Economics and Finance Review Vol. 2(2) pp.

55 59, April, 2012

Available online at http://www.businessjournalz.org/efr

ISSN: 2047 - 0401

The Relationship between Dividend Policy and Shareholders Wealth

(Evidence from Pakistan)
Sajid Gul
Faculty of Administrative Sciences Air University Islamabad, Pakistan
Mardan 23200 KPK, Pakistan
E-mail: sajidali10@hotmail.com
Muhammad Sajid
Faculty of Administrative Sciences Air University Islamabad, Pakistan
E-mail: chsajid_24@yahoo.com
Nasir Razzaq
Faculty of Administrative Sciences Air University Islamabad, Pakistan
E-mail: master_nasir18@yahoo.com
Muhammad Farrukh Iqbal
Bahauddin Zakariya University Multan, Pakistan
Email: mfarrukhiqbal@hotmail.com
Muhammad Bilal Khan
MS Scholar Air University Islamabad Pakistan
E-mail: mbilalkhan88@yahoo.com
ABSTRACT
The article examined the influence of dividend policy on shareholders wealth of 75 companies listed in
Karachi Stock Exchange, for duration of six years from 2005 to 2010 using multiple regression and stepwise
regression. We have used shareholders wealth as a dependent variable which is measured as market price per
share, whereas the explanatory variable dividend policy is measured as dividend per share. Furthermore we
also used, Lagged Price earnings ratio, Retained Earnings and Lagged Market Value of equity as explanatory
variables. Data has been collected from companys annual reports, Karachi Stock Market and State Bank of
Pakistan. We have found that the difference in average market value (AMV) relative to book value of equity
(BVE) is highly significant between dividend paying companies and non-paying companies. Retained earnings
have insignificant influence on market value of equity. There is significant influence of dividend policy on
wealth of shareholders, as far as the dividend paying companies are concerned. Lagged Price earnings ratio
did not appear to have any significant influence on dependent variable, whereas lagged market value of equity
has a significant impact on market price per share.
Keywords: Dividend Policy, Bird in the Hand Theory, Karachi Stock Exchange.
1. INTRODUCTION
The dividend policy decision is one of the most important decisions in any organization in order to achieve
efficient performance and attainment of objectives, because the role of finances increased significantly in
companys overall growth strategy thats why dividend decisions are recognized as centrally important. The
attention of economists and scholars of management have been attracted by the field of dividend policy
culminating into theoretical modeling and empirical examination. In finance dividend policy is a complex aspect
and is among the top 10 perplexing issues in finance as suggested by Brealey and Myers (2002). The policy that
results in maximization of the firms stock price which in turn maximizes shareholders wealth is called an
optimal dividend policy. However, the association between dividend policy and shareholders wealth is still
unsolved. The maximization of the wealth of shareholders is the ultimate goal of companys management,
which will result in maximizing firms value as measured by the price of the companys common stock. In order
to achieve the desired goal management needs to give shareholders a fair payment on their investments. The
market price of common stock of a firm actually represents the wealth of shareholders, which, in turn, is a
function of financing, investment, and dividend decisions of a firm. A companys dividend policy has
implications for many parties such as managers, investors, lenders and other stakeholders. Through dividends
investors can value a company and for them it is a regular income whether declare today or at some future date.

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Economics and Finance Review Vol. 2(2) pp. 55 59, April, 2012
Available online at http://www.businessjournalz.org/efr

ISSN: 2047 - 0401

Dividend policy also has implications for managers because when they distribute dividends they will have fewer
funds available to invest in projects, thus their investment decision depends on dividend policy. For lenders the
more a company declares dividends the fewer amounts will remain for lenders claim.
Generally the study is planned to find out how far wealth of shareholders is impacted by dividend policy, and
particularly to investigate the association between dividend policy and wealth of shareholders.
2. LITERATURE REVIEW
The firm value is independent of its dividend policy according to Modigliani and Miller (1961), because it is
determined by selecting optimal investments. Thus a firm dividend policy does not influence the wealth of
shareholder. The theory of the bird in the hand was presented by Gordon and Walter (1963), according to this
theory because of minimum risk investors will always prefer dividends over capital gains. Thus researchers are
puzzled by the question, whether shareholders wealth is affected by dividend policy? for many years. In the
prior literature we have found different views that whether dividend payments Affect Companys share price in
the long run. Some studies have found that firm value is not influenced by the increase or decrease in dividend
payouts, whereas some studies found that dividend payouts affect firm value. A survey was conducted by
Farrelly, Baker, and Edelman (1985) in which they found that according to the view of managers there is an
optimal level of dividend payouts, and firm is influenced by dividend payouts. The same results were found by
Baker and Powell (1999) in a survey that firm value and wealth of shareholder is affected by dividend policy.
The future profitability of firms is assessed by the information regarding the announcements of Cash dividends.
Moreover investors use such information to assess the price of firm's stock according to the survey results. The
value of the firm will be maximized by high dividend yield according to the theory of bird in the hand. The
continuity of dividends is the main concern for managers according to the respondents of the survey, because
due to continuity of dividends the firms earnings will grow constantly and become stable. As a result investors
will receive constant return on their investment which will increase their confidence.
2.1 Literature on Determinants of Dividend Policy
According to Fama & French (2002) three characteristics affecting dividend decisions are: the investment
opportunity, yield and firm size. The dividend payout ratio diminished during the time especially from 19781999 because most of these corporations tend to be small in low yield, size and with lesser investment
opportunities.
Many studies show that large companies have better opportunity to raise funds at comparatively lower cost
because of more consistent cash flows, also they are more diversified and bear less risk and they have greater
right of entry to capital markets. Thats the reason they does not dependent much on internal funding and more
likely pay their shareholders higher dividend Fama and French (2001). In a study done by Baker et al, (2007) it
was stated that many Canadian firms paying dividends are remarkably larger in size with higher profits. They
are having huge positive cash flows, greater ownership structure and also available with some growth
opportunities. DeAngelo et al, (2004) focused on why the firms pay dividends? This study was based on
dividend policy, agency cost and earned equity. It concluded that there is a very significant relationship between
the choices to pay or not to pay dividends and the profitability, cash balance, firm size, leverage, growth and
dividends paid in past. Study by Amidu and Abor (2006), examined determinants of dividend policy in Ghana.
After study outcome concluded that the profitable firms tend to disburse more dividends. In a latest study
Ahmad and Attiya (2009) have taken data from a sample of 320 non-financial companies listed in KSE. The
duration of the study is from 2001 to 2006. They found a trend that Pakistani companies fix their dividend
payments through past dividends and current earnings. Furthermore, they have showed that more dividends are
paid by stable companies. Afzal & Mirza (2010) found positive association of operating cash flow and
profitability with dividend policy whereas negative association was found for ownership, cash flow sensitivity,
size and leverage.
2.2 Research Objectives
(1) The first objective of this research paper is to examine the association between wealth of shareholders and
dividend payout. (2) Secondly we will try to study the impact of variation in dividend policy on the wealth of
shareholder of dividend paying and non-paying companies. (3) Finally we will examine the impact of retained
earnings and past performance in the presence of dividend policy on wealth of shareholders.
2.3 Hypotheses
H1: AMV relative to BVE lacks any significant difference between dividend paying and non-paying
companies.
H2: There is no association between wealth of shareholders and dividend policy.

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Economics and Finance Review Vol. 2(2) pp. 55 59, April, 2012
Available online at http://www.businessjournalz.org/efr

ISSN: 2047 - 0401

3. RESEARCH METHODOLOGY AND EMPIRICAL DATA

3.1 Sample Size and Selection Criteria
The sample for the study consisted of 75 companies listed in the KSE for the period of six years from 20052010. Companies that were not listed in the KSE for the duration of the six year were left out of the sample.
Companies that did not have a full set of data on variables mention in the study were also left out. Companies
that come in to existence after year 2005 are also not included in the sample.
3.2 Data Collection
The data is taken from reliable sources to ensure the reliability of the study. Secondary data was collected from
various databases to undertake the analysis. Such as income statements, balance sheets and cash flow statements
were collected from the KSE, State bank of Pakistan and Bloom burg business week.
3.3 Data Analysis
Statistical analysis technique was used to provide descriptive statistics to determine the mean and standard
deviation of each construct variable. Multiple regression and stepwise regression method were used to study the
impact of dividend policy on wealth of shareholders.
4. REGRESSION EQUATIONS
The methods that have been used in this article are taken from the study of R. Azhagaiah and N. Sabari Priya
(2008) are multiple regression and stepwise regression in order to find out best fitted model for predicting the
association between wealth of shareholders and dividend policy. T-values have been computed for the purpose
of testing the significance of different independent attributes. R-square has been used to find out how much
variation is explained in the dependent variable; then with the help of F-value the significance of R-square has
been tested. The equations used are as follows:
MPSit= a + b DPSit + eit--------------------------------------------------------- (1)
MPSit = a + b DPS it + c RE it + eit .. (2)
MPSit = a + b DPS it + c RE it + (PE) t-1 + eit (3)
MPSit = a + b DPS it + c RE it + (MPS) it-1 + eit .. (4)
Where, MPSit represent Market price per share, DPSit stands for dividend per share, REit is Retained earnings
per share, PEt-1 represent Lagged Price Earnings Ratio and MPSit-1 is for Lagged Market Price (MVit-1).
5. RESULTS AND DISCUSSION
5.1. Shareholders Value comparison between Dividend Payers and Non-Payers
Table 1 presents the comparison of the mean wealth of shareholders of firms that pay dividends and those that
do not pay dividends on the basis of market value to book value of equity. The mean values are compared with
the t-values between dividend paying and non-paying companies. As it can be seen in table 1 that the mean
market value relative to book value of equity of dividend paying companies is higher than 1 for individual as
well as pooled years. The mean market value relative to book value of equity for pooled years is 1.47; however
the minimum mean value is 1.43 while the maximum value is 1.55 in year 2007 and 2010 respectively. Thus it
is clear from the results that the market value of companies that pay dividends is well above the book value.
In contrast the scenario is different when it comes to companies that do not pay dividends. The mean MV
relative to BV of equity is less than 1 for dividend non-payers. The average value is 0.64 for pooled years. The
shareholders wealth has been declined in year 2009 as indicated by the decline in the mean value of 0.63. The
difference in mean values between dividend paying companies and non-paying companies is highly significant
as shown by t-values. Therefore we can say that there is significant difference between shareholders wealth of
dividend payers and non-payers. The wealth of shareholders of dividend payers increased significantly as
compare to non-payers, which shows the impact of dividend policy on shareholders wealth. Thus we will reject
hypothesis H1.
H1: There is no significant difference in AMV relative to BE between dividend payers and non-payers.

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Economics and Finance Review Vol. 2(2) pp. 55 59, April, 2012
Available online at http://www.businessjournalz.org/efr

ISSN: 2047 - 0401

Table 1: Year-wise Comparison of MVE/BVE Between firms that pay dividends and those that does not
Year

Dividend payers
Mean

Dividend None Payers

Std: Dev

Mean

Std: Dev

t-value

P-value

2001

1.45

1.15

0.65

1.78

2.31

0.05

2002

1.47

1.16

0.65

1.79

2.35

0.05

2003

1.43

1.12

0.65

1.81

1.68

ns

2004

1.46

1.14

0.64

1.77

2.33

0.05

2005

1.51

1.18

0.63

1.78

2.39

0.05

2006

1.55

1.20

0.66

1.80

2.47

0.04

2007

1.61

1.23

0.67

2.00

2.34

0.05

2008

1.52

1.19

0.60

2.00

2.32

0.05

Overall

1.50

1. 21

0.64

1.81

4.35

0.00

LS Level of Significance; ns Not Significant

Table 2: Regression results
Regression Model
Variables
Intercept

DPS

2
21.55

22.11

16.33

11.10

(2.34)**

(2.05)**

(1.52)

(1.98) *

77.61

65.24

0.54

59.88

(3.21)***

(3.03) ***

(1.35)

(2.77) **

Retained Earnings

1.41
(0.52)

PE t-1

-0.17
- (1.31)

-1.25
- (0.47)

-0.77
- (1.23)

MV t-1

0.85
(3.63) ***

R-square

0.2332

0.3812

0.3324

0.5465

Adjusted R-square

0.2214

0.3745

0.4014

0.5235

F-value

6.42***

7.21***

7.77***

9.54***

*** Significant at the 1% level, ** significant at the 5% level, * significant at the 10% level

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Economics and Finance Review Vol. 2(2) pp. 55 59, April, 2012
Available online at http://www.businessjournalz.org/efr

ISSN: 2047 - 0401

In table 2 we have used multiple regression method in order to investigate the impact of dividend payments on
shareholders wealth. The dependent variable of the study is market value of equity and is used as a proxy for
measuring the wealth of shareholders. Explanatory variables include dividend per share, retained earnings,
lagged price to earnings ratio and lagged market value of equity. Dividend per share is used as a proxy for
measuring the dividend policy of companies. The regression results are presented in table 2 for the sample of
companies listed in the Karachi Stock Exchange. As it can be seen in table 2 that all four models are significant
at the 1% level. However, the value of model 4 is high as compare to other three models. Dividend per share has
significant positive influence on the dependent variable in all models except model 3. Therefore it suggests that
the higher the companies pay dividend per share the higher will be their shareholders wealth. In model 1 the
coefficient of DPS is 77.61 with a t-value of 3.21, whereas in model 2 the coefficient is 65.24 with a t-value of
3.03, thus both models are significant at the 1% level. In model 4 the coefficient of DPS is 59.88 with a t-value
of 2.77, which means the relationship is significant at the 5% level. However in model 3 dividends per share has
insignificant influence on market value of equity. Retained earnings have insignificant influence on market
value of equity. R-square measures the proportion of the variance jointly explained by the independent
variables, and generally increases, if we add another variable to a regression model. In model 1 and 2 total 23%
and 38% of the variation is explained in the dependent variable respectively. Whereas in model 3 and 4 total
41% and 54% of the variation is explained in the dependent variable respectively. To conclude we can say that
the model which is most suitablefor the finalinterpretation is model 4.
H2: There is no significant impact of dividend policy on shareholders wealth.
Thus we will reject hypothesis that shareholders wealth is not affected by dividend policy because we find that
companies that pay higher dividends increased the wealth of their shareholders as can be seen in model 2.
6. CONCLUSION
In this article, we use multiple regressions and step wise regression method to investigate the impact of
shareholder wealth on dividend policy of firms listed in Karachi Stock Exchange, for a period of six years.
We have used shareholder wealth as a dependent variable which is measured as market price per share, whereas
the explanatory variable dividend policy is measured as dividend per share. Furthermore we also used, Lagged
Price earnings ratio, Retained Earnings and Lagged Market Value of equity as explanatory variables. We have
compared the average wealth of shareholders between dividend payers and non-payers, in order to test the
association between shareholders wealth and dividend policy. A firm is considered as a dividend paying firm if
it has paid dividend for 2 years or more than two years during the period of the study.
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