant role of normalized earnings and retained earnings but the effect of normalized price earning ratio was constant. When they examined the later equation they found that the difference between dividend and retained earnings coefficient disappeared. Finally they conclude that management might be able to increase price somewhat by raising dividend in food and steel industries. They conducted more detailed examinations of chemical samples which disclosed that the result obtained largely reflected the undue regression weighting given the three firms with price deviating most from the average price in the sample of twenty firms and retained earnings as a price determinant. Finally, Friend and Puckett concluded that, management might be able, at least in some measure, to increase stock prices in non-growth by raising dividends payout and in growth industries by greater retention. Foong, Zakaria, and Tan (2007) investigated the relationship between individual stock returns with dividend yield, dividend stability and changes in dividend yield from 1992 to 2000 in the Malaysian Trading/Services and Plantation firms. The statistical result from annually cross-sectional regression show weak evidence to support the significant role of dividend yield and dividend stability in explaining

41

firm stock returns. Changes in dividend yield, on the other hand, have negative and significant coefficients in explaining stock returns in Trading/Services firms throughout 1993-1996 and the average crisis period. For Plantation firms, it is negatively significant only in 1994 and 1997. The main purpose in conducting this study was to identify the role of dividend in explaining Malaysian firm stock returns. They tested the relationship of firm stock returns with the so-called the dividend related variables, comprising dividend yield, dividend stability and changes in dividend yield. Although they do not obtained very strong results that the dividend related variables are the main factors explaining firm stock returns, they do find that changes in dividend play some role in explaining firm stock returns, especially of the Trading/Services firms, which are essentially representing growth firms. If this holds true across the whole Malaysia listed firms, this suggests that CEO and top management of growth firms should pay careful attention to the changes of dividend yield in their firms, which has an inverse relationship with the stock returns. The frequent changes in firm dividend policy may be particularly useful in attempting to differentiate high value firm from their low-value counterparts that have high dividend payout levels. The negative sign documented implies that the lower the changes in the dividend yield, the higher the stock returns. This suggests that the management should try to minimize changes in the dividend yield. Smoothing dividends payment over time can push the stock price to higher level. Another option is to maintain the level of dividend yield by adjusting the dividend payment relative to the stock price. Furthermore, announcing changes in the level of dividend payment provides important information to investors and must be carefully considered. This will eventually maximize the firm value; follow by the maximization of shareholder wealth.

Uddin (2003) empirical results based on 137 samples of dividend paying companies listed on Dhaka Stock Exchange (DSE) showed that investors do not gain value
42

from dividend announcement. Indeed shareholders lost about 20 percent of value over a period of 30 days prior to the dividend announcement through to 30 days after the announcement. The lost value may be partially compensated because of the current dividend yield. Overall, the evidence tends to support the dividend irrelevancy hypothesis. Evidence also indicates that dividend payment does not signal any information to the investors. The study shows that the highest average dividend was paid in the Fuel and Power sector, followed by that in the banking sector. The highest dividend was announced in the food sector, and lowest in the Jute and Services sectors. In Jute sector, only one company announced dividend during the sample period. The average dividend was 19.5 percent with standard deviation of 12.9 percent. Overall, the study shows that the sample includes stocks from all sectors, except the paper sector. The number of samples are also fairly equally distributed with 10 to 20 stocks from each sector except Paper, Jute and Services sectors. This is also noted that out of 137 companies, 34 companies announced dividend in 2001 and 103 in 2003. Sample also displays that 108 companies belong to A category, 17 belong to B category and 12 belong to Z category.3

Fama and Babiak (1968) study has proven that there is significant positive relationship between the change of a firms dividend payment and change in its stock price. Fama and Babiak (1968) find a time series relation between annual dividends and earnings that is consistent with the view that dividend paying firms increase their dividend only when management is relatively confident that their higher payment can be maintained. Their view is supported by Capstaff, et al. (2004), who found that stock market reaction is more pronounced for large, positive dividend announcements that are followed by permanent cash flow increases.

Anagho and Tah (2007) in their case study "The ex-dividend day stock price behavior," studied the movement of ex-dividend day stock price behavior for the FTSE100 stock index for the period 2001 to 2006. The study was carried out by

43

comparing the actual value of the raw price ratio, market adjusted price ratio, raw price drop and market adjusted price drop to their theoretical values. The difference was tested for significance using the one sample t-test. The results showed that there are significant differences in the observed figures from their theoretical or expected values. The observed raw price ratio is higher than the expected value of 1, implying that the stock price on the ex-dividend day drops by an amount that is higher than the dividend paid. Similarly, the market adjusted raw price ratio is also higher than the expected value of 1. The raw price drop and market adjusted price drop are lower than the dividend yield, indicating again that the stock price drops by an amount that is less than the dividend paid. The study is inconsistent with the findings by Nikolas et al (2006), who studied the ex-dividend day stock price behavior in the SHSE and SZSE indices of the Chinese Stock Exchange using a similar method but consistent with Alm et al (1999) who carry out a study using the Stockholm stock exchange where his findings showed that the stock price drop on average is less than the dividend been paid out.

Raw Price Ratio (RPR) is the drop in share price expressed as a fraction of the difference between the cum-dividend price and the ex-dividend price all over the actual dividend paid. Under normal circumstances, that is, where there are no arbitrage opportunities and where the market efficiency hypothesis is assumed to be true, the theoretical value of the raw price ratio should be equal to 1.

Market Adjusted Price Ratio (MAPR) is the difference between the cumdividend price and the market adjusted ex-dividend price expressed as a fraction of the actual dividend. Similarly under perfect capital markets, the theoretical or expected value of the market adjusted raw price ratio is equal to 1.

Raw Price Drop (RPD) is the difference between the cum-dividend price and the ex-dividend price expressed as a fraction of the cum-dividend price. In

44

perfect capital markets, the hypothesized value of the raw price drop is equivalent to the dividend yield.

Market Adjusted Price Drop (MAPD) is the difference between the cumdividend price and the market adjusted price expressed as a fraction of the cum-dividend price. Also, under perfect capital markets, the market adjusted price drop is equivalent to the dividend yield.

45

2.3 DIVIDEND POLICY AND ASYMMETRIC INFORMATION

In a symmetrically informed market, all interested participants have the same information about a firm, including mangers, bankers, shareholders, and others. However, if one group has superior information about the firms current situation and future prospects, an informational asymmetry exists. Most academics and financial practitioners believe that managers possess superior information about their firms relative to other interested parties.

Dividend changes (increases and decreases), dividend initiations (first time dividends or resumption of dividends after lengthy hiatus), and elimination of dividend payments are announced regularly in the financial media. In response to such announcements, share prices usually increase following dividend increases and dividend initiations, and share prices usually decline following dividend cuts and dividend eliminations. The idea that dividend payouts can signal a firms prospects seems to be well accepted among the chief financial officers (CFOs) of large US corporations. In a survey of these executives conducted by Abrutyn and Turner (1990), 63% of the respondents ranked signaling explanation as the first reason for dividend payouts.

Information about the prospects of a firm may include the firm's current projects and its future investment opportunities. The firm's dividend policy, either exclusively or in combination with other signals, such as capital expenditure announcements or trading by insiders, may communicate this information to a less informed market. Empirical studies in this area include Akerlofs (1970) Bhattacharya model (1979), John and Williams model (1985) Miller and Rock model (1985) Constantinides and Grundy (1989) John and Nachman (1986) Kale and Noe (1990), Allen . Bernado , and Welch (2000)
46

Pettit (1972) documented that announcements of dividend increases are followed by significant price increases and that announcements of dividend decreases are followed by significant price drops. Three studies of large changes in dividend policyAsquith and Mullins (1983) (dividend initiations), Healy and Palepu (1988), and Michaely, Thaler, and Womack (1995) (dividend omissions)showed that the market reacts dramatically to such announcements[6]. Other research studies which tested the dividend announcement effects include Aharony and Swary (1980) Ofer and Siegel (1987) [25] , Dyl and Weigand (1998)

Empirical studies however showed mixed evidence, using the data from US, Japan and Singapore markets. A number of studies found that stock price has a significant positive relationship with dividend payments (Gordon (1959) ,Oggden (1994) ,Stevents and Jose(1989),Kato and Loewenstein (1995) ,Ariff and Finn(1986),and Lee(1985)),while others found a negative relationship like Loughlin(1989) and Easton and Sinclair(1989))

47

Dividends are meant convey private information to the market, predictions about the future earnings of a firm based on dividend information should be superior to forecasts made without dividend information.A number of studies have tested these implications of the information content of dividends which includes studies by Watts (1973) Gonedes (1978) . Charest (1978) Michaely , Thaler and Womack (1995) Benartzi, Michaely, and Thaler (1997) Grullon, Michaely and Swaminathan (2002Lipson, Maquieira, and Megginson (1998) Brook, Charlton, and Hendershott (1998) Nissim and Ziv (2001)

2.4 RESEARCH ON CORPORATE DIVIDEND POLICY DETERMINANTS

Black (1976) in his study concluded with the following question: What should the corporation do about dividend policy? We dont know .A number of factors have been identified in previous empirical studies to influence the dividend policy decisions of the firm. Profits have long been regarded as the primary indicator of the firms capacity to pay dividends. Lintner (1956) conducted a classic study on how U.S. managers make dividend decisions. He developed a compact mathematical model based on survey of 28 wellestablished industrial U.S. firms which is considered to be a finance classic. According to him the current year earnings and previous year dividends influence the dividend payment pattern of a firm[22]. Fama and Babiak (1968) studied the determinants of dividend payments by individual firms during 1946-64 . The study concluded that net income seems to provide a better measure of dividend than either cash flows or net income and depreciation included as separate variables in the model. Baker, Farrelly and Edelman (1986) surveyed 318 New York stock exchange firms and concluded that the major
48

determinants of dividend payments are anticipated level of future earnings and pattern of past dividends. Pruitt and Gitman (1991) asked financial managers of the 1000 largest U.S. and reported that, current and past year profits are important factors influencing dividend payments and found that risk (year to year variability of earnings) also determine the firms dividend policy [28] .Baker and Powell (2000) concluded from their survey of NYSE-listed firms that dividend determinants are industry specific and anticipated level of future earnings is the major determinant. [9]

In other studies, Rozeff (1982), Lloyd et. al. (1985), and Colins et. al. (1996) used beta value of a firm as an indicator of its market risk. They found statistically significant and negative relationship between beta and dividend payout. DSouza (1999) also found statistically significant and negative relationship between beta and dividend payout[30]. D,Souza (1999) however showed a positive but insignificant relationship in the case of growth and negative but insignificant relationship in case of market to book value[12]. Alli et.al (1993) reveal that dividend payments depend more on cash flows, which reflect the companys ability to pay dividends, than on current earnings, which are less heavily influenced by accounting practices.Green et. al.(1993) questioned the irrelevance argument and investigated the relationship between the dividends and investment and financing decisions .Their study showed that Dividend decision is taken along with investment and financing decisions. The results however do not support the views of Miller and Modigliani (1961) [23]. Dhrymes and Kurz (1967) and McCabe (1979) found that the firms investment decision is linked to its financing decision. Higgins (1972),

49

Fama (1974), and Smirlock and Marshall (1983) documented no interdependence between investments and dividends. Higgins (1981) indicated a direct link between growth and financing needs: rapidly growing firms have external financing needs because working capital needs normally exceed the incremental cash flows from new sales[16]. Rozeff (1982), Lloyd et al.(1985) and Collins et al .(1996) all show significantly negative relationship between historical sales growth and dividend payout.

Arnott and Asness (2003) based their study on American stock markets (S&P500) and found that higher aggregate dividend payout ratios were associated with higher future earnings growth. Both Zhou and Ruland(2006) and Gwilym et.al. (2006) supported the findings of Arnot and Asness. Zhou and Ruland examined the possible impact of dividend payouts on future earning growth. Their study used a sample of active and inactive stocks listed on NYSE and NASDAQ with positive, non- zero payout ratio companies covering the period from 1950- 2003.Their regression results showed a strong positive relation between payout ratio and future earnings growth. Mancinelli and Ozkan (2006) undertook an empirical investigation of the relationship between the ownership structure of companies and dividend policy using 139 firms listed in Italian exchange. Their results suggested that the dividend payout ratio is negatively associated with the voting rights of the largest shareholders. Mohammed Amidu and Joshua Abor(2006) examined the factors affecting dividend payout ratios of listed companies in Ghana. The results of their study showed that payout ratios were positively related to profitability, cash flow and tax but are negatively related risk and growth. [5]
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2.5 INDIAN SCENARIO

In Indian Context, a few studies have analyzed the dividend behavior of corporate firms. Krishnamurty and Sastry (1971) analyzed dividend behaviour of Indian chemical industry for the period 1962-67 and undertook crossectional data of 40 Public Limited companies. The results revealed that Lintner model provides good explanation of dividend behavior.Dhameja (1978) in his study tested the dividend behaviour of Indian companies by classifying them into size group, industry group, growth group and control group. The study found there was no statistically significant relationship between dividend payout, on the one hand and industry and size on the other. Growth was inversely related to dividend payout and was found to be significant .The main conclusion were that dividend decisions are better explained by Lintners model with current profit and lagged dividend as explanatory variable. Mahapatra and Sahu (1993) found cash flows as a major determinant of dividend followed by net earnings[35]. Bhat and Pandey (1994) undertook a survey of managers perceptions of dividend decisions and found that mangers perceive current earnings as the most significant factor. Narsimhan and Asha(1997) observed that a the uniform tax rate of 10 % on dividend as proposed by Union Budget 1997-98 , alters the demand of investors in favor of high payouts[32]. Mohanty (1999) found that firms, which issued bonus shares, have either maintained the payout at the pre bonus level or only decreased it marginally thereby increasing the payout to shareholders[36].Narsimhan and VijayLakshmi (2002) analysed the influence of ownership structure on dividend payout of 186 manufacturing firms. Regression analysis shows that promoters holding as

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of September 2001 has no influence on average dividend payout for the period 19972000[26][33].

Anand Manoj (2002) analyzed the results of 2001 survey of 81 CFOs of Business today500 companies in India to find out the determinants of the dividend policy decisions of the corporate India. He used factor analytic framework on the CFOs' responses to capture the determinants of the dividend policy of corporate India. The findings revealed that most of the firms have target dividend payout ratio and were in agreement with Lintner's study on dividend policy. CFOs use dividend policy as a signaling mechanism to convey information on the present and future prospects of the firm and thus affects its market value. The managers design dividend policy after taking into consideration the investors' preference for dividends and clientele effect. [41]Reddy Y.Subba and Rath Subhrendu (2005) examined Dividend trends for large sample of stocks traded on Indian markets indicated that the percentage of companies paying dividend declined from over 57% in 1991 to 32% in 2001, and that only a few firms paid regular dividends. Dividend paying companies were less likely to be larger and more profitable than non-paying companies, though growth opportunities do not seem to have significantly influenced the dividend policies of Indian firms. The rise of the number of firms not paying dividends is not supported by the requirements of cash for investments [40] Sharma Dhiraj (2007) empirically examined the dividend behavior of select Indian firms listed on BSE from 1990 to 2005.The study analyzed whether or not the dividends are still vogue in India and tried to judge the applicability of one of the two extremely opposite schools of thoughtsrelevance and irrelevance of dividend decision. The study also analyzed the applicability
52

of tax theory in the Indian context. The findings offered mixed and inconclusive results about tax theory indicating that the change in the tax structure does not have a substantial effect on dividend behavior of firms.[42]

A number of conflicting theoretical models, all lacking strong empirical support, define recent attempts by researchers in finance to explain the dividend phenomenon. But to come with concrete conclusions an intensive study of all theoretical models together with empirical proof is needed. The extensive literature on dividend policy in the last five decades have been unable to reach a consensus on research on a general dividend theory that can either explain the process of dividend decision making or predict an optimal dividend policy. Therefore it becomes important to study dividend behavior of Indian companies using the framework of empirical models.

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3. RESEARCH OBJECTIVES:

The study is focussed on achievement of following four objectives:

1. To empirically examine the determinants of dividend smoothing by firms and find out its linkage with information content of dividends.

2. To analyze the influence of firms characteristics like profitability, growth, risk, cash flows, agency cost and on dividend payment pattern. i.e. to identify various determinants of dividend payout.

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3. To investigate the association between various ownership groups and dividend payout policies of Indian corporate firms.

4. To find the impact of dividend announcement on shareholders wealth

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4. RESEARCH METHODOLOGY

In this section a brief overview of various dimensions of the research, tools and techniques and methods used to achieve various research objectives has been discussed.

4.1 THE DATA AND SAMPLE The study is focused on three sectors IT, FMCG and Service sector.

IT sector IT sector has been chosen for study because it is a sunshine sector of India. It currently accounts for almost 4.8% of Indias GDP. It will account for 7% of Indias GDP by 2010.The dividend payment pattern of IT companies have changed leaps and bounds over past few years. They were at the bottom of the charts in terms of dividend payout in 2000 and but after 2004 there was a sudden spurt in their dividend payout. To the best of our knowledge, so far no study has been undertaken in India to empirically test the above stated four research objectives in the Indian IT sector. Therefore, this sector has been chosen for study. FMCG FMCGs (Fast Moving Consumer Goods) are those goods and products, which are nondurable, mass consumption products, available off the shelf. FMCG industry has been chosen for study because it has played a major role in the Indian economy during the last few years and it is registering an uptrend in growth. FMCG stocks are known as dividend yield stocks. FMCG companies are consistent dividend payers. So it would be an interesting exercise to study the dividend payment pattern of FMCG companies. SERVICE SECTOR
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Indian service sector comprises of trade hotels, transport, communication, IT and software, banking and insurance etc. Till 2002 service sector was ignored in India and the main emphasis was on manufacturing and agricultural sector. It was only after 2002 that service sector started growing at a healthy rate of 8-10%. Today it is the highest contributor to the GDP of our economy.

THE DATA The research is analytical and empirical in nature and makes use of secondary data. The data has been sourced from Prowess database of Centre for Monitoring Indian Economy (CMIE). The sample period undertaken for study of each objective is from the year 2000 to 2008 except for the third objective, which is from the year 2001 to 2008 due to nonavailability of data for the year 2000. The data has been taken after 2000 because of definitional change in the shareholding pattern.

57

The data used for achieving each objective was made suitable for analysis as per the methodology. Thus, the data collected from Prowess database has been complied and used with due care and caution as per the requirement of the study. The analysis has been carried out on both panel and pooled data depending on the requirements of the techniques used for analysis.

The analysis of first and third research objective has been carried out on panel data as panel data overcomes the various shortcomings of purely cross sectional or time series data.

THE SAMPLE The sectoral analysis has been done by taking sample of companies, which are the constituents of CNX IT, CNX FMCG and CNX Service Sector respectively.

In order to have a good benchmark of the Indian IT sector, IISL (India Index services and Product Ltd.) has developed the CNX IT sector index. IISL is a joint venture between NSE and credit rating agency CRISIL Ltd. The sample selected for study consists of all the companies, which are constituents of CNX IT index of NSE.

Akin to CNX IT index, IISL (Indian Index Services and Products Ltd.) has developed the CNX FMCG sector index. The CNX FMCG Index is a 15 stock Index from the FMCG sector that trade on the National Stock Exchange.
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In the similar manner to do analysis of research objectives in service sector, all the companies, which are constituent of CNX service sector Index, have been undertaken. CNX service sector index is a 29 stock index developed by IISL.

The list of the sample companies for each of the sector has been appended to the annexure (Annexure I)

4.2

MODELS AND TECHNIQUES

For the conduct of the study various models have been developed and used. This section discusses these models and various tools and techniques used to carry out the research.

4.2.1

LINTNER MODEL

Lintner (1956) developed a model to study the determinants of the dividend behavior of American corporations assuming that the dividend payout is a function of net current earnings after tax (PAT) and dividend paid during the previous year i.e. lagged dividend (Div t-1). Companies decide to payout a fixed proportion of their net profits as dividend to common stockholders; but in view of their well known preference for stable dividends may try to achieve the target level only by a fraction of the amount indicated by the target payout ratio whenever profit changes. The above theoretical formulation of Lintner has been used as an estimating equation for corporate dividend in the present study, which is as follows-

59

D*it = iEit (1)

Dit D i(t-1) =ai + Ci{D*it -Di(t-1)}+ uit.(2) Where, D*it= desired dividend payment during periodt Dit= Actual dividend payment during periodt i= Target payout ratio Eit = Earnings of firm during periodt ai= a constant related to dividend growth Ci= partial adjustment factor uit= error term

Dit D i(t-1) = ai + Ci{ iEit -Di(t-1)}+ uit .(3) Dit=a+ i Ci Eit + (1-Ci) D i(t-1) +uit ...(4)

This model can further be simplified in the form of a multiple regression equation Dt=a+ iEit + Ci D (t-1) +uit (5)

To understand the relationship between dividend and earnings (PAT) a Multiple linear regression analysis was carried out in respect of companies which are constituent of CNX IT index, CNX FMCG Index and CNX Service sector Index respectively, for panel data of
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9 years i.e. from 2000 to 2008.Fixed effect (one way) static panel data analysis has been carried.

LINTNER MODEL USED:

Y= + 1X1+ 2X2 + uit + it Where,

(6)

Y= dependent variable (equity dividend in Rs. crore during period t) X1= independent variable (PAT) in Rs. Crore = Constant 1= regression coefficient of PAT (target payout ratio) X2= Equity dividend during period t-1 2= regression coefficient of dividend during period t-1 i.e. (1-c) and c is the adjustment factor. uit = firm specific components it = disturbance term

Therefore, Target payout ratio* adjustment factor = 1 i* Ci = 1 i*(1-2) = 1 This implies I = target payout ratio = 1/(1-2) Speed of adjustment factor=(1-2)

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Thus ,the regression results forms the basis of testing the applicability of Lintner model which is a finance classic in each of the sectors.

4.2.2. FACTOR ANALYSIS

To know the key determinants of corporate dividend payout ratios for Indian Information Technology, FMCG and Service sectors factor analysis is used. On the basis of literature review, the following key variables have been identified that influence the dividend payout ratio of the firm.

Y= Equity dividend (in crores),X1=PAT (in Rs crore),X2=Lagged dividend (Rs. crore),X3=Current ratio of firm i during periodt, X4=Debt equity ratio of firm i during periodt,X5= Quick ratio of firm i during periodt,X6= Annual sales growth of firm i during periodt,X7= Natural log National Stock Exchange adjusted average closing stock prices of the firm i during period t, X8= Cashflows of firm i during period t,X9= Retained profits of the firm i during periodt,X10= Capital expenditure or Gross fixed assets (t-(t-1)),X11= Nifty beta of firm i during periodt,X12=Market capitalisation of firm i during period t,X13=Price earning ratio of firm i during period t,X14=Price to book value ratio of firm i during periodt,X15= Promoter holding of firm i during periodt,X16= Natural Log of Total assets of firm i during periodt,X17= Interest coverage ratio of firm i during periodt,X18= RONW of the firm i during period t, X19= ROE of firm i during period t,X20=Lagged PAT (in Rs crore), X21= Standard deviation of earnings per share
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The statistical techniques of Principal Component Factor analysis and regression analysis were used to explore the relationship between these variables. Since the variables identified as per the available literature were not on same scale. Therefore all the variables were standardised and converted to same scale. The final analysis was carried by reckoning the following key variables.

Y= dividend payout ratio X1=PAT to assets ratio4 X2=Lagged dividend ratio X3=Current ratio of firm i during periodt X4=Debt equity ratio of firm i during periodt X5= Quick ratio of firm i during periodt X6= Annual sales growth of firm i during periodt5 X7= Natural log National Stock Exchange adjusted average closing stock prices of the firm i during period t X8= Cashflows ratio of firm i during period t 6

In FMCG and Service sector respectively PAT has been expressed as % of total assets. At the same time

to obtain better results total assets was substituted by gross fixed assets in IT sector
5

In case of constituent companies of CNX Service sector the annual sales growth was replaced with growth

in revenue as majority of the constituents of this Index are banks where sales growth figure is not available
6

In case IT and FMCG sector cashflows have been expressed as a percentage of Netsales.However, in case

of Service sector cashflows ratio has been computed by expressing cashflow as a% of PBIT 63

X9= Retained ratio of the firm i during periodt X10= Capital expenditure or Gross fixed assets (t-(t-1)) to fixed asset ratio X11= Nifty beta of firm i during periodt X12=Natural log of Market capitalisation of firm i during period t X13=Price earning ratio of firm i during period t X14=Price to book value ratio of firm i during period t X15= Promoter holding of firm i during period t X16= Log of Total assets of firm i during period t X17= Interest coverage ratio of firm i during period t X18= RONW of the firm i during period t X19= ROE of firm i during period t X20=Lagged PAT to lagged assets ratio (in Rs crore)7 X21= Standard deviation of earning per share

A two step multivariate procedure is employed where the data are first subjected to a factor analysis and then multiple regression is performed on extracted factors. 8 In the first step, a set of dimensions (unobservable attributes) were measured by relating them to observable proxy variables using factor analysis.[13] In the second step, the relationship between equity dividend and dimensions obtained from first step was estimated using regression analysis. The equity dividend payout ratio (Y) is the dependent variable and other variables

(X1,X2,X3,X4,X5,X6,X7,X8,X9,X10,X11,X12,X13,X 14,X15,X16,X17,X18,X19,X20,X21,X22) 64

are

taken as independent variables.

The first model can be expressed as X=BT+ E (7) Where X is a matrix of independent variables, T is a vector of unobservable factors; B is the vector of error terms. The regression model for second step is shown in equation (8)

DPR = 0 + i=1 to n i i + .(8) Where, i represents factor i , i its regression coefficient , 0 is the intercept , and is the error term. The Scree plot method has also been used.

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4.2.3 DATA

QUADRATIC POLYNOMIAL REGRESSION ANALYSIS USING PANEL

The results in IT sector are reported by expressing lagged PAT as a% of gross fixed assets. Dillion and Golstein ,1984) Alli L. Kasin, Khan Qayyum,Ramirez G. Gabriel , Determinants of Corporate

Dividend Policy : A factorial Analysis, The Financial Review , Vol.28No.4 , November 1993

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Apart from the above determinants of corporate dividend policy, influence of ownership groups on dividend payout has also been reported by the previous studies. The key ownership variables that can affect Dividend Payout (DP ratio) are as follows: Promoter holding (Percentage of equity shares held by promoters i.e. persons in overall control of the company) Institutional holding (Aggregate percentage of equity shares held by Insurance companies, Mutual funds, Financial Institutions, banks, Venture capital funds). Foreign institutional investment (Percentage of equity shares held by companies registered in country other than the country in which they are currently investing) Corporate holding(Percentage of equity shares held by corporate bodies.) Debt equity ratio (Ratio of total debt to equity capital, measure of leverage. It is used to address debt holders and shareholders conflicts)

The basic reason of using a quadratic polynomial regression is that the relationship is supposed to have only one knot i.e. increasing effect up to the threshold and decreasing thereafter or vice versa. Previous studies have hypothesised that the ownership control would have non-linear relationship i.e. positive up to a threshold level and negative thereafter due to shift in priorities and benefits to owners.

For the analysis the square of the variables namely, (promoters)2 ; (institutional)2 , (foreign)2 and (corporate)2 to examine the presence of non-linearity in ownership effect after a certain threshold has been included. The squared percentages have been taken in the model to test for the hypothesized parabolic relation between dividend payout and
67

ownership groups. A negative coefficient for ownership variables and a positive coefficient for squared ownership variables support the postulated relation. Equation 9 and 10 shows the model developed for analysing the third research objective. The technique of quadratic polynomial regression analysis has been used for data analysis.

LINEAR MODEL: Dividend payoutit=i+1X1it+2X2it+3X3it+4X4it+5X5it+uit+it+it (9)

Y= Dividend payout ratio of firm iduring time period t X1it= Promoter holding of firm iduring time period t X2it= Institutional holding of the firm iduring time period t X3it= Corporate holding of the firm iduring time period t X4it= Foreign institutional holding of the firm iduring time period t X5it= Debt Equity ratio of firm iduring time period t

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QUADRATIC POLYNOMIAL MODEL

Dividend payout

it

= i + 1 X1it + 2 X2it + 3 X3it + 4 X4it + 5 X5it + 6it X6it + 7 X7it

+8X8it+9X9it+uit+it+it(10) Where , uit = firm specific components, it = time specific components , it = disturbance term

69

Y= dividend payout ratio of firm iduring time period t X1it= Promoter holding of firm iduring time period t X2it= Institutional holding of the firm iduring time period t X3it= Corporate holding of the firm iduring time period t X4it= Foreign institutional holding of the firm iduring time period t X5it= Debt Equity ratio of firm iduring time period t X6it =Square of promoter holding of firm iduring time period t X7it = Square of Institutional holding of the firm iduring time period t X8it = Square of Corporate holding of the firm iduring time period t X9it = Square of foreign institutional holding of the firm iduring time period t

If the coefficients are assumed to be fixed then the coefficients are estimated by dummy variable models. This estimation approach is known as fixed effect approach which yields consistent estimates regardless of correlation between firm specific error component and regressors. If the dummy variables are taken for the firms only then the model is called one way fixed effect model, and if taken both for firm and time then the model is known as Two way fixed effect model [37]

The results were obtained by estimating the above mentioned static panel models, F test (Moulto and Randolph, 1989), Langrange Multiplier (LM) test (Breusch and Pagan ,1980) ,and Hausman specification test (Hausman ,1978).It was necessary to carry out these tests to know the significance of the firm and time effects in the data sets, and to find out a appropriate panel data method for estimation of the model.
70

The Lagrange Multiplier (LM) test shows the acceptability of panel data models over classical regression models. Langrange Multiplier test statistics indicate that either the fixed effect firm and firm and models or the random effect firm and firm and time models are to preferred to Classical Linear Regression model. [36]High values of Hausman statistics indicate the use of fixed effect models over Random Effect models and the low value of Hausman statistics induces to use the Random effect models. The F test and Likelihood Ratio(LR)test results show that both the firm and time effects are present in the data.

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4.2.4. EVENT STUDY

To analyse the impact of dividend announcements on shareholders' wealth in the selected sectors in India Event study9 approach has been used. The following steps were followed to perform event study. The first step was to find out the dividend announcement dates in each of the sector respectively from 2001 to 2008.Consequently 168 dividend announcements dates were obtained in IT sector and 199 and 202 dates in the FMCG and service sector respectively. Estimation window of 150 days was chosen based on literature survey.

This section has been taken from A beginners guide to event studiesby William H. Wells

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 The event window of 20 days before the event and 20 days after the event i.e. 41 days has been taken For calculating expected returns as per Market model daily adjusted closing prices were taken Cumulative abnormal returns were calculated with the help of average abnormal returns to see the reaction over a period of time Finally, t statistics were calculated to cross sectionally by using standard deviation of abnormal returns. To estimate the stock price response to dividend announcements, Returns (Rit) which is the time t return on security i were calculated as (Pit Pit-1)/Pit-1 where Pit is the adjusted closing price of the stock ion day t .Pit-1 is the adjusted closing price of stock i on day t-1

Rit = (Pit Pit-1)/Pit-1 (11) Similarly returns on Market Index were calculated using the following formulae: Rmt =(It It-1)/It-1 (12) Then, abnormal returns were calculated for each of the days in the event window according to the equation:

ARit = Rit E (Ri,t) , t=(-20,-1920),..(13)

The expected return is estimated by employing the market model[11]. The market model parameters were estimated prior to the event window. In the present study an estimation
73

window of 150days have been used. E(Rit) = a + bi Rm,t+ei,t...(14)

Where, Rm,t is the return on the market portfolio on day t proxied by specific sector indices10 , ei,t is the random error term and ai and bi are the market model parameters.

The abnormal returns may be positive or negative as per the response of investors to the occurrence of event (In this case dividend announcement). For this one has to apply as many regressions as the numbers of dividend announcement dates are.

The ARs are then averaged across the sample of firms according to the formula: AARs =Avg(ARt) = (1/N) ARit .(15) Where, N is the number of sample observations.

10

Note that CNX IT index has been taken as proxy for market index in IT sector while in FMC G and

Service sector, the proxies used are BSE FMCG and NIFTY 50 repectively.BSE FMCG and NIFTY 50 Index have been taken because the values of CNX FMCG and CNX Service sector are not reported by NSE.

74

Thus, the abnormal returns were averaged by dividing it by the number of days to find out daily average abnormal returns. The process was repeated for all the dates and finally average cumulative abnormal returns were obtained. This is the second measure (CAR), it measures the investors total return over a period starting from before the announcement of dividend to after the dividend announcement day. The cumulative abnormal returns from day t1 through t2 ,CARt , are :[39]

CAARt = Avg (ARt) where t = t1 to t2 ..(16)

CAAR may be positive or negative. If CAAR is negative in periods after dividend announcements, this suggests dividend announcements do not carry information about future earnings and cash flows of the companies. A positive CAR indicates distribution of dividend adds to shareholders value by conveying good news to the market. We use a 41 day event window period starting from 20 to

+20 day relative to the dividend announcement day (0 day) .For the purpose of analysis both interim and final dividend announcements has been taken. To compute the t-statistic, first, all abnormal returns are standardized as: SAR it= ARit / Si (AR)(17)

where ,Si (AR) is the standard deviation of the abnormal returns of stock i in the estimation period. The t-statistic for the sample of N observations for each day t in the event window is calculated as:

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t(SAR) = (i=1 to N SAR it) .1/N (18)

5 ANALYSIS AND FINDINGS11

5.1. LINTNER MODEL IN IT SECTOR

The regression results (refer to Annexure 2) of one way Fixed effect model shows that divided paid during previous year is significant at 5% level of significance. The Adjusted R square is 80%.F statistics is significant at 5% level of significance showing overall validity of the model.The results highlight that there is Low dividend smoothing in this sector as it is characterized by high target payout ratio and high speed of adjustment coefficient.

5.2. LINTNER MODEL IN FMCG SECTOR

The regression results (refer to Annexure 2) show that PAT and dividend paid during previous year are significant at 5% level of significance. The value of Adjusted R square is 95%. The F statistics are also significant at 95% confidence interval showing the overall validity of the model in the FMCG sector. Target payout is high but speed of adjustment factor is between the range suggested by Lintner(1956).Therefore, it can be said that in this sector dividend signaling and smoothing effects are present.

11

It may be noted that LM test results show that Classical linear regression model could also be used 76

5.3 LINTNER MODEL IN SERVICE SECTOR

Dividend paid during the previous year and PAT both (refer to Annexure 2) are found to be significant at 5% level of significance. The value of adjusted R Square is 76.18% The overall validity of the model has been found out with the help of F statistics. The findings show very high target payout ratio of 315% combined with high adjustment coefficient of .5278265 indicates absence of dividend signaling and smoothing effects.

6. FACTOR ANALYSIS AND REGRESSION RESULTS ON EXTRACTED FACTORS

6.1. ANALYSIS OF IT SECTOR

Table 2.1. (refer to Annexure 3) shows Kaiser-Meyer-Olkin Measure of Sampling Adequacy values .It is measure that judges the sampling adequacy. The value obtained is .560 which ensures the sample size is adequate to apply Factor Analysis.

6.1.1 FACTOR EXTRACTION

Principal Component Analysis method was used to extract the factors. The Table 2.2 (refer to annexure 3) shows the factor pattern matrix, which highlights variance exhibited by extracted factors Generally, the identification of the factors is determined by the factor
77

loadings, and the relationship of the factor with the variable is based on the signs of factor loadings. A factor loading is simply the correlation of an original variable with factor. As suggested by Dillion and Goldstein, variables with factor loadings greater than absolute value of 0.30 or more are considered significant and, thus, used in labelling of factors. As shown in the factor pattern matrix a set of 8 factors have been been extracted. These factors have been labelled as Factor of dividend signaling and promoter holding, Factor of liquidity ratios, Factor of longterm solvency, Factor of financial and systematic risk, Factor of firm size, Factor of retained earnings and dividend stability, Factor of growth and expansion and Factor of valuation and capital market ratios.

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FIGURE 1: SCREE PLOT

Scree Plot
5

alue E igenv

0 1 3 5 7 9 11 13 15 17 19 21

Component Number

An elbow in the scree plot indicates the point at which the inclusion of additional factors does not contribute significantly in explaining the variance in data set. Factors above the elbow of the plot are retained. The Scree plot shown above has an elbow at Factor 8.Therefore a set of 8 Factors were chosen which accounts for about 77% of the variations in the data.

6.1.2

REGRESSION RESULTS ON EXTRACTED FACTORS

The Table 2.3(refer annexure 3) shows the regression results on extracted factors. Factors 3, 4,5,6 and 8 have expected signs. Out of these factors only two factors i.e. Factor 6 and 8 have regression coefficients, which are statistically significant at 5% level of significance. Both factor 1 and 2 have exactly opposite signs of regression coefficients compared to
79

what was expected based on previous research studies. The value of Adjusted R2 is 0.757 The F values are also significant at 5% level of significance.

6.1.3. FINDINGS

A set of 8 factors has been extracted through the technique of Principal Component analysis. The regression results show that Factor of dividend signaling and ownership, liquidity ratios are significantly negatively related with DP ratio. Also a positive significant relationship exists between RE earnings and DP ratio. This shows that in IT sector capital gains are preferred are cash dividends. The information environment is highly symmetrical. Therefore, cash dividends are not used to signal their profitability to shareholders.

6.2 ANALYSIS OF FMCG SECTOR

The first step was to calculate KMO. The value obtained is .690 which ensures the sample size is ample to apply Factor Analysis (refer to Table 2.4 in annexure 3 for test values)

6.2.1

FACTOR EXTRACTION

The Table 2.5 in annexure 3 shows the factor pattern matrix, which highlights variance exhibited by extracted factors. It also depicts the loadings of each variable on a given factor. The extracted factors has been labelled as Factor of Dividend signalling and
80

smoothing, Factor of cash flow quality and firm size, Factor of future expansion and growth, Factor of ownership and liquidity, Factor of earning variability and systematic risk, Factor of longterm solvency and financial leverage.

FIGURE 2: SCREE PLOT

Scree Plot

Eigenvalue

As discussed, Factors above the elbow of the plot are retained. The Scree plot shown above has an elbow at Factor 6.Therefore a set of 6 Factors were chosen which accounts for about 76% of the variations in the data.

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6.2.2 REGRESSION RESULTS OF EXTRACTED FACTORS

Table 2.6 (refer to annexure 3) shows Factors 1,2,3 and 6 have expected signs. Out of these factors only one factor i.e. Factor 2 has regression coefficient, which is statistically insignificant at 5% level of significance. Factor 4 and 5 have exactly opposite signs of regression coefficients compared to what was expected based on previous research studies. The value of Adjusted R2 is 0.632. F statistics are significant at 5% level of significance.

6.2.3 FINDINGS

Out of six extracted factors 5 were found to be significantly related to DP ratio.A Positive and significant relationship between factor of systematic risk, Dividend signaling and smoothing,Longterm solvency and financial leverage. Negative and significant relationship has been found between Factor of liquidity and ownership and Factor of growth and expansion. This implies that if the systematic risk increases these firms increase their dividend payout. The agency conflicts are not so grave since FMCG firms operate with low levels of debt. Higher the growth opportunities available to a firm lower will be the dividend payout ratio in the FMCG sector.

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6.3. ANALYSIS OF SERVICE SECTOR

As done in the other sectors the first step was to calculate KMO. It is a measure that judges the sampling adequacy. The value obtained is .506 which ensures the sample size is sufficient to apply Factor Analysis.(refer to table 2.7 in annexure 3) Bartlett test of spherecity is the statistical test for overall significance of all correlations with in a correlation matrix. It also judges the appropriateness of factor analysis.

6.3.1 FACTOR EXTRACTION

The table 2.8(refer to annexure 3) shows the variance exhibited by extracted factors. It shows that the first factor accounts for highest amount of variance, the second factor accounts for second highest and so on.The principal components analysis using varimax rotation method of correlation matrix of the 22 variables have led to the extraction of seven broad components of dividend policy of the corporate India. These factors accounted for 20%,12%,10%,10%,7%,7% and 5% of the total variance explained, respectively. Accordingly, these factors have been labeled as Factor of dividend signaling and profitability, Factor of liquidity ratios and systematic risk, Factor of firm size, Factor of agency conflicts and ownership, Factor of cash flow quality and dividend stability, Factor of growth and expansion and Factor of longterm solvency.

FIGURE 3: SCREE PLOT

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Scree Plot

Eigenvalue

10 11 12 13 14 15 16 17 18 19 20 21

Component Number

An elbow in the scree plot indicates the point at which the inclusion of additional factors does not contribute significantly in explaining the variance in data set. Factors above the elbow of the plot are taken. The procedure involves certain amount of subjectivity, if no clear elbow appears in the curve. The Scree plot shown below shows a clear elbow at Factor 7. These seven factors account for about 72% of the variations in the data. Consequently these seven Factors are retained in the analysis

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6.3.2 REGRESSION RESULTS OF EXTRACTED FACTORS

The regression results are highlighted in the Table 2.9(refer to the annexure 3). Out of 7 factors 6 factors have statistically significant regression coefficients. Only one Factor i.e.Factor of dividend signaling and profitability has statistically insignificant regression coefficient at 5% significance level. Factor 3 and 5 have exactly opposite signs as established by previous research studies. The value of Adjusted R2 is .657 which indicates that these factor combined together explain 66% of the dividend payout pattern of Indian Service sector. The F values are also found to be significant at 5% level of significance.

6.3.3 FINDINGS

A set of 6 factors out of 7 are found to be significantly related to DP ratio. This shows that capital gains are preferred to cash dividends. The regression results have indicated a negative and significant relationship between DP ratio and Factor of liquidity, firm size, growth & expansion. However, the Factor of long-term solvency is significantly positively related. Thus It can be said, Smaller firms tend to pay more dividends in order to allure shareholders and compensate them for risk involved [24]. Firms in Service sector prefer to retain funds whenever any future investment opportunity is foreseen for further
85

growth and expansion.

7. QUADRATIC POLYNOMIAL REGRESSION ANALYSIS AND FINDINGS

7.1 ANALYSIS OF IT SECTOR

Tables 3.1 and 3.2(refer to annexure 4) show the hypothesis testing results of the different models. Table3.1 show that the null hypothesis H01 ; 2 = 0 and H02 ; 2= 2 =0 are rejected. The F- test results show that both firm and time effects are present in the data.Langrange Multiplier test statistics presented in the Table 3.2 indicate that either the fixed effect firm and firm and time models or the random effects firm and firm and time models are to be preferred to Classical Linear regression model.Hausman specification test results presented in this Table3.2 conclude to prefer random effect model to fixed effect model. But we restrict our interpretation to fixed effect firm and time models (two way).

Table 3.3(refer to annexure 4) depicts the results from Fixed effect firm Model estimation assuming non-monotonic relationship between regressors and regressand. Table 3.4(refer to annexure 4) shows regression results of Fixed effect two way model. Model represented in Table 3.4 assumes linear relationship between DP ratio and ownership variables. and Table 3.5(refer to annexure 4) depicts the Fixed Effect firm and time effects results of quadratic polynomial model.

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In Model I none of the variable is found to be significant at 5% and 10% respectively. F statistics also show that this model does not fit well in IT sector in India. In Model II only debt equity and time effects are found to be significant. The regression coefficient of debt equity ratio is positive at 10% level of significance. This implies that conflicts of interest do not exist between debt holders and shareholders and they do not consider dividend payment a way to expropriate their value.

A panel data quadratic polynomial regression analysis increased the value of Adjusted R square to 31% from 18% in Model III. However none of the regression coefficient is significant at 5% level of significance. The regression coefficients of Institutional holding are 81.30 in level and 2.434747 in square. These coefficients are significant for

confidence interval of 90%.This implies a non monotonic (inverted U shaped) relationship between Institutional holding and dividend payout of IT firms in India. For 10% level of significance the regression coefficient of debt equity ratio is also found to be positive and significant. The F values are also significant at 5% level of significance (refer to annexure 4)

Thus the results show that relationship between institutional ownership and dividends is non-linear. When institutional ownership is low, an increase in ownership percentage tends to reduce agency costs. At the margin, as agency costs falls, cash dividends become less desirable as a tool for further reducing agency costs, and thus dividends tend to decrease. At, high levels of institutional ownership agency costs tend to rise with further increases in ownership percentage and the increased scrutiny placed on the firm by higher dividends
87

become necessary .Thus ,dividends are expected to decrease over range of Institutional ownership, and increase after the point of entrenchment indicating a parabolic relation.

7.2 ANALYSIS OF FMCG SECTOR

The technique of panel fixed effect firm and time model has been applied for analysis. F Test results indicate the presence of firm and time effects. Table 3.9(refer to annexure 4) depicts the results from Fixed effect firm Model estimation assuming an inverted U shaped relationship between regressors and regressand. Table 3.9 shows regression results of FE firm and time estimations assuming linear relationship between DP ratio and ownership variables and Table 3.10 depicts the Fixed Effect firm and time effects results of quadratic polynomial model.Hausman Test shows random effect model should be preferred to fixed effect firm and time model. Therefore Table 3.11 reports One-way random group effect model using Generalised Least square Model.

The FGLS estimates show that corporate holding is only the significant ownership determinant of DP ratio. A significant negative relationship has been observed between corporate holding and dividend payout ratio. The results of Model I shows promoter holding have a positive relationship with dividend payout in level and negative in square. This implies at lower level of promoter holding, Dividend payments are high but gradually as their holding increases they prefer lesser dividend distribution. Finally according to the results of Model III corporate holding has negative significant relationship with DP ratio in level and promoter holding has negative statistically significant relationship with Dividend

88

payout in square. However we do not consider the results of Model III in data interpretation as Hausman test suggests use of Random effect Model over this model. Thus, it can be stated there is no significant influence of ownership pattern on dividend payout ratio in the FMCG sector.

7.3 ANALYSIS OF SERVICE SECTOR

Table3.14 (refer to annexure 4) depicts the results from Fixed effect firm Model estimation assuming non-monotonic relationship between regressors and regressand. Table3.15 potrays regression results of Fixed effect two-way model assuming linear relationship between dependent and independent variables. Table 3.16 depicts the FE firm and time effects results of quadratic polynomial regression model. Hausman test results show that Fixed effect firm and time model is preferred to random effect model. Model I (Table 3.14) and II (Table 3.15) do not fit well as F values are not significant. Also the results presented in these two models are corroborated by the results of Fixed effect firm and time model estimations. The results of Model III (Table 3.1) show FII negative relationship in level. None of the other ownership variable is significant at 5% and 10% level of significance. Thus , it can be said that in Service sector Linear relationship holds well.FII holding , corporate holding and promoter holding are inversely related to DP ratio

8. EVENT STUDY: ANALYSIS AND FINDINGS

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8.1 IT SECTOR

FIGURE 4.:Average abnormal and CAARs of 20 IT companies over a window period starting from day 20 to day +20 relative to dividend announcement day (0- day)

-5 CAARs/AARs

-10

AARs CAARs

-15

-20

-25

-30

EVENT WINDOW

The results show that abnormal returns are negative during the entire window period except for the dividend announcement day. Though small positive abnormal returns are generated on dividend announcement but they are not statistically significant at 10 %. This shows that dividend announcements do not contain signaling effect in this sector. Other reason may be that investors prefer other modes of dividend distribution to cash dividends.
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8.2. EVENT STUDY OF FMCG SECTOR

FIGURE 5 : AARs and CAARs of 15 FMCG companies over a window period starting from day 20 to day +20 relative to dividend announcement day (0- day)

30

20

10 CAARs/AARs

-19

-17

-15

-13

-11

11

13

15

17

19

21

-9

-7

-5

-3

-1

AARs CAARs

-10

-20

-30

-40

EVENT WINDOW

Huge abnormal returns are created 3 days post dividend announcement and sustained till 18th day(refer annexure 5) in the event window with minor fluctuations. Positive Abnormal returns are also witnessed 3 days before dividend announcements.
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8.3 EVENT STUDY OF SERVICE SECTOR

FIGURE 6 :AARs and CAARs of Service companies over a window period starting from day 20 to day +20 relative to dividend announcement day (0- day)

CAARs/AARs (%)

CAARs AND AARs

0.5

0 AARs CAARs -0.5

-1

-1.5

EVENT WINDOW

Abnormal returns are generated prior to dividend announcements but are not sustained as CAARs start falling. Positive abnormal returns occur from 7th till 92 2nd day pre dividend

announcement as shown in Table4.3(results appended to Annexure5)

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Presentation and Analysis of Data

This is an analytical chapter, where an attempt has been made to analyze and evaluate the data collected. To analyze the data collected various presentation and interpretation is done in order to fulfill the objective of this study.

4.1 No. of Cash Dividend Paying Listed Companies

Table No. 4.1 No. of Cash Dividend Paying Listed Companies Total Listed Companies Cash Dividend Paying Companies 114 32 125 26 135 37 135 39 142 41 Source: Annual Report of SEBON

F/Y 2003/04 2004/05 2005/06 2006/07 2007/08

Ratio 28.07% 20.80% 27.41% 28.89% 28.87%

Cash Dividend (In Rs.)

140 120 100 80 60 40 20 0

2003/04 2004/05 2005/06 2006/07 2007/08

Fiscal Year Total Listed Companies Cash Dividend Paying Listed Companies

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Figure No. 4.1 No. of Cash Dividend Paying Listed Companies

The number of Nepalese listed companies that paying cash dividend is seen fluctuating. About 28% of the total listed companies distributed cash dividend

during the fiscal year 2003/04. But it decreases to 20.80% in the fiscal year 2004/05. Thereafter the increase has been seen to the fiscal year 2007/08. Among the cash dividend paying total financial institutions majority are from the banking sectors or finance companies. Very few numbers of financial institutions are from development banks, manufacturing and processing companies and hydropower company. From the correlation calculation we came to conclusion that there is very low degree of positive correlation between the total no. of listed companies and the no. of cash dividend paying listed companies. Though, the general public is highly attracted towards the shares of the commercial banks of the country as they are performing well in the secondary market. Similarly they are providing the stock dividend to the shareholders. But the financial performance of other institutions is not so good. Even majority of the commercial banks are also not providing good percentage of the cash dividend to their shareholders. Note: For detail calculation see Annex-I

4.2 Cash Dividend Payment of Sector-wise Financial Institutions

4.2.1 Cash Dividend Payment of Commercial Banks
Table No.4.2 Cash Dividend Payment of Commercial Banks (In NPR) EBL NABIL NIBL SCBNL HBL SBI 20 50 20 110 1.32 8 20 65 15 110 CDND CDND 20 70 12.58 120 11.5 CDND 25 85 20 130 30 5
95

F/Y 2003/04 2004/05 2005/06 2006/07

DCBL 10 10 12 12

2007/08 A.M. S.D. C.V.

10 19 4.90 25.78%

100 5 80 15 74 14.52 110 11.56 17.15 5.56 16.73 10.86 23.17% 38.29% 15.21% 93.94% Source: Annual Report of SEBON

10 4.60 4.08 88.69%

12 11.20 0.98 8.75%

140 120
Cash Dividend (In Rs.)

100 80 60 40 20 0 2003/04
EBL NABIL

2004/05
NIBL

2005/06
Fiscal Year

2006/07
HBL SBI DCBL

2007/08

SCBNL

Figure No. 4.2 Cash Dividend Payment of Commercial Banks

Large amount of cash dividend paying A class commercial banks of the sample are seen SCBNL. The average payment of cash dividend by SCBNL is Rs.110 per share. In other word it paid average 110% cash dividend in average to its shareholders. The least average percent was of SBI with only 4.60% cash dividend. Being an A class financial institution SBI has not been able to declare cash dividend to its shareholders. The amount it has declared also is also not seen so satisfactory from the record than the other commercial banks. The situation of the NABIL bank is also seen well. It has also been distributing cash dividend regularly. The average cash dividend payment is seen 74% i.e. Rs. 74 per share.

96

HBL payment of cash dividend has been seen fluctuating. The amounts it has paid as a cash dividend is minor with average of Rs.11.56. The C.V of the DCBL is the least among the sample commercial banks with 8.75%, show the cash dividend payment of the bank is most consistent than other commercial banks. The most inconsistent in paying cash dividend is HBL with C.V. 93.94%. The situation of SBI is also not good, its C.V, is also seen high.

4.2.2 Cash Dividend Payment of Development Banks

Table No.4.3 Cash Dividend Payment of Development Banks (In NPR) F/Y SBBL NUBL CBBL SBB 2003/04 CDND CDND CDND CDND 2004/05 CDND CDND CDND CDND 2005/06 CDND 4 10 CDND 2006/07 CDND 5 30 CDND 2007/08 CDND CDND CDND 3.50 1.8 8.00 A.M. 0.70 2.23 11.66 S.D. 1.40 C.V. 123.89 145.75 200% Source: Annual Report of SEBON

97

35 30
Cash Dividend (In Rs.)

25 20 15 10 5 0 2003/04 2004/05 2005/06

Fiscal Year

2006/07

2007/08

SBBL

NUBL

CBBL

SBB

Figure No. 4.3 Cash Dividend Payment of Development Banks Being categorized as an A class development banks, the situation of cash dividend payment of the bank is not seen good. Only NUBL and CBBL have been seen paying the cash dividend in fiscal year 2005/06 and 2006/07 with average of Rs. 1.80 and Rs. 8 per share respectively. Other development banks have not seen paying cash dividend since past five years.

4.2.3 Cash Dividend Payment of Insurance Company

Table No.4.4 Cash Dividend Payment of Insurance Companies (In NPR) F/Y UIC NLIC HGI EIC 2003/04 CDND CDND CDND CDND 2004/05 CDND CDND CDND CDND 2005/06 CDND CDND CDND CDND 2006/07 CDND CDND CDND CDND 2007/08 CDND CDND CDND CDND A.M. S.D. C.V. Source: Annual Report of SEBON
98

The cash dividend situations of the Insurance Companies are not good in record. None of the Insurance Companies listed as A class financial institutions have declared cash dividend since past five fiscal year.

4.2.4 Cash Dividend Payment of Finance Company

Table No.4.5 Cash Dividend Payment of Finance Companies (In NPR) F/Y AFC EFL BFL 2003/04 12 CDND CDND 2004/05 2.632 CDND CDND 2005/06 3.158 CDND CDND 2006/07 0.53 CDND CDND 2007/08 1.05 CDND 0.50 A.M. 3.87 0.10 S.D. 4.18 0.2 C.V. 108.01% 200% Source: Annual Report of SEBON

14 12
Cash Dividend (In Rs.)

10 8 6 4 2 0 2003/04 2004/05
AFC

2005/06
Fiscal Year

2006/07

2007/08

EFL

BFL

Figure No. 4.4 Cash Dividend Payment of Insurance Company

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There is large no. of finance companies operating in Nepal. But most of them are not able to operate in an efficient ways. Their financial position is not so sound to be categorized as an A class financial institution. They are not been able to pay cash dividend to their shareholders. AFC has been paying cash dividend with average of Rs. 3.87 per share in last five fiscal year. BFL has been paid Rs. 0.50 per share cash dividend in the fiscal year 2007/08.

10 0

4.2.5 Cash Dividend Payment of Manufacturing and Processing Company

Table No.4.6 Cash Dividend Payment of Manufacturing and Processing Companies (In NPR) F/Y ULN BNL BNL(Balaju) BNL(Terai) 2003/04 90 5 10 2004/05 100 CDND 5 2005/06 400 CDND CDND 2006/07 250 CDND CDND 2007/08 275 CDND CDND A.M. 223 1 3 S.D. 116.26 2 4 C.V. 52.13% 200% 133.33% Source: Annual Report of SEBON

10 1

450 400
Cash Dividend (In Rs.)

350 300 250 200 150 100 50 0 2003/04 2004/05

ULN

2005/06
Fiscal Year

2006/07
BNL (Terai)

2007/08

BNL (Balaju)

Figure No. 4.5 Cash Dividend Payment of Manufacturing and Processing Companies

Under manufacturing and processing companies, only one company has been included under the A class financial institution i.e. ULN. The company has been paying the cash dividend regularly in the past five fiscal year. Similarly, the amount of the cash dividend is seen increasing to fiscal year 2005/06 and it has been decreased to Rs. 250 per share and have been slight increase of Rs. 25 per share in fiscal year 2007/08. BNL is not included under the A class financial institution but we have taken as a sample from the manufacturing and processing companies for study. It has not been able to distribute cash dividend with good amount being one of the renowned multinational soft drink company. BNL (Terai) has paid cash dividend of Rs. 10 and Rs. 5 in the early fiscal years. The C.V. of BNL (Terai) is lesser than that of BNL (Balaju).

10 2

4.2.6 Cash Dividend Payment of Other Company

Table No.4.7 Cash Dividend Payment of Other Company (In NPR) 2003/04 2004/05 2005/06 2006/07 CDND CDND CDND 35 A.M. S.D. C.V. Source: Annual Report of SEBON

F/Y CHPCL

2007/08 30 13 16 123.08%

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9. CONCLUSION

This study has tested empirically the agency cost theory, Lintner model, dividend signaling and smoothing effects using a framework of various econometric models.

Out of the chosen sectors Lintner model fits well in the FMCG sector signifying dividend signaling and smoothing effects are present in this sector. Thus these firms follow stable dividend payments year on year basis, even though earnings might change dramatically. The findings in the FMCG sector are in alignment with Brave et.al that mangers are very reluctant to cut dividends once they are initiated. This reluctance leads to dividends that are sticky, smoothed from year to year and tied to long run profitability of the firm However IT sector and service sector demonstrate a pattern, which is seen in emerging economies like Tunisia, Zimbabwe and Turkey. These sectors are characterized by high target payouts coupled with high speed of adjustment coefficient.

Through the analysis of second objective it was found that there are sectoral differences in corporate dividend policy determinants. The results are consistent with conclusion of Baker, Farrelly, and Edelman (1985) and Ho Horace (2002) that firms industry type influence dividend policy. A factor which may be relevant for one industry becomes irrelevant for another depending upon the Industry characteristics like growth phase, ownership pattern, size, systematic risk and earnings variability.

FMCG companies score high on dividend stability and consistency as Lagged dividend and PAT are important factors governing dividend distribution. The quality of cash flows, which is measure of liquidity of the firm and10 firm size are found be inconsequential in
4

determining the dividend payout. The opportunities for future growth and expansion are found to be negatively related to dividend payout ratio. Larger is the growth and investment opportunities available to the firm, lesser is the incentive to pay dividends by retaining larger proportion of profits. The regression results also disclose negative and significant relationship with Retained earnings and Capital Expenditure during the current year which is in conformity with the existing literature. A company which prefers retention of profits for financing the capital expenditure from internal resources distributes fewer dividends compared to a firm which finances the investment expenditure from external sources. Also larger the retention of profits by a company lesser is the dividend distributed. (Pecking order hypothesis) Thus, the extent to which the company decides to finance CAPEX from retained earnings; both retained earnings and CAPEX would be negatively related to dividend payments. The results establish a negative relationship between liquidity and Dividend payout ratio and promoter holding. Though systematic risk and earning variability obstruct the stable dividend payout but the results report that Dividend Payout ratio is positively related to risk. Dividend Payout ratio is found to be significantly positively related to longterm solvency of the firm. The firms in FMCG sector operate with very low level of debt. These firms are highly liquid firms, any increase in debt proportion in capital structure do not put pressure on firms capacity to pay dividend. A positive and significant relation has been obtained between Debt Equity ratio and Dividend Payout ratio through the results, which is consistent with Easterbrook

10 5

analysis. This positive relation can also be attributed to the fact that Firms in FMCG sector use dividends as a source to allay conflicts that may arise between bondholders and shareholders with increase in Debt equity ratio

It has been noted that IT sector score high on the dividend stability. The dividend paid during previous year is an important governing factor. Firms in IT sector do not use dividends as a medium to signal their prosperity to the shareholders. This also reflects that there is lesser information asymmetry in this sector. IT sector is a human intensive sector and do not require huge capital asset base like manufacturing companies for their operations. The major asset of this sector is manpower. The funds required for recruitment and retention of manpower is comparatively less than funds required for purchasing capital assets. So these firms can easily release funds for payment of dividends. Also a negative relationship between profitability can be attributed to the fact that agency problems are not very relevant and thus Dividend payout as a monitoring mechanism may be less needed. The results demonstrate that Promoters holding in this sector also negatively influence the Dividend Payout ratio.

A negative regression coefficient of Factor of liquidity ratio and Dividend Payout ratio can be attributed to the fact that in IT sector capital gains are preferred to cash dividends. Higher debts equity ratio and changeability in the earnings per share may negatively influence the dividend payout of company. But in case of IT firms which are very low debt or zero debt companies eg. Infosys is a zero debt company, these variables may not be an important determinant of dividend payout. Therefore, Factor of financial and
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systematic risk has not emerged as an imperative factor affecting the dividend payout ratios of firms in IT sector.

The results signify that Service companies do not score high on dividend stability. Profitability is not a primary determinant of dividend payout though it is positively associated with Dividend payout ratio. Firms in service sector do not use cash dividends to signal their prosperity to the shareholders. The results are in contrast to the previous studies on banking industry, which state that banks use their dividend history to set their dividend. These results were established by Dickens N.Ross and Newman.A.Joseph in their study Bank Dividend policy: explanatory factors and Pal Karam and Goyal Puja Leading determinants of Dividend policy: A case study of the Indian Banking Industry. Their study displayed that stable dividend policy is followed by Indian banking industry as lagged dividend emerged as the most significant determinant of dividend payout.

A negative relationship between systematic risk and earnings variability potray that higher the earnings variability lower will be dividend paid by the companies in Service sector. The results also highlight that promoter holding is positively related to dividend payout. The results also show that there is a negative relationship between growth and investment opportunities and dividend payout ratio. This result is in alignment with pecking order hypothesis.

Firms with high leverage are those whose value shifting is potentially costly. Such firms are expected to pay large dividends. Also low leverage firms are high growth firms.

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Therefore they pay low dividends. This positive relationship between debt equity and dividend payout in Service sector can be considered consistent with Easterbrook Analysis

A finding in the Service sector that refutes the existing literature is a negative relationship between firms size and the dividend payout ratio. This finding is not in agreement with Pecking order hypothesis and stands in sharp contrast with results of Smith and Watts (1992). Larger companies despite having the opportunity to tap easily the financial markets by issuing stocks or bonds prefer to retain dividends so as to avoid the costly external financing. Moreover, small firms, which are more risky, need to have a high payout ratio, in order to attract investors to but their stocks.

The analysis of third objective demonstrates that the influence of ownership pattern on the dividend payout is heterogeneous. It has been observed that there are sectoral differences in impact and influence of ownership groups on dividend payout. India is a common Law country characterized by strong investor protection and dispersed ownership (the role of the insider is played by the manager), hence the agency conflicts are not so severe and cash dividends may not be essential to mitigate the agency conflicts. According to Laporta et.al greater the investor protection in a country dividend payouts tend to be higher. In the IT sector results are consistent with Manager Entrenchment hypothesis depicting that institutional holding regression coefficient is positive in level and negative in square. This implies that upto a certain threshold12, dividends act as substitute for corporate governance. After the threshold the direct monitoring efforts of institutional holders are insufficient or become too costly. Therefore, dividend payments are increased so that
10 8

managers are forced to raise finance from external capital markets and acts as an external monitoring device. These results are in agreement with the findings of Short, Zhang and Keasey 2002, and Farinha, 2003). A non-monotonic and parabolic relationship has been established by the research in IT sector for the period under study. However in the FMCG sector none of the ownership groups were found to have considerable influence on dividend payout. As regards Service sector, the relationship between dividend payout and various ownership groups i.e. FII, Corporate holding and Institutional holding has been found to be linear .These ownership groups negatively impact dividend payout of the companies supporting the hypothesis that dividend payments are the means to alleviate the agency conflicts. These ownership groups act as monitoring device reducing the need of high dividend payments.

Through the analysis of the fourth objective it has been found that cash dividends may not always create abnormal returns for the shareholders. In the modern scenario a gradual drift to other modes of payment of dividends has been observed. Small abnormal returns on dividend announcement can also be attributed to the fact that the dividend announced is below the investors expectations. More so, dividend income, being a marginal constituent in investment return, may not inspire much to the over enthused investors in rising capital markets. The findings of the research highlight that in FMCG sector investors respond positively to cash dividends announcements whether increasing or decreasing. Thus, Cash dividends are welcomed by the investors in this sector. This implies that signaling

12

Jayesh Kumar in his study on association between corporate Governance and dividend payout identified

this threshold level to be 25 % 10 9

hypothesis holds. However abnormal returns are created in service sector but they are not sustained over the event window and gradually CAARs (Cumulative average abnormal returns) become negative. Finally it can be stated that dividend announcements create shareholders wealth in the FMCG and Service sector. Thus, the investors tend to applaud the dividend announcements.

However, inspite of the fact that managers view dividend decisions as important it cannot be concluded that market rewards a carefully managed dividend policy with higher share price.In India financial managers typically view dividend decisions as an important part of their job. The typical firm does not follow a residual policy nor leave its dividend payout to chance. Rather, firms manage their dividends as proposed by Lintners model and partially follow stable dividend policy.

10. CHAPTER PLAN

The study is organized in following nine chapters: Chapter 1: Introduction This chapter introduces the dividend puzzle. It throws light on the theoretical background, genesis, concept and meaning of dividends. The primacy and importance of dividend decision has also been discussed in this chapter.

Chapter 2: Literature Review Chapter two reviews the literature in detail and discusses the various research studies on
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the topic under study.

Chapter 3: Research Methodology Chapter three traces the research methodology and discusses in detail the various models developed, tools and techniques used for analyzing the research objectives.

Chapter 4: Overview of the industry This chapter gives brief overview of the financial performance, growth prospects, characteristics of the various sectors under study.

Chapter 5: Data analysis: Lintner dividend model This chapter covers the empirical analysis of the Lintner model proposed by John Lintner (1956) in the three sectors under study. The chapter highlights the target payout ratios and speed of adjustment coefficients of each sector respectively using panel data analysis.

Chapter 6: Data analysis: Corporate divided policy determinants Chapter six contains the analysis and findings of factor analysis, which is used to develop model of corporate dividend policy determinants in each of the sector respectively.

Chapter 7: Data analysis: Impact of various ownership groups on dividend payout ratios Chapter seven discusses in detail the data analysis and findings of quadratic polynomial regression analysis. This model has been developed to find the impact of various

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ownership groups on the dividend payout ratios in all the three sectors undertaken for study.

Chapter 8: Data analysis: Event study This Chapter unfolds the impact of dividend announcement on shareholders wealth as reflected by the shareprices through the use of most sophisticated technique in Corporate Finance i.e. Event study.

Chapter 9: Conclusion This chapter summarizes and concludes the research. Areas for future research are also discussed in this chapter

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SELECTED REFERENCES

[1] Agarwal R N (1991), Dividends and Stock Prices: A Case Study of Commercial Vehicle Sector in India 1966-67 to 1986-87, Indian Journal of Finance and Research,Vol. 1, pp. 61-67. [2] Aivazian Varouj, Booth Laurence, Cleary Sean( 2003), Dividend policy and the organization of capital market, Journal Of Multinational Financial Management ,pp.101121 [3] Aivazian, V, and Booth, L(2003), Do emerging firms follow different dividend policies from US firms.?, Journal of Financial research, Vol.26 No.3,pp.371-87. [4] Allen Franklin and Michael Roni(April 2002) ,Payout Policy, North-Holland handbook of Economics and Finance, Wharton Financial Institutions center. [5] Amidu, Mohammed, and, Abor Joshua (2006), Determinants of Dividend payout ratios in Ghana , The Journal Of Risk Finance, Vol 7 No.2 , pp136-145 [6] Asquith, P. and Mullins, D. (1983), The impact of initiating dividend payments on shareholders wealth, Journal of Business, Vol. 56, pp. 77-96. [7] Baker, H.K. (1999), Dividend Policy issues in regulated and unregulated firms: a managerial perspective, Managerial Finance, Vol.25 No.6, pp.1-19. [8] Baker,H.Kent, Garry E.Powell., Theodore E. Veit (2001), Factors influencing dividend policy decisions of Nasdaq firms, The Financial Review, pp 19-38 [9] Baker,H.Kent,and Garry E.Powell.,(2000) ,Determinants of corporate dividend policy: a survey of NYSE firms , Financial Practice and education 9 ,pp29-40 [10] Black, Fischer, The Dividend Puzzle, The Journal of Portfolio Management, winter 1976, pp.634-639.
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