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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 onership. !1"# Dividend policy connotes to the payout policy$ hich

managers pursue in deciding the si%e and pattern of cash distribution to shareholders

over time. &anagements' primary goal is shareholders' ealth maximi%ation$ hich

translates into maximi%ing the value of the company as measured by the price of the

company's common stock. his goal can be achieved by giving the shareholders a fair*

payment on their investments. +oever$ the impact of firm's dividend policy on

shareholders ealth is still unresolved

he area of corporate dividend policy has attracted attention of management scholars

and economists culminating into theoretical modelling and empirical examination. hus$

dividend policy is one of the most complex aspects in finance. hree decades ago$ ,lack

(1-/) in his study on dividend rote$ The harder we look at the dividend picture the

more it seems like a puzzle, with pieces that just dont fit together.!10#.hy

shareholders like dividends and hy they reard managers ho pay regular

increasing dividends is still unansered.

2ccording to ,realey and &yers (3003) dividend policy has been kept as the top ten

pu%%les in finance. !45#.he most pertinent 6uestion to be ansered here is that ho

much cash should firms give back to their shareholders7 Should corporations pay their

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shareholders through dividends or by repurchasing their shares$ hich is the least costly

form of payout from tax perspective7 8irms 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 to types9 managed and residual. :n residual dividend policy

the amount of dividend is simply the cash left after the firm makes desirable investments

using ; groth firms ith larger cash flos and feer pro?ects tend to pay more

of their earnings out as dividends. he dividend policies of firms may follo several

interesting patterns adding further to the complexity of such decisions. 8irst$

dividends tend to lag behind earnings$ that is$ increases in earnings are folloed by

increases in

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 hen earnings drop. hird$ dividends tend to follo a much

smoother path than do earnings. 8inally$ there are distinct differences in dividend policy

over the life cycle of a firm$ resulting from changes in groth rates$ cash flos$ and

pro?ect investments in hand. Aspecially the companies that are vulnerable to

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macroeconomic vicissitudes$ such as those in cyclical industries$ are less likely to be

tempted to set a relatively lo maintainable regular dividend so as to avoid the dreaded

conse6uences of a reduced dividend in a particularly bad year.

Shareholders ealth is represented in the market price of the company's common stock$

hich$ in turn$ is the function of the company's investment$ financing and dividend

decisions. 2mong the most crucial decisions to be taken for efficient performance and

attainment of ob?ectives in any organi%ation are the decisions relating to dividend.

Dividend decisions are recognised as centrally important because of increasingly

significant role of the finances in the firm's overall groth strategy. he ob?ective of the

finance manager should be to find out an optimal dividend policy that ill enhance

value of the firm. :t is often argued that the share prices of a firm tend to be reduced

henever there is a reduction in the dividend payments. 2nnouncements of dividend

increases generate abnormal positive security returns$ and announcements of dividend

decreases generate abnormal negative security returns.2 drop in share prices occur

because dividends have a signalling effect. 2ccording to the signalling effect mangers

have private and superior information about future prospects and choose a dividend level

to signal that private information. Such a calculation$ on the part of the management

of the firm may lead to a stable dividend payout ratio.

Dividend policy

1

of a firm has implication for investors$ mangers and lenders andother stakeholders (more specifically the claimholders). 8or investors$ dividends B

hether declared today or accumulated and provided at a later date are not only a means

of regular income3$ but also an important input in valuation of a firm4. Similarly$

managers' flexibility to invest in pro?ects is also dependent on the amount of dividend

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that they can offer to shareholders as more dividends may mean feer funds available for

investment. enders may also have interest in the amount of dividend a firm declares$ as

more the dividend paid less ould be the amount available for servicing and redemption

of their claims. he dividend payments present an example of the classic agency situation

as its impact is borne by various claimholders. 2ccordingly dividend policy can be used

as a mechanism to reduce agency costs.he payment of dividends reduces the

discretionary funds available to managers for per6uisite consumption and investment

opportunities and re6uire managers to seek financing in capital markets. his

monitoring by the external capital markets may encourage the mangers to be more

disciplined and act in oners' best interest.

Companies generally prefer a stable dividend payout ratio because the shareholders

expect it and reveal a preference for it. Shareholders may ant a stable rate of dividend

payment for a variety of reasons. isk averse shareholders ould be illing to invest

only in those companies hich pay high current returns on shares. he class of

investors$ hich 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 ill not be able to carry on their

current operations otherise. Such investors ould therefore$ prefer companies$ hich

pay a regular dividend every year. his clustering of stockholders in companies ith

dividend policies that match their preference is called clientele effect.

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1 Background of the Study

2fter the restoration of democracy in 1--0 2.D.$ ;epal has implemented liberal

economic policy. 2s a result$ many more companies are established in different

sectors such as industrial$ tourism$ transportation$ trade and mostly in financial

sector ho contribute to build up economy of the country. ;epal is a country trying

to develop its economy through global trend and cooperation ith developed

countries.

he development of an economy re6uires expansion of productive activities$ hich

in turn is the result of the capital formation$ hich is the capital stock of the country.

he change in the capital stock of the country is knon as investment. :nvestment iskey factor for capital formation. :nvestment promotes economic groth and

contributes to a nation's ealth. :nvestor desire to earn some return from the

investment$ ithout any return there is no any investment. :nvestment ill block$ if

there is no return. he total expected return include to components one is capital

gain and other is dividend.

:n the capital market$ all firms operate in order to generate earnings. Shareholders

make investment in e6uity capital ith the expectation of making earning in theform of dividend or capital gains. hus$ shareholders ealth can increase through

either dividend or capital gain. Ence the company earns a profit$ it should decide on

hat to do ith the profit. :t could be continued to retain the profit ithin the

company$ or it could pay out the profit to the oners of the company in the form of

dividend. Dividends are payment made to stockholders from a firm's 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

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firm. he ob?ective of a dividend policy should be to maximi%e shareholder's ealth

position.

etained earnings are used for making investment in favorable investment

opportunities$ hich in turn help to increase the groth rate of the firm. hat andho much it is desirable to pay dividend is alays a controversial topic because

shareholders expect higher dividend from corporation$ but corporation ensure

toards setting aside funds for maximi%ing the overall shareholders' ealth.

&anagement is therefore concerned ith the activities of corporation that affect the

ell being of shareholders. hat ell being can be partially measured by the

dividend received$ but a more accurate measure is the market value of stock. ,ut

stockholders think dividend yield is less risky than capital gain.

Dividends are payments made by a corporation to its shareholders. :t is the portion

of corporate profits paid out to stockholders. hen a corporation earns a profit or

surplus$ that money can be put to to uses9 it can either be re>invested in the

business i.e. retained earnings$ or it can be paid to the shareholders as a dividend.

&any corporations retain a portion of their earnings and pay the remainder as a

dividend.

he most idely accepted ob?ective of a firm is to maximi%e the value of the firm

and to maximi%e shareholder ealth. :n general$ there are three types of financial

decisions hich might influence the value of a firm9 investment decisions$ financial

decisions and dividend decisions. hese three decisions are interdependent in a

number of ays. he investments made by a firm determine the future earnings and

future potential dividends@ and dividend policy influences the amount of e6uity

capital in a firm's capital structure and further influences the cost of capital. :n

making these interrelated decisions$ the goal is to maximi%e shareholder ealth.

Dividends are decided upon and declared by board of directors. 2 firm's profits

after>tax can either be used for dividends payment or retained in the firm to increase

shareholdersF fund. his may involve comparing the cost of paying dividend ith

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the cost of retaining earnings. Generally$ hichever component has a loer cost that

is here the profit after>tax ill flo. +oever$ there is a need to strike for a

balance because it is a %ero sum decision.1 2lthough 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.

he theory of dividend and its effect on the value of the firm is perhaps one of the

most important yet pu%%ling theories in the field of finance. 2cademics have

developed many theoretical models describing the factors that managers should

consider hen making dividend policy decisions. ,y dividend policy$ e mean thepayout policy that managers follo in deciding the si%e and pattern of cash

distributions to shareholders over time. &iller and &odigliani (1-/1) argue that

given perfect capital markets$ the dividend decision does not affect firm's value and

is$ therefore$ irrelevant. +oever$ most financial practitioners and many

academicians believe otherise. hey offered many theories about ho dividends

affect firm's value and ho managers should make dividend policy decisions. Ever

time$ the number of factors identified in the literature as being important to consider

in making dividend decisions increased substantially. here are plenty of potential

determinants for the dividend decisions. he more prominent determinants include

protection against li6uidity$ after>tax earnings of the firm$ li6uidity and cash flo

consideration$ stockholdersF expectationHpreference$ future earnings$ past dividend

practices$ return on investment$ industry norms$ legal constraints$ groth prospects$

inflation and interest rate. (8oong$ Iakaria and an$ 300$ p.-)

he development of an economy re6uires expansion of productive activities$ hichin turn is the result of the capital formation$ hich is the capital stock of the country.

he change in the capital stock of the country is knon as investment. :nvestment is

key factor for capital formation. :nvestment promotes economic groth and

contributes to a nation's ealth. :nvestor desire to earn some return from the

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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.

:t is fact that dividend ork as a simple sufficient signal of management's

interpretation of the firm's recent performance and its future prospects.

1.2 The Proble Stateent

Dividend policy is an integral part of financial management decision of a business

firm. Dividend refers to that portion of a firm's net earning hich are paid out to the

shareholders. hether dividends have an influential on the value of the firm is the

most critical 6uestion in dividend policy. :f dividends are irrelevant$ the firm should

retain earnings for investment opportunities. :f there are not sufficient investment

opportunities providing expected returns in excess of the re6uired 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 stockholderFs point of vie. :n one hand the payment of

dividend makes the investors happy. ,ut in the other hand the payment of dividend

decreases the internal financing re6uired for making investment in golden

opportunities. his ill hamper the groth of the firm$ hich in turn affects the

value of the stock.

Aarnings are also treated as financing sources of the firms. he 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. hereas if firm

pays dividend$ it may need to raise capital through capital that ill affect on riskcharacteristics of the firm. herefore there are many dimensions to be considered on

dividend theories$ policies and practices.

Shareholders make investment in e6uity capital ith the expectation of making

earnings. Dividend is kind of earning that the shareholders expect form their

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investment. ,ut$ the dividend decision is still a fundamental as ell as controversial

area of managerial finance. he effect of dividend on market price of stock is the

sub?ect matter of the study.

here are many empirical studies on dividend and stock price behavior. 8orexample$ fe of them are inter (1-"/)$ &iller and &odigliani (1-/1)$ Durand and

&ay (1-/0)$ 8riend and

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1.$ S%gn%f%cance of the Study

:n the capital market the investor can earn return in to ays$ one is dividend and

another is capital gain. he term dividend is defined as a return from investment in

e6uity shares. So dividend is important factor for investor hile investing in e6uityshares. his study helpful to investor to take rational decision like here to invest$

ho to invest$ hat portfolio should be made to obtain maximum profit from their

investment7 hen a ne company floats shares through capital market$ large

numbers of people gathers to apply for onerFs certificate. :t indicates peopleFs

expectation on higher return of investment in shares. :n ;epalese context$ most of

investors are investing in the stock ithout ade6uate knoledge of the company and

performance and dividend policies. his study helps to aare the ;epalese

investors.

his study is useful for the firm's perspective too. hey kno the investor ob?ective's

from this study. here are basically to types of ob?ective one is receiving dividend

and another is receiving capital gain. Lnoing the ob?ective of investor they can

develop their plans and policies accordingly.

,asically this study is conducted to help the investor hile 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.

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1.2 R&'&()NC& O* T+& STUD,

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analy%ed the dividend behavior of corporate firms in the :ndian context. o date$ most

studies have paid attention on influence of cash flos or earnings on the dividend payment

of a firm.

8urther$ for the dividend policy makers of the :ndian :$ 8&CG M Service :ndustry$ the

study may prove to be useful for re>sketching their dividend policy keeping in vie the

analysis$ results and discussions presented. hrough the research one can have better

understanding of the factors that should systematically affect firms' payout decisions. :t

also gives insight into hat kind of onership structure is beneficial for the shareholders.

1.! S+)R&+O'D&RS- ()'U& CR&)TION )ND ITS 'IN)/& 0IT+

DI(ID&ND PO'IC, D&CISIONS

:t has been recogni%ed by various research studies that a dividend policy could make

significant impact on corporate future value hen established and carefully folloed. he

goal of ealth maximisation is idely accepted goal of the business as it reconciles the

varied$often conflicting $interest of the stakeholders.

he interest in shareholders value is gaining momentum as a result of several recent

developments9

N he threat of corporate takeovers by those seeking undervalued$ under managed

assets

N :mpressive endorsements by corporate leaders ho have adopted the approach

N he groing recognition that traditional accounting measures such as A

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N 2 groing recognition that executives' longterm compensation needs to be more

closely tied to returns to shareholders.

he shareholders value approach* estimates the economic value of an investment (e.g

shares of a company$ strategies$ mergers and ac6uisitions$ capital expenditure) by

discounting forecasted cash flos by the cost of capital. hese cash flos$ in turn$ serve

as the foundation for shareholder returns from dividends and share price appreciation.

2 going concern must strive to enhance its cash generating ability. he 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 e6uity financing are to basic external sources.

,orroing poer and the market value of the shares both depend on a company's cash

generating ability. he market value of the shares directly impacts the second source of

financing$ that is$ e6uity financing. 8or a given level of funds re6uired$ the higher the share

price$ the less dilution ill be borne by current shareholders. herefore$ management's

financial poer to deal effectively ith corporate claimants also comes from increasing

the value of the shares. his increase in value of shares can be brought about by rearding

shareholder ith returns from dividends and capital gains.

he most famous statement about the relationship beteen dividend policy and corporate

value claimed that$ in the presence of perfect markets$ given a firmFs investment policy$

the dividend payout policy it chooses to follo ill affect neither the current price of its

shares nor the total return to its shareholders* +oever$ Omarket imperfections as

differential tax rates$ information asymmetries beteen insiders and outsiders$ conflicts of

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interest beteen managers and shareholders$ transaction costs$ flotation costs$ and

irrational investor behavior might make the dividend decision relevant*

he 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

ithout re6uiring any selling of shares. En the contrary$ capital gains or losses are

defined as the difference beteen the sell and buy price of shares. 8riction costs are one

of the market imperfections and are further distinguished in transaction costs$ floatation

costs and taxes. 2nother market imperfection is that of information asymmetries

beteen the insiders (e.g. managers) and the outsiders (e.g. investors). 2gency

conflicts$ stemming from the different ob?ectives of companyFs stakeholders$

form the third market imperfection. 8inally$ 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. R&(I&0 O* T+&

'IT&R)TUR&

he research aims at analysing information asymmetry$ agent conflicts$ signalling effect

and corporate dividend policy determinants. his section on literature revie is

focussed on various models and theories that are relevant to our study.

he revie of the literature is organised into various schools of thoughts on dividend

policy hich are discussed as follos9

2.1 DI(ID&ND IRR&'&()NC& PROPOSITION ODI/'I)NI 3I''&R

)PPRO)C+ 415617

:n 1-/1$ to noble laureates$ &erton &iller and 8ranco &odigiliani (&M&) shoed that

under certain simplifying assumptions$ a firms' dividend policy does not affect its value.

he basic premise of their argument is that firm value is determined by choosing optimal

investments. he net payout is the difference beteen earnings and investments$

and simply a residual. ,ecause the net payout comprises dividends and share repurchases$

a firm can ad?ust its dividends to any level ith an offsetting change in share outstanding.

8rom the perspective of investors$ dividends policy is irrelevant$ because any

desired stream of payments can be replicated by appropriate purchases and sales of

e6uity. hus$ investors ill not pay a premium for any particular dividend policy. !3#&M& concluded that given firms optimal investment policy$ the firm's choice of

dividend policy has no impact on shareholders ealth. :n other ords$ all dividend

policies are e6uivalent. he most important insight of &iller and &odigliani's analysis is

that it identifies the situations in hich dividend policy can affect the firm value. :t could

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matter$ not because dividends are safer* than capital gains$ as as traditionally argued$

but because one of the assumptions underlying the result is violated. he propositions

rest on the folloing four assumptions9

1. :nformation is costless and available to everyone

e6ually.

3. ;o distorting taxes

exist

4. 8lotation and transportation costs are non>

existent

5. ;on contracting or agency cost

exists

2.2 DI(ID&ND PO'IC, )ND )/&NC,

PROB'&S

he level of dividend payments is in part determined by shareholders preference as

implemented by their management representatives. +oever$ the impact of dividend

payments is borne by a variety of claim holders$ including debt holders$ managers$ and

supplier. he agency relationship exists beteen

P he shareholders versus debt holders conflict$ andP he shareholder versus management conflict

Shareholders are the sole receipts of dividends$ prefer to have large dividend payments$

all else being e6ual@ conversely$ creditors prefer to restrict dividend payments to

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maximi%e the firm's resources that are available to repay their claims. he empirical

evidence discussed is consistent ith the vie that dividends transfer assets from the

corporate pool to the exclusive onership of the shareholders$ hich negatively

affects the safety of claims of debt holders.

:n terms of shareholder> manger relationships$ all else being e6ual$ managers$ hose

compensation (pecuniary and otherise) is tied to firm profitability and si%e$ are

interested in lo dividend payout levels. 2 lo dividend payout maximi%es the si%e of the

assets under management control$ maximi%es management flexibility in choosing

investments$ and reduces the need to turn to capital markets to finance investments.

Shareholders$ 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 management's hands and to force mangers to turn to

capital markets to fund investments. hese markets provide monitoring services that

discipline managers. 2ccordingly$ shareholders can use dividend policy to encourage

managers to look after their oners' best interests@ higher payouts provide more

monitoring by the capital markets and more managerial discipline.

a de B Silannes $ Shleifer $ and =ishny (3000) !30#$ have argued that a

legal environment provides strong protection to shareholders enables them to force

companies to disgorge cash. he implication is that effective monitoring byshareholders in KL$ here legal protection is strong$ should be associated ith higher

dividend payments. Studies for the KL here empirical evidence on the relationship

beteen dividends and onership structures is rather limited sho that there is a

negative relationship beteen

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Qinside' onership and dividends (Short $Ihang and Leasey$3003$ enneboog and

ro?anoski$300"$ 8arinha$ 3004).+oever $ evidence regarding financial institutions

is not only limited but also contradictory9 Short $Ihang and Leasey report a positive

relationship beteen dividends and shareholding by financial institutions hile

enneboog and ro?anoski find a negative.

Some of the important esearch studies on agency conflicts are ,erle and &eans (1-43)$

Aasterbrook analysis (1-5)$ the Jensen M &eckling (1-/) !1#$ ang and in%enberger

(1--)$ Jensen$ Solberg and Iorn (1--3) 2graal and Jayaraman (1--5) !1#$ Roon and

Starks (1--")$ Denis$ Denis$ and Sarin (1--) +eaton (3003)

Dividend policy refers to the issue of ho much of the total profit a firm should pay to its

stockholders and ho much to retain for investment so that the combined present and

future benefits maximi%e the ealth of stockholders. he dividend policy$ hoever$

not only specifies the amount of dividend$ but also form of dividend$ payment procedure

etc.

Dividend policy according to the application could be categori%ed as follos9

a. Stable dividend policy

hen 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. his policy is considered as a desirable policy by the management of companies.

&ost 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. ,y

stability$ e mean maintaining their positions in relation to a trend live preferably one that

is upard sloping. hree of the common used dividend policies are9

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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. 2 number of companies follo the policy of paying fixed amount per share

as dividend every period$ ithout considering the fluctuation in the earnings of thecompany. he policy does not imply that the dividend per share or dividend rate

ill never be increased. hen the company reaches ne level of earnings and

expects to maintain it the annual dividend per share may be increased. :nvestors

ho have dividends as the only source of their income prefer the constant dividend

policy.

ii) Constant payout ratio

he ratio of dividend to earning is knon as payout ratio. hen fixed percentage of

earnings is paid as dividend in every period$ the policy is called constant payout

ratio. Since earnings fluctuate$ folloing this policy necessarily means that the

rupee amount of dividends ill fluctuate. :t ensures that dividends are paid hen

profits are earned$ and avoided hen it incurs losses.

iii) Low regular plus extra policy

he policy of paying a lo regular dividend plus extras in a compromise beteen a

stable dividend (or stable groth rate) and a constant payout rate. Such a policy

gives the firm flexibility$ yet investors can count on receiving at least a minimum

dividend. :t is often folloed by firms ith relatively volatile earnings from year to

year. he lo regular dividend can usually be maintained even hen earnings

decline and extra dividends can be paid hen excess funds are available.

b. N o immediate dividend policy

:f the company does not declare dividend unless the company earn large income is

called no immediate dividend policy. :n other ords$ if there is not any hurry about

dividend payment and if it could be paid only hen the company earns more profit

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is knon as no immediate dividend policy. his policy is usually pursued the

folloing circumstances9

hen the firm is ne and rapidly groing concern$ hich needs largeamount of funds to finance its expansion program$

hen the firms' excess to capital market is difficult$

hen availability of funds is costlier$

hen stockholders have agreed to accept higher return in future.

:n fact$ this policy should follo by issue of bonus shares.

c. Regular stock dividend policy

:f the company regularly pays dividends to its shareholders in stock instead of cash$

then it is called regular stock dividend policy. egular stock dividend policy is ale

designated as bonus shares. Such policy should follo under the folloing

circumstances9

hen the firm needs cash generated by earning to cover its moderni%ationand expansion of pro?ects.

hen the firm is lacking in cash despite high earning$ this is particularly true

hen the firm's sales is affected through credit and entire sales proceeds are

tied in receivables.

d. I r r e gu l ar dividend policy

:t is the policy in hich$ the firm does not pay any fixed amount of dividend every

year or dividend varied in correspondence ith change in level of earning$ i.e.

higher earnings means higher dividend and vice>versa. he firm ith unstable

earnings also adopts this policy$ hen there are investable opportunities the

company retains more and hen 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 ;epalese

context at present.

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e. I r r e g u l a r dividend policy

his 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 forthemselves on other investments of comparable risk. 8urther$ it is less expensive for

the firm to use retained earnings than is to issue ne common stock.

2.! *actor# affect%ng D%8%dend Pol%cy

2.!.1 'egal Re9u%reent#

he legal rules provide that the dividends must be paid from earnings either form

the current year's earnings or from past years' earnings as reflected in the balance

sheet account Qretained earnings'. State las emphasi%e three rules9

a) Capital impairment Rules

he firm cannot pay dividend out of its paid up capital. :f it does so there ould be

reduction in the capital that ould affect the creditors of a corporation.

b) nsolvenc! Rule

his rules state that cash dividend should be prohibited$ if the company is insolvent.

:nsolvency in the legal services defined as the situation hen the recorded value of

liabilities exceeds the recorded value of assets. Similarly in the technical sense$ it is

the firm's inability to pay its current debtors.

c) "et profit rule

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

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2.!.2 '%9u%d%ty "o#%t%on

he cash or li6uidity position of the firm influences its ability to pay dividends. 2

firm may have sufficient retained earnings$ but if they are invested in fixed assets$

cash may not be available to make dividend payment. hus$ the company must haveade6uate cash available as ell as retained earning to pay dividends.

2.!.! )cce## to the ca"%tal arket#

2 large$ ell>established firm ith a record of profitability and stability of earnings

has easy access to capital markets and other forms of external financing. 2 small$

ne or venturesome firm$ hoever$ is riskier for potential investors. :ts ability to

raise e6uity or debt funds from capital markets is restricted$ and it must retain moreearnings to finance its operations. 2 ell>established firm is thus likely to have a

higher dividend payout ratio than a ne or small firm.

2.!.$ Need to re"ay debt

8irms may have the policy to retire its past debts by means of retained earning. :f

such alternative are being adopted then such firm ill retain more and pays less

dividend.

2.!.: Re#tr%ct%on# %n debt contract#

Debt contracts$ particularly hen long>term debt is involved$ fre6uently restrict a

firm's ability to pay cash dividends. Such restrictions$ hich are designed to protect

the position of the lender$ usually state that (:) 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 hen net

orking capital is belo 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.!.6 /ro;th rate of f%r

2 rapidly groing concern ill have constant needs of long>term funds to sei%e

favorable opportunities for hich it has to retain more and pays less dividend.

2.!.< Control

2nother important variable is the effect of alternative sources of financing on the

control situation of the firm. 2s a matter of policy$ some corporations expand only

to the extent of their internal earnings. his policy is defended on the ground that

raising funds by selling additional common stock dilutes the control of the dominant

group in that company. 2t the same time$ selling debt increases the risks of

fluctuating earnings to the present oners of the company. eliance on internalfinancing in order to maintain control reduces the dividend payout.

2.!.= Stab%l%ty of earn%ng#

2 firm that has relatively stable earnings is often able to predict approximately hat

its earnings ill be. Such a firm is therefore more likely to pay out a higher

percentage of its earnings than a firm ith fluctuating earnings. he unstable firm is

not certain that in subse6uent years earning ill be reali%ed$ so it is likely to retain ahigh proportion of current earnings. 2 loer dividend ill be easier to maintain if

earning fall off in the future.

2.!.5 Ta> "o#%t%on of #hareholder#

he tax position of a corporation's oners greatly influences the desire for

dividends. 8or e.g. a corporation oned by largely taxpayers in high income tax

brackets tend toard loer dividend pay>out hereas corporations oned by small

investors tend toard higher dividend pay>out.

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2.$ Payent Procedure follo;ed by Co"an%e#

he actual payment procedure is of some importance$ and the folloing is an

outline of the payment se6uence.

1. Declarat%on date his is the day on hich board of directors declares the

dividend. 2t this time they set the amount of the dividend to be paid$ the

holder>of>record date and payment date.

2. +older?of?record date his is the date the company opens the onership

books to determine ho ill receive the dividend@ the stockholders of record

on this date receive the dividend. :n that date$ the company closes its stocktransfer books and make up a list of the shareholders as of that day.

!. &>?d%8%dend date he date hen the right to the dividend leaves the stock is

called the ex>dividend date. :n this case$ the ex>dividend date is four days

before holder of record date. herefore if someone ants to receive the

dividend$ heHshe must buy the stock four days before the holder of record day.

$. Payent date his is the day hen dividend checks are actually mailed to

the holders of record. (eston and Copeland$ 1--3$ p. /")

2.: &>? d%8%dend Day Te#t#

he ex>dividend test involved the ex>dividend behavior of common stock prices.

:nvestors 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.

:n one of the earliest published studies on the ex>dividend stock price anomaly is

that of Campbell and ,eranek (1-"") ho reversed the general vie that stock

prices drop by the full dividend amount on ex>days. Ksing data from the ;RSA

stocks$ they observed that the ex>dividend price drop as -0 of the dividend

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amount. Durand and &ay (1-/0) conducted another seminal ork examining the

ex>dividend day behavior of 2merican elephone and elegraph stock (2and)

for a time series of 54 consecutive dividends. hey found that the average price

change from the cum>dividend day to the ex>dividend day as T3.1/$ or about 5

percent less than the T3.3" dividend.

Alton and Gruber (1-0) ere the first researchers that offered a reasonable

explanation for the ex>dividend stock price anomaly. Ksing a one>year sample ith

5$15 dividends$ Alton and Gruber (1-0) confirmed that ex>day stock prices tend to

fall by significantly less than the dividend and developed a model explaining the

effect knon as the long>term trading hypothesis* or the tax>effect hypothesis*.

Alton and Gruber shoed that hen 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 beteen (i) selling the stock cum>dividend and (ii) holding the stock$

receiving the dividend$ and selling ex>dividend. +ence$ in case that an investor

decides to sell on the cum>dividend day he receives the cum>dividend price (dividend price over

to the price at hich the share as bought (dividend$ he receives a dividend and the ex>dividend price (dividend price (

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Alton and Gruber (1-0) sorted their sample into deciles by the dividend yield andcomputed the mean yield

stocks. hus$ Alton and Gruber (1-0) confirmed the existence of the dividendclientele effect* as firstly proposed by &iller and &odigliani (1-/1).

8rank and Jagannathan (1--) examined the ex>dividend day stock price behavior in

the +ong Long market$ here neither dividends nor capital gains ere taxed and

unlike in the ;RSA$ in the +ong Long Stock &arket (+LSA) there ere no market

makers until 1--4. hey found that stock prices dropped on the ex>dividend day by

half the dividend amount. 8rank and Jagannathan argued that the unexpected pricedrop on the ex>dividend day as the result of transactions on the cum>dividend day

occurring at the bid price$ hile transactions on the ex>dividend day took place at

the asked price. hat 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. &arket makers$ instead$ find themselves in a better position to collect

the dividend$ so they buy the stock on the cum>dividend day. 2s a conse6uence$ on

the cum>dividend day most trades occur at the bid price$ hile on the ex>dividend

day most trades occurred at the asked price. (Dasilas$ 300$ p.1>)

Similarly other many studies have been made in this matter. :n a number of these

studies$ the evidence is consistent ith the previous$ namely$ that stock prices

decline on the ex>dividend day but less than the amount of the dividend. (,hattarai$

300$ p.4-4)

2.6 @ual%ty Rat%ng of Co"an%e# %n Ne"al

;epalese capital market is still lacking an independent 6uality rating agency. ,ut$

;A

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to categories9 Category 2* and Category ,*$ on different criteria. 2ccording to

the ;Alisted by

the ;A

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a) Shareholder's full name and address.

b) ;o. of shares holding by shareholder.

c) otal amount paid by shareholder and remaining balance if any.

d) egistered date of shareholder's certificate.

e) Cancellation date of shareholder's certificate.

f) Enership right on share after the death of the registered shareholder.

Sect%on 1=2 D%8%dend

Sub#ect%on 417

Axpect in the folloing circumstances$ dividend shall be distributed among the

shareholders ithin 5" days from the date of decision to distribute them$

a) :n case any la forbids the distribution of dividends.

b) :n case of right to dividend is disputed.

c) :n case dividends cannot be distributed ithin the time limit mentioned

above oing to circumstance beyond anyone's control and ithout any

fault on the part of the company.

Sub#ect%on 427

Government oned companies either fully or partly can't issue dividend ithout

permission of government and also necessary direction in the matter of dividend.

Sub#ect%on 4!7

:n case dividends are not distributed ith the time limit mentioned in subsection

(1)$ adding interest at prescribed rate.

Sub#ect%on 4$7

Enly the person hose 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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Sub#ect%on 4:7

he Company can't issue any formHamount as dividend expected separate reserve

amount for the distribution of dividend.

Sub#ect%on 467

he Company should deduct the operating cost$ deprecation amount$ payable$

ad?ustment for previous year's losses by>la before distributing dividend from

profit.

Sub#ect%on 4

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Sub#ect%on 4117

2fter the dividend declared form 2G&$ the company should establish separate book

of account ithin 5" days and distribute to the shareholders and the amount should

not be used for other purpose by the company.

2.= Re8%e; of the Internat%onal Stud%e#

inter (1-"/) conducted a study$ hich is focused in the behavioral aspect of

dividend policy. +e investigated dividend pattern of 3 different companies of

2merica and found that$ firm generally predetermines the desired payout and tries to

achieve it and rarely considers other factors. he model developed firm is his

research is as follos9

D:=WtU pA D:=t>1UaVb (D:=Wt> D:=t>1) Ve1XX.XX (ii)Er$ D:=tUaVb D:=WtV (aVb) D:=t>1 Ve1XXXXX (iii)

here$

D:=Wt U 8irm's desired paymentA

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8irm generally

have target payout

ratios in vie hile

determining change

in dividend per share.

alter (1-") has proposed a model for share valuation hich supports the vie

that the dividend policy of the firm has impact on share valuation. +is orks shos

clearly the importance of the relationship beteen the firm's internal rate of return

on investments (r) and its cost of capital (k) in determining the dividend policy that

ill maximi%e the ealth of shareholders. alters's model is based on the

folloing assumptions (Chandra$ 1---$ p.403)

etained earnings represent the only source of financing for the firm.

he return on the firm's investment remains constant.

he cost of the capital for the firm remains constant.

he firm has an infinite life.

alter's formula to determine the market price per share is as follos.

< =D

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#rowth $irm r%k

8irm having rZk may be referred as groth firm. he optimum payout ratio for a

groth firm is 0. he market price per share increases as payout ratio decreases.

"ormal $irm r&k

8irm having rUk may be referred as normal firm. here is no uni6ue optimum

payout ratio for a normal firm. Ene dividend policy is a good as the other. he

market price per share is not affected by the payout ratio hen rUk. he payout ratio

for a normal firm is irrelevant.

'eclining $irm r(k

8irm having rYk may be referred as declining firm. he optimum payout ratio for a

declining firm is 100. he market price per share increases as payout ratio

increases.

hus$ in alter's &odel the dividend policy of the firm depends on the availability

of investment opportunities and the relationship beteen the firm's internal rate of

return (r) and its cost of capital (k).he firm should use earning to finance investment if rZk$ should distribute all

earnings hen rYk and ould remain indifferent hen rUk.

&odigliani and &iller's (1-/1) model (&>&) dividend policy of the firm is

irrelevant. :t doesn't affect the ealth of the shareholder. hey argue that the value

of the firm depends on the firms earning$ hich result from its investment policy.

he literature suggests that dividend payments should have no impact on

shareholders value in the absence of taxes and market imperfections. +ence$

companies should invest excess funds in the positive net present value pro?ects

instead of paying out them to the shareholders.

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&odigliani and &iller's model hypothesis of irrelevance is based ion the folloing

assumptions. (

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No #xternal $inancing

:f no external financing exist the market value of firm can be computed by

multiplying both sides by number of outstanding shares as follos9

here

=U n

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here

:1 U otal investment at time 1

A U otal net profit of the firm

A>nD1 U etained earning

Substituting e6uation (iv) to e6uation (iii) e get

n

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;o external financing is available. Conse6uently retain earning ould be

used to financial expansion. he internal rate of return (r) of the firm is constant. his ignores the

diminishing marginal efficiency of the investment.

he appropriate discount rate (k) for the firm remains constant. he firm and its stream of earning are perpetual.

he tax does not exist.

he relation ratio (b) ones decide upon$ is constant. hus the groth rate

gUbr$ each constant forever. kZbr Ug. if this condition is not fulfilled$ e can't get a meaningful value for

the share.

2ccording to Gordon's Dividend Capitali%ation &odel the market value of a shareis e6ual to the present value of an infinite stream of dividend to be received by the

share. hus9

D1+ D 3

.............. + D n

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risk associated ith future capital gain. Gordon stressed that the higher payout

increases the dividend yield and hence increases the value of stock. ,ut the

assumption of this model is also far from the reality. (

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here$

1U ast year dividend

hey found that more than 0 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

beteen the dividend and retained earnings coefficient are not 6uite so marked as in

the first set of regression. hey 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 1-"/ and the correlations are higher again except for steels.

hey also calculate the dividend supply e6uation (DtU e V fAt VgDt>1 Vd(AH1)

and derived price e6uation for four>industry group in 1-". he derived price

e6uation shoed that there ere no significant changes' from those obtained in the

single e6uation approach as explained above. hey argued that the stock price or

more accurately the price>earning ratio does not seem to have a significant effect on

dividend payout. En the other hand they noted that the retained earnings effect

increased relatively in the three of the four cases tested. 8urther 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. 8urther they used lagged price as a variable

instead of lagged earning price ratio and shoed that more than -0 percent of

variation in stock prices can be explained by three independent variables and

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retained earnings received greater relative eight than dividends in most of the

cases. he only exception as steels and food in 1-". hey considered chemicals$

electronics$ and utilities as groth industries in these groups and the retained

earnings effect as larger than the dividends effect for both the years covered. 8or

the other to industries$ namely food and steels$ there as no significant systematic

difference beteen the retained earnings and dividends coefficient.

Similarly$ they tested the regression e6uation$

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firm stock returns. Changes in dividend yield$ on the other hand$ have negative and

significant coefficients in explaining stock returns in radingHServices firms

throughout 1--4>1--/ and the average crisis period. 8or called the dividend related variables$ comprising dividend yield$

dividend stability and changes in dividend yield.

2lthough 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

radingHServices firms$ hich are essentially representing groth firms. :f this

holds true across the hole &alaysia listed firms$ this suggests that CAE and top

management of groth firms should pay careful attention to the changes of dividend

yield in their firms$ hich has an inverse relationship ith the stock returns.

he fre6uent changes in firm dividend policy may be particularly useful in

attempting to differentiate high value firm from their lo>value counterparts thathave high dividend payout levels. he negative sign documented implies that the

loer the changes in the dividend yield$ the higher the stock returns. his suggests

that the management should try to minimi%e changes in the dividend yield.

Smoothing dividends payment over time can push the stock price to higher level.

2nother option is to maintain the level of dividend yield by ad?usting the dividend

payment relative to the stock price. 8urthermore$ announcing changes in the level of

dividend payment provides important information to investors and must be carefully

considered. his ill eventually maximi%e the firm value@ follo by the

maximi%ation of shareholder ealth.

Kddin (3004) empirical results based on 14 samples of dividend paying companies

listed on Dhaka Stock Axchange (DSA) shoed that investors do not gain value

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from dividend announcement. :ndeed shareholders lost about 30 percent of value

over a period of 40 days prior to the dividend announcement through to 40 days

after the announcement. he lost value may be partially compensated because of the

current dividend yield. Everall$ the evidence tends to support the dividend

irrelevancy hypothesis. Avidence also indicates that dividend payment does not

signal any information to the investors.

he study shos that the highest average dividend as paid in the 8uel and

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comparing the actual value of the ra price ratio$ market ad?usted price ratio$ ra

price drop and market ad?usted price drop to their theoretical values. he difference

as tested for significance using the one sample t>test. he results shoed that there

are significant differences in the observed figures from their theoretical or expected

values. he observed ra 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 ad?usted ra price ratio is also higher than

the expected value of 1. he ra price drop and market ad?usted price drop are

loer than the dividend yield$ indicating again that the stock price drops by an

amount that is less than the dividend paid. he study is inconsistent ith the

findings by ;ikolas et al (300/)$ ho studied the ex>dividend day stock price

behavior in the S+SA and SISA indices of the Chinese Stock Axchange using asimilar method but consistent ith 2lm et al (1---) ho carry out a study using the

Stockholm stock exchange here his findings shoed that the stock price drop on

average is less than the dividend been paid out.

a dividend price all

over the actual dividend paid. Knder normal circumstances$ that is$ here

there are no arbitrage opportunities and here the market efficiencyhypothesis is assumed to be true$ the theoretical value of the ra price ratio

should be e6ual to 1.

&arket 2d?usted dividend price expressed as a

fraction of the actual dividend. Similarly under perfect capital markets$ the

theoretical or expected value of the market ad?usted ra price ratio is e6ual

to 1.

a dividend price expressed as a fraction of the cum>dividend price. :n

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perfect capital markets$ the hypothesi%ed value of the ra price drop is e6uivalent

to the dividend yield.

&arket 2d?usted dividend price. 2lso$ under perfect capital markets$ the market ad?usted

price drop is e6uivalent to the dividend yield.

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2.! DI(ID&ND PO'IC, )ND )S,&TRIC IN*OR)TION

:n a symmetrically informed market$ all interested participants have the same information

about a firm$ including mangers$ bankers$ shareholders$ and others. +oever$ if one group

has superior information about the firm's current situation and future prospects$ an

informational asymmetry exists. &ost 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. :n response to such announcements$ share

prices usually increase folloing dividend increases and dividend initiations$ and share

prices usually decline folloing dividend cuts and dividend eliminations. he idea that

dividend payouts can signal a firm's prospects seems to be ell accepted among the chief

financial officers (C8Es) of large KS corporations. :n a survey of these executives

conducted by 2brutyn and urner (1--0)$ /4 of the respondents ranked signaling

explanation as the first reason for dividend payouts.

:nformation about the prospects of a firm may include the firmFs current pro?ects and its

future investment opportunities. he firmFs dividend policy$ either exclusively or in

combination ith other signals$ such as capital expenditure announcements or trading by

insiders$ may communicate this information to a less informed market. Ampirical studies

in this area include 2kerlof's (1-0) ,hattacharya model (1--)$ John and illiams

model (1-") &iller and ock model (1-") Constantinides and Grundy (1--) John and

;achman (1-/) Lale and ;oe (1--0)$ 2llen . ,ernado $ and elch (3000)

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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

ithout dividend information.2 number of studies have tested these implications of the

information content of dividends hich includes studies by atts (1-4) Gonedes (1-)

. Charest (1-) &ichaely $ haler and omack (1--") ,enart%i$ &ichaely$ and haler

(1--) Grullon$ &ichaely and Saminathan (3003ipson$ &a6uieira$ and &egginson

(1--) ,rook$ Charlton$ and +endershott (1--) ;issim and Iiv (3001)

2.$ R&S&)RC+ ON CORPOR)T& DI(ID&ND PO'IC, D&T&RIN)NTS

,lack (1-/) in his study concluded ith the folloing 6uestion9 hat should the

corporation do about dividend policy7 e don't kno* .2 number of factors have been

identified in previous empirical studies to influence the dividend policy decisions of the

firm.

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past dividends.

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8ama (1-5)$ and Smirlock and &arshall (1-4) documented no interdependence beteen

investments and dividends.

+iggins (1-1) indicated a direct link beteen groth and financing needs9 rapidly

groing firms have external financing needs because orking capital needs normally

exceed the incremental cash flos from ne sales!1/#. o%eff (1-3)$ loyd et al.(1-")

and Collins et al .(1--/) all sho significantly negative relationship beteen historical

sales groth and dividend payout.

2rnott and 2sness (3004) based their study on 2merican stock markets (SM 3004.heir regression results shoed a strong positive relation

beteen payout ratio and future earnings groth. &ancinelli and E%kan (300/) undertook

an empirical investigation of the relationship beteen the onership structure of

companies and dividend policy using 14- firms listed in :talian exchange. heir results

suggested that the dividend payout ratio is negatively associated ith the voting rights of

the largest shareholders. &ohammed 2midu and Joshua 2bor(300/) examined the factors

affecting dividend payout ratios of listed companies in Ghana. he results of their study

shoed that payout ratios ere positively related to profitability$ cash flo and tax but are

negatively related risk and groth. !"#

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2.: INDI)N SC&N)RIO

:n :ndian Context$ a fe studies have analy%ed the dividend behavior of corporate firms.

Lrishnamurty and Sastry (1-1) analy%ed dividend behaviour of :ndian chemical industry

for the period 1-/3>/ and undertook crossectional data of 50 - $ alters the

demand of investors in favor of high payouts!43#. &ohanty (1---) found that firms$

hich issued bonus shares$ have either maintained the payout at the pre bonus level or

only decreased it marginally thereby increasing the payout to shareholders!4/#.;arsimhan

and =i?ayakshmi (3003) analysed the influence of onership structure on dividend

payout of 1/ manufacturing firms. egression analysis shos that promoters holding as

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of September 3001 has no influence on average dividend payout for the period 1-->

3000!3/#!44#.

2nand &ano? (3003) analy%ed the results of 3001 survey of 1 C8Es of ,usiness today>

"00 companies in :ndia to find out the determinants of the dividend policy decisions of the

corporate :ndia. +e used factor analytic frameork on the C8EsF responses to capture the

determinants of the dividend policy of corporate :ndia. he findings revealed that most of

the firms have target dividend payout ratio and ere in agreement ith intnerFs study on

dividend policy. C8E's 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. he managers design dividend policy after taking into consideration the investorsF

preference for dividends and clientele effect. !51#eddy R.Subba and ath Subhrendu

(300") examined Dividend trends for large sample of stocks traded on :ndian markets

indicated that the percentage of companies paying dividend declined from over " in

1--1 to 43 in 3001$ and that only a fe firms paid regular dividends. Dividend B paying

companies ere less likely to be larger and more profitable than non>paying companies$

though groth opportunities do not seem to have significantly influenced the dividend

policies of :ndian firms. he rise of the number of firms not paying dividends is not

supported by the re6uirements of cash for investments !50# Sharma Dhira? (300)empirically examined the dividend behavior of select :ndian firms listed on ,SA from

1--0 to 300".he study analy%ed hether or not the dividends are still vogue in :ndia and

tried to ?udge the applicability of one of the to extremely opposite schools of thoughts>

relevance and irrelevance of dividend decision. he study also analy%ed the applicability

of tax theory in the :ndian context. he findings offered mixed and inconclusive results

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about tax theory indicating that the change in the tax structure does not have a substantial

effect on dividend behavior of firms.!53#

2 number of conflicting theoretical models$ all lacking strong empirical support$ define

recent attempts by researchers in finance to explain the dividend phenomenon. ,ut to

come ith concrete conclusions an intensive study of all theoretical models together ith

empirical proof is needed. he 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. herefore it becomes important to study dividend behavior of :ndian

companies using the frameork of empirical models.

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!. R&S&)RC+ OB&CTI(&S

he study is focussed on achievement of folloing four ob?ectives9

1. o empirically examine the determinants of dividend smoothing by firms and find out

its linkage ith information content of dividends.

3. o analy%e the influence of firms' characteristics like profitability$ groth$ risk$ cash

flos$ agency cost and on dividend payment pattern. i.e. to identify various

determinants of dividend payout.

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4. o investigate the association beteen various onership groups and dividend payout

policies of :ndian corporate firms.

5. o find the impact of dividend announcement on shareholders' ealth

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$. R&S&)RC+ &T+ODO'O/,

:n this section a brief overvie of various dimensions of the research$ tools and techni6ues

and methods used to achieve various research ob?ectives has been discussed.

$.1 T+& D)T) )ND S)P'&

he study is focused on three sectors :$ 8&CG and Service sector.

IT #ector

: sector has been chosen for study because it is a sunshine sector of :ndia. :t currently

accounts for almost 5. of :ndia's GD

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banking and insurance etc. ill 3003 service sector as ignored in :ndia and the main

emphasis as on manufacturing and agricultural sector. :t as only after 3003 that service

sector started groing at a healthy rate of >10. oday it is the highest contributor to the

GD< of our economy.

T+& D)T)

he research is analytical and empirical in nature and makes use of secondary data. he

data has been sourced from

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he data used for achieving each ob?ective as made suitable for analysis as per the

methodology. hus$ the data collected from

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companies$ hich are constituent of C;] service sector :ndex$ have been undertaken.

C;] service sector index is a 3- stock index developed by ::S.

he list of the sample companies for each of the sector has been appended to the annexure

(2nnexure :)

$.2 OD&'S )ND T&C+NI@U&S

8or the conduct of the study various models have been developed and used. his section

discusses these models and various tools and techni6ues used to carry out the research.

$.2.1 'INTN&R OD&'

intner (1-"/) developed a model to study the determinants of the dividend behavior of

2merican corporations assuming that the dividend payout is a function of net current

earnings after tax (1). Companies decide to payout a fixed proportion of their net profits as dividend to

common stockholders@ but in vie of their ell knon preference for stable dividends

may try to achieve the target level only by a fraction of the amount indicated by the target

payout ratio henever profit changes. he above theoretical formulation of intner has

been used as an estimating e6uation for corporate dividend in the present study$ hich is

as follos>

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DWit U ^iAit XXXXXXXXXXXXXXXXXXXXXXXXXX(1)

DitBD i(t>1) Uai V Ci_DWit >Di(t>1)`V uitXXXXXXXXXXXXXXXX.(3)

here$

DWitU desired dividend payment during periodQt'

DitU 2ctual dividend payment during periodQt'

^iU arget payout ratio

Ait U Aarnings of firm during periodQt'

aiU a constant related to dividend groth

CiU partial ad?ustment factor

uitU error term

DitBD i(t>1) U ai V Ci_ ^iAit >Di(t>1)`V uit XXXXXXXXXXXXXXX.(4)

DitUaV ^i Ci Ait V (1>Ci) D i(t>1) Vuit XXXXXXXXXXXXXXXX...(5)

his model can further be simplified in the form of a multiple regression e6uation

DtUaV ^iAit V Ci D (t>1) Vuit XXXXXXXXXXXXXXXXXXXXXXXXXXXXXX(")

o understand the relationship beteen dividend and earnings (

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carried.

'INTN&R OD&' US&D

RU^ V 1]1V 3]3 uit V it XXXXXXXXXXXXXXXX XXX(/)

here$

RU dependent variable (e6uity dividend in s. crore during period t)

]1U independent variable (1 i.e. (1>c) and c is the ad?ustment

factor.

uit U firm specific components

it U disturbance term

herefore$

arget payout ratioW ad?ustment factor U 1

^iW Ci U 1

^iW(1>27 E 1

Th%# %"l%e# ^: U target payout ratio U 1F41?27

Speed of ad?ustment factorU41?27

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hus $the regression results forms the basis of testing the applicability of intner model

hich is a finance classic in each of the sectors.

$.2.2. *)CTOR )N)',SIS

o kno the key determinants of corporate dividend payout ratios for :ndian :nformation

echnology$ 8&CG and Service sectors factor analysis is used. En the basis of literature

revie$ the folloing key variables have been identified that influence the dividend payout

ratio of the firm.

RU A6uity dividend (in crores)$]1U

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he statistical techni6ues of

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]-U etained ratio of the firm Qi' during periodQt'

]10U Capital expenditure or Gross fixed assets (t>(t>1)) to fixed asset ratio

]11U ;ifty beta of firm Qi' during periodQt'

]13U;atural log of &arket capitalisation of firm Qi' during period Qt'

]14U

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taken as independent variables.

he first model can be expressed as

]U,V A XXXXXXXXXXXXXXXXXXXXXXXXXXXXX()

here ] is a matrix of independent variables$ is a vector of unobservable factors@ , is

the vector of error terms.

he regression model for second step is shon in e6uation ()

D

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$.2.! @U)DR)TIC PO',NOI)' R&/R&SSION )N)',SIS USIN/ P)N&'

D)T)

he results in : sector are reported by expressing lagged

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2part from the above determinants of corporate dividend policy$ influence of onership

groups on dividend payout has also been reported by the previous studies. he key

onership variables that can affect Dividend

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coefficient for s6uared onership variables support the postulated relation. A6uation - and

10 shos the model developed for analysing the third research ob?ective. he techni6ue of

6uadratic polynomial regression analysis has been used for data analysis.

'IN&)R OD&'

Dividend payoutitU^iV1]1itV3]3itV4]4itV5]5itV"]"itVuitVitVitXXXXXX (-)

RU Dividend payout ratio of firm Qi'during time period Qt'

]1itU

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RU dividend payout ratio of firm Qi'during time period Qt'

]1itU

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he agrange &ultiplier (&) test shos the acceptability of panel data models over

classical regression models. angrange &ultiplier 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 inear egression model. !4/#+igh values of +ausman

statistics indicate the use of fixed effect models over andom Affect models and the lo

value of +ausman statistics induces to use the andom effect models. he 8 test and

ikelihood atio()test results sho that both the firm and time effects are present in the

data.

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$.2.$. &(&NT STUD,

o analyse the impact of dividend announcements on shareholdersF ealth in the selected

sectors in :ndia Avent study

-

approach has been used. he folloing steps ere folloedto perform event study.

P he first step as to find out the dividend announcement dates in each of the sector

respectively from 3001 to 300.Conse6uently 1/ dividend announcements dates

ere obtained in : sector and 1-- and 303 dates in the 8&CG and service sector

respectively.

P Astimation indo of 1"0 days as chosen based on literature survey.

- his section has been taken from Q2 beginner's guide to event studies'by illiam +. ells

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P he event indo of 30 days before the event and 30 days after the event i.e. 51 days

has been taken

P 8or calculating expected returns as per &arket model daily ad?usted closing prices

ere taken

P Cumulative abnormal returns ere calculated ith the help of average abnormal

returns to see the reaction over a period of time

P 8inally$ t statistics ere calculated to cross Bsectionally by using standard deviation of

abnormal returns.

P

o estimate the stock price response to dividend announcements$ eturns (it) hich is the

time t return on security Qi' ere calculated as (

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A(it) U a V bi m$tVei$tXXXXXXXXXXXXXXXXXXXXXX...(15)

here$ m$t is the return on the market portfolio on day Qt' proxied by specific sector

indices10

$ ei$t is the random error term and ai and bi are the market model parameters.

he abnormal returns may be positive or negative as per the response of investors to the

occurrence of event (:n this case dividend announcement). 8or this one has to apply as

many regressions as the numbers of dividend announcement dates are.

he 2s are then averaged across the sample of firms according to the formula9

22s U2vg(2t) U (1H;) 2it XXXXXXXXXXXXXXXXXX.(1")

here$

; is the number of sample observations.

10;ote that C;] : index has been taken as proxy for market index in : sector hile in 8&C G and

Service sector$ the proxies used are ,SA 8&CG and ;:8R "0 repectively.,SA 8&CG and ;:8R "0

:ndex have been taken because the values of C;] 8&CG and C;] Service sector are not reported by

;SA.

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hus$ the abnormal returns ere averaged by dividing it by the number of days to find out

daily average abnormal returns. he process as repeated for all the dates and finally

average cumulative abnormal returns ere obtained. his is the second measure (C2)$ it

measures the investors' total return over a period starting from before the announcement of

dividend to after the dividend announcement day. he cumulative abnormal returns from

day t1 through t3 $C2t $ are 9!4-#

C22t U 2vg (2t) here t U t1 to t3 XXXXXXXXXXXXXXX..(1/)

C22 may be positive or negative. :f C22 is negative in periods after dividend

announcements$ this suggests dividend announcements do not carry information about

future earnings and cash flos of the companies. 2 positive C2 indicates distribution of

dividend adds to shareholders' value by conveying good nes to the market. e use a 51

day event indo period starting from B30 to

V30 day relative to the dividend announcement day (0 day) .8or the purpose of analysis

both interim and final dividend announcements has been taken.

o compute the t>statistic$ first$ all abnormal returns are standardi%ed as9

S2 itU 2it H Si (2)XXXXXXXXXXXXXXXXXXXXXXX(1)

here $Si (2) is the standard deviation of the abnormal returns of stock Qi' in the

estimation period. he t>statistic for the sample of" observations for each day Qt' in the

event indo is calculated as9

t(S2) U (iU1 to ; S2 it) .1H; XXXXXXXXXXXXXXXXXXX(1)

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: )N)',SIS )ND *INDIN/S11

:.1. 'INTN&R OD&' IN IT S&CTOR

he regression results (refer to 2nnexure 3) of one ay 8ixed effect model shos that

divided paid during previous year is significant at " level of significance. he 2d?usted

s6uare is 0.8 statistics is significant at " level of significance shoing overall

validity of the model.he results highlight that there is o dividend smoothing in this

sector as it is characteri%ed by high target payout ratio and high speed of ad?ustment

coefficient.

:.2. 'INTN&R OD&' IN *C/ S&CTOR

he regression results (refer to 2nnexure 3) sho that

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:.! 'INTN&R OD&' IN S&R(IC& S&CTOR

Dividend paid during the previous year and

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loadings. 2 factor loading is simply the correlation of an original variable ith factor. 2s

suggested by Dillion and Goldstein$ variables ith factor loadings greater than absolute

value of 0.40 or more are considered significant and$ thus$ used in labelling of factors. 2s

shon in the factor pattern matrix a set of factors have been been extracted. hese

factors have been labelled as 8actor of dividend signaling and promoter holding$ 8actor of

li6uidity ratios$ 8actor of longterm solvency$ 8actor of financial and systematic risk$

8actor of firm si%e$ 8actor of retained earnings and dividend stability$ 8actor of groth

and expansion and 8actor of valuation and capital market ratios.

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*I/UR& 1 SCR&& P'OT

Scree Plot

5

4

3

2

1

0

1 3 5

7 9 11 13 15 17 19 21

Component Number

2n elbo in the scree plot indicates the point at hich the inclusion of additional factors

does not contribute significantly in explaining the variance in data set. 8actors above the

elbo of the plot are retained. he Scree plot shon above has an elbo at 8actor

.herefore a set of 8actors ere chosen hich accounts for about of the variations

in the data.

6.1.2 R&/R&SSION R&SU'TS ON &GTR)CT&D *)CTORS

he able 3.4(refer annexure 4) shos the regression results on extracted factors. 8actors

4$ 5$"$/ and have expected signs. Eut of these factors only to factors i.e. 8actor / and

have regression coefficients$ hich are statistically significant at " level of significance.

,oth factor 1 and 3 have exactly opposite signs of regression coefficients compared to

hat as expected based on previous research studies. he value of 2d?usted 3 is 0."

igenvalue

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he 8 values are also significant at " level of significance.

6.1.!. *INDIN/S

2 set of factors has been extracted through the techni6ue of

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smoothing$ 8actor of cash flo 6uality and firm si%e$ 8actor of future expansion and

groth$ 8actor of onership and li6uidity$ 8actor of earning variability and systematic

risk$ 8actor of longterm solvency and financial leverage.

*I/UR& 2 SCR&& P'OT

Scree Plot

6

5

4

3

2

1

0

2s discussed$ 8actors above the elbo of the plot are retained. he Scree plot shon

above has an elbo at 8actor /.herefore a set of / 8actors ere chosen hich accounts

for about / of the variations in the data.

Eigenvalue

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6.2.2 R&/R&SSION R&SU'TS O* &GTR)CT&D *)CTORS

able 3./ (refer to annexure 4) shos 8actors 1$3$4 and / have expected signs. Eut of

these factors only one factor i.e. 8actor 3 has regression coefficient$ hich is statistically

insignificant at " level of significance. 8actor 5 and " have exactly opposite signs of

regression coefficients compared to hat as expected based on previous research studies.

he value of 2d?usted 3 is 0./43. 8 statistics are significant at " level of significance.

6.2.! *INDIN/S

Eut of six extracted factors " ere found to be significantly related to D< ratio.2

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6.!. )N)',SIS O* S&R(IC& S&CTOR

2s done in the other sectors the first step as to calculate L&E. :t is a measure that

?udges the sampling ade6uacy. he value obtained is ."0/ hich ensures the sample si%e

is sufficient to apply 8actor 2nalysis.(refer to table 3. in annexure 4) ,artlett test of

spherecity is the statistical test for overall significance of all correlations ith in a

correlation matrix. :t also ?udges the appropriateness of factor analysis.

6.!.1 *)CTOR &GTR)CTION

he table 3.(refer to annexure 4) shos the variance exhibited by extracted factors. :t

shos that the first factor accounts for highest amount of variance$ the second factor

accounts for second highest and so on.he principal components analysis using Qvarimax

rotation method' of correlation matrix of the 33 variables have led to the extraction of

seven broad components of dividend policy of the corporate :ndia. hese factors

accounted for 30$13$10$10$$ and " of the total variance explained$

respectively. 2ccordingly$ these factors have been labeled as 8actor of dividend signaling

and profitability$ 8actor of li6uidity ratios and systematic risk$ 8actor of firm si%e$ 8actor

of agency conflicts and onership$ 8actor of cash flo 6uality and dividend stability$

8actor of groth and expansion and 8actor of longterm solvency.

*I/UR& ! SCR&& P'OT

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Scree Plot

5

4

3

2

1

0

1 2 3 4 5

6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21

Component Number

2n elbo in the scree plot indicates the point at hich the inclusion of additional factors

does not contribute significantly in explaining the variance in data set. 8actors above the

elbo of the plot are taken. he procedure involves certain amount of sub?ectivity$ if no

clear elbo appears in the curve. he Scree plot shon belo shos a clear elbo at

8actor . hese seven factors account for about 3 of the variations in the data.

Conse6uently these seven 8actors are retained in the analysis

Eigenvalue

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6.!.2 R&/R&SSION R&SU'TS O* &GTR)CT&D *)CTORS

he regression results are highlighted in the able 3.-(refer to the annexure 4). Eut of

factors / factors have statistically significant regression coefficients. Enly one 8actor

i.e.8actor of dividend signaling and profitability has statistically insignificant regression

coefficient at " significance level. 8actor 4 and " have exactly opposite signs as

established by previous research studies. he value of 2d?usted 3 is ./" hich indicates

that these factor combined together explain // of the dividend payout pattern of :ndian

Service sector. he 8 values are also found to be significant at " level of significance.

6.!.! *INDIN/S

2 set of / factors out of are found to be significantly related to D< ratio. his shos that

capital gains are preferred to cash dividends. he regression results have indicated a

negative and significant relationship beteen D< ratio and 8actor of li6uidity$ firm

si%e$ groth M expansion. +oever$ the 8actor of long>term solvency is significantly

positively related. hus :t can be said$ Smaller firms tend to pay more dividends in order

to allure shareholders' and compensate them for risk involved !35#. 8irms in Service sector

prefer to retain funds henever any future investment opportunity is foreseen for further

groth and expansion.

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test results sho that both firm and time effects are present in the

data.angrange &ultiplier test statistics presented in the able 4.3 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 inear regression model.+ausman specification test

results presented in this able4.3 conclude to prefer random effect model to fixed effect

model. ,ut e restrict our interpretation to fixed effect firm and time models (to ay).

able 4.4(refer to annexure 5) depicts the results from 8ixed effect firm &odel estimation

assuming non>monotonic relationship beteen regressors and regressand. able 4.5(refer

to annexure 5) shos regression results of 8ixed effect to ay model. &odel represented

in able 4.5 assumes linear relationship beteen D< ratio and onership variables. and

able 4."(refer to annexure 5) depicts the 8ixed Affect firm and time effects results of

6uadratic polynomial model.

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:n &odel : none of the variable is found to be significant at " and 10 respectively. 8

statistics also sho that this model does not fit e