conclusions and future research and...
TRANSCRIPT
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CHAPTER 9
CONCLUSIONS AND FUTURE RESEARCH AND
THINKING
9.1 CONCLUSIONS
Academic researchers cannot specify a theoretical optimal dividend policy that
simultaneously fits all firms (a macro-level policy). Because of the complexities
involved, it is skeptical that a one-size-fits-all theory of dividend policy will ever gain
acceptance. Over the years researchers have proposed numerous theories on how
imperfections—various market frictions—might influence dividend policy. Each firm
faces a combination of potentially different market frictions with varying levels of
relevance; the optimal dividend policy for each firm may be unique. If each firm has a
uniquely optimal dividend policy, one should not be surprised that significant
statistical generalizations still elude researchers. Existing models studying the impact
of dividend policy on firms' value cannot fully reflect the complexities of the market
environment. The goal of this research is to provide a comprehensive framework to
assist managers in making dividend policy decisions.
Corporate Financial Managers view dividend decision as important and relevant
decision. However any advice offered to managers on how to set their dividend
policies must be made at the firm-specific level. These Corporate Financial managers
must examine how the various market frictions affect their firms, as well as their
current claimholders, to arrive at "Optimal" dividend policies for their firms.
Usually management of a firm believes that three market frictions are relevant to a
firm: They are taxes, asymmetric information, and agency costs. The firm's managers
should evaluate the impact on a dividend decision of each market friction in isolation
and then consider the potentially complex interaction of the three imperfections
before formulating a reasonable dividend policy. The figure 9.1 shows the competing
frictions framework, or schematic model. If a balance of scale is considered on which
the merits of the dividend policy are weighted on t he right-hand side against dividend
policy irrelevance on the left-hand side as illustrated in 9.2. Panel (a) reflects the view
of dividend policy relevance in a world of perfect capital markets, in which the scale
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strongly tips toward the irrelevance of dividend policy. In Panel (b) portrays the scale
in a world beset with market imperfections. It is believed that the forces of market
frictions tip the scale toward the relevance of dividend policy. For certain firms,
specific frictions will have a large influence; for other firms these same market
imperfections may be insignificant. In other words, the weights on the market
frictions will differ from firm to firm.
Figure 9.1: The "Balance Scale" of Dividend Relevance
Source: Lease, C,.Ronald, John Kose, Kalay Avner,Loewenstein Uri,Sariq H.Oded,
“Dividend Policy: Its Impact on Firm Value”
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Figure 9.2: The Competing Friction Model
Source: Lease, C,.Ronald, John Kose, Kalay Avner,Loewenstein Uri,Sariq H.Oded,
“Dividend Policy: Its Impact on Firm Value”
In the forthcoming sections the big three imperfections have been discussed and their
interaction with the little frictions has been discussed. An attempt has also been to
throw light on how financial managers should incorporate these imperfections into
their decision-making.
9.1.1 THE BIG THREE MARKET IMPERFECTIONS AND THEIR
INTERACTION WITH LITTLE FRICTIONS
9.1.1.1 Taxes
Firms should have a reasonable idea of the identity of their main categories of
shareholders. The attributes of the shareholders generally can be classified as:
Investors who prefer capital gains,
Investors who prefer dividend income, and
Low Payout
High Payout
Asymmetric information
High Payout
High payout
Low Payout
Taxes Agency costs
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Investors who are tax-neutral.
Evidence supporting the existence of tax-induced dividend clienteles of shareholders
is limited. It may be stated such tax- induced clienteles may not exist in India as
dividend income is tax exempt for shareholders. However, literature believes that
investors have a tendency to self-select into investing in firms that have dividend
payouts that best match their tax circumstances.
However, in the long-run, one tax-induced dividend clientele should be as good as
another. Because of the potential importance of tax considerations in making the
dividend policy decision, financial managers should keep a close eye on changes in
the tax code. Substantial changes may dictate a shift in dividend policy. The dual
moral of this discussion is, Know Both The Investors and Tax Code!
9.1.1.2 Agency Costs
Firms should adopt a dividend policy that allows implementation of an investment
policy that maximizes market value. In general, firms should not underpay dividends.
Retained funds should be invested in projects that pass the NPV Rule. Having too
much cash lying around is an ill-advised investment. Consistent with this observation
is research that illustrates that the market responds positively to the announcement of
increases in capital expenditures.
In short, excessive cash balances increase managers' degree of investment flexibility,
which may be to the detriment of shareholders. After all, managers experience a
normal set of human temptations. If management compensation and/or prestige is
based on firm size or sales, managers may be tempted to over invest in projects or to
acquire other firms that may not be strategically advisable nor value enhancing.
Several researchers have identified dividend payments as a source to mitigate agency
conflicts.
In general, high-growth firms can afford to write strict or tight dividend constraints
that severely limit their ability to pay future dividends. Moreover, dividends are less
important to investors in high-growth firms who seek out these firms in the
expectation of receiving little, if any, dividend income. Dividend slack decreases the
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protection of debt holders and results in an interest rate that is too high relative to the
risk of the debt.
For the opposite reasons, low-growth firms should negotiate looser dividend
constraints. With a scarcity of future positive NPV investments, these firms are likely
to generate large free cash flows that should be paid to shareholders. Without the
dividend payout commitment, overinvestment may be a temptation. Dividend slack
under the constraints is desirable in case of future economic setbacks and the desire to
maintain a high dividend payout level.
Highly leveraged firms can write strict dividend policy constraints. Heavy debt
service obligations limit these firms' ability to overinvest, and frequent refinancing
provides capital market discipline. Indeed, empirical research indicates that growth
firms and firms with higher leverage, all else being equal, choose tighter dividend
constraints and pay fewer dividends (Kalay 1979). Thus, the evidence suggests that
many financial practitioners share these views.
9.1.1.3 Information Asymmetry
Research consistently has shown that dividend changes convey significant
information to the market. One of the most compelling pieces of empirical evidence
regarding dividends is the announcement effect of dividend changes on share prices.
Several empirical studies have documented significant increases in share prices when
firms initiate payment of dividends for the first time or after a hiatus of at least five
years. Several studies also have documented share-price increases on announcement
of dividend increases versus dramatic share-price decreases when firms reduce
dividends. Hence managers must be aware of documented market reactions before
they make dividend policy decisions.
The empirical evidence also documents that the market infers different messages with
respect to different dividend types. For instance, the market reacts more strongly to
regular dividend increases relative to specially designated dividends, or dividends
labeled extra or special.
Decreases in free cash flows should not be accompanied by dividend cuts, unless the
reduced levels of free cash flow are expected to continue into the future. Investors
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interpret dividend cuts as especially bad news, and share prices decline dramatically
when dividend cuts are announced.
Similarly, managers should be cautious about large increases in dividends, again to
avoid the possibility of subsequent dividend decreases. If increases in free cash flows
occur and are expected to persist, the dividend increases should be made gradually
over time. Alternatively, or simultaneously with the increase in dividends, a firm
should declare some of the distribution as a specially designated dividend or engage
in some share repurchases, along with smaller dividend increases. This approach
avoids making implicit (optimistic) statements that later may have to be reversed.
Again, while the market's interpretation of the underlying cause of dividend changes
is not well understood, it is not known that such changes are met with significant
market reactions. This observation supports an effort to smooth dividends in relation
to expected free cash flows over time as suggested by the John Lintner (1956)
Similarly little market imperfections can also have an impact on firms’ dividend
policy decisions. Considered in isolation, the existence of transaction costs favors a
managed dividend policy. If firms have a consistent and stable dividend policy—
whether the policy is high, low, or no distribution—investors can select the policy that
best matches their consumption and tax profiles.
Similarly, flotation costs favor a residual policy when considered in isolation.
Flotation costs can be substantial, especially for small firms and small equity issues.
Accordingly, small firms should pay out cash only if operating cash flows exceed
expected capital expenditure levels. Managing dividends will, almost without doubt,
result in a higher level of flotation costs.
In the real world, imperfections affect firms interactively, and managers should
consider these interactions when making dividend policy decisions.
The number of permutations of the six market imperfections discussed is large. For
instance, we could consider a market setting that includes (1) taxes and agency costs,
(2) taxes and asymmetric information, (3) taxes plus transaction and floatation costs,
(4) agency costs plus floatation costs, or (5) asymmetric information, taxes,
transactions costs, and flotation costs.
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9.1.2 STRATEGIES IN DEALING WITH MARKET IMPERFECTIONS
Dealing strategically with market imperfections can be diagrammed on
multidimensional axes in a competing frictions model, as illustrated in Figure 9.2
wherein the frictions (imperfections) are weighted by management's assessment of
importance. Managers should qualitatively mark each market imperfection having an
impact on their firm on a continuum reflecting their assessed level of importance. The
managers can sequentially analyze the dividend policy implications of the relevant
imperfections. Decisions on the trade-offs among imperfections must be made in the
context of their relative importance.
For example, if the management believes that three market imperfections—taxes,
asymmetric information, and agency costs—are relevant to the dividend decision for
their firm. Further, they believe that these imperfections affect their dividend decision
in this same order of importance. Within this framework, the managers consider each
imperfection in isolation and then in combination to arrive at their choice of dividend
policy. (Refer again to Figure 9.2)
The present study is a fact finding research and complicated in nature like the other
functional areas of finance. In course of the study the importance and nature of
dividend decision in Indian corporate sector has been examined. The various
dimensions of dividend decisions have been dealt in the light of the existing theories
on dividend policy. The detailed review of empirical studies and the research work
has provided a direction and insight into various determinants having a direct bearing
on the dividend policy decision of the firm. This may help the financial managers in
handling the crucial and the complicated dividend policy decision-making. The
analysis of trend of dividend payout ratio tries to bring a close shot on payout policy
of the companies belonging to select sample industries.
The analysis of the determinants of dividend policy in select sectors in India based on
sophisticated statistical models highlighted the determinants that best explains
dividend policy in Indian IT, FMCG and Service sectors in India. Thus, this analysis
provides adequate information to the investors, managers and researchers to know the
relative significance of the various determinants influencing the dividend payment
decision of companies.
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As discussed in the section on literature review dividend relies on two sets of
explanation. Dividend signaling or information asymmetry models and secondly
agency costs. Both explanations to the dividend theories have been studied in the
present research work.
This study has tested empirically the agency cost theory, Lintner model, dividend
signaling and smoothing effects using a framework of various econometric models.An
attempt has also been made to identify linkage of dividend decision with shareholders’
wealth.
Assuming that dividend has information content and managers try to make efforts to
smooth dividend payments, the validity of the Lintner model in the select sectors under
study was tested. This also highlighted to what extent dividend smoothing efforts are
done by managers in the three sectors chosen for study.
Out of the chosen sectors Lintner model fits well in the FMCG sector signifying that
the dividend signaling and smoothing effects are present. Thus these firms follow
stable dividend policy year on year basis, even though earnings might change
dramatically. The findings in the FMCG sector are in alignment with Brave et.al that
managers are very reluctant to cut dividends once they are initiated. This reluctance
leads to dividends that are sticky, smoothed from year to year and tied to long run
profitability of the firm.
The regularity of dividend payment and constancy of its rate is an important objective
of the dividend policy followed by the Chief Finance officers of the FMCG sector. The
findings reflect the companies ensure that the current dividend signals their
performance and the desire of management to maintain a stable dividend.
The target payout ratio in FMCG sector hovers with in the range of 69% to 128%. The
partial adjustment factor is found to be 0.115 to0.52, which lies between one sixth and
one half as highlighted by Lintner in his findings. Due to strong bias against dividend
cuts, increase in earnings is translated into increase in dividends only gradually to
avoid future downward revision. It may be stated that the principal determinant of
dividend policy in FMCG sector is profitability. Thus, FMCG firms use dividends to
signal their surge in profit margins over the years. These findings are in conformity
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with Mookerjee Rajen(1992)who found that Lintner model is successful in explaining
dividend payout behavior of private corporate sector.
The amount of dividend distributed during the previous year was also found to be a
significant factor governing the dividend distribution of the current year. The results
in FMCG sector is in conformity with the pattern seen in developed economies like
USA and Germany and is in agreement with the studies by Fama and Babiak (1968)
and Behm and Zimmermann (1993).
However, IT sector and service sector demonstrated a pattern, which is seen in
emerging economies like Tunisia, Zimbabwe and Turkey. These sectors are
characterized by high target payouts coupled with high speed of adjustment
coefficient. The target payout ratio in service sector derived from β1 lies between the
broad ranges of 31 to 35%. This is relatively a low target payout ratio as compared to
what was suggested by Lintner. The partial adjustment factor is found to be with in
the range of 0.369 to 0.5278, which lies between one sixth and one half as
highlighted, by Lintner in his study. The choice of a particular speed of adjustment
factor depends upon possible variations in net earnings after tax and stability of
dividends required. Stable net earnings after tax would induce a management to
choose a higher adjustment coefficient. But if net earnings were subject to wide
fluctuations, a desire to have stable dividend would lead to choosing lower adjustment
coefficient.
It may be stated that the principal determinant of dividend policy in Service sector is
profitability. The results signify that Service sector companies score high on dividend
stability. Firms in Service sector use cash dividends to signal their prosperity to the
shareholders. The results are in agreement with the previous studies on banking
industry, which state that banks use their dividend history to set their dividend. These
results were established by Dickens N.Ross and Newman.A.Joseph in their study
“Bank Dividend policy: explanatory factors” and Pal Karam and Goyal Puja “Leading
determinants of Dividend policy: A case study of the Indian Banking Industry”. Bodla
B.S.,Pal Karam ,Sura S Jasvir “Examining Application of Lintner’s Dividend Model
in Indian Banking Industry”
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The firms in IT sector are not averse to cut dividends. Profits seem to be a noteworthy
determinant of dividend payments during entire time period under study. PAT is
significant at 5% level depicting for all the IT firms profitability is an indispensable
factor to be considered while determining dividend policy. But it should always be
kept in mind there are other factors also apart from profitability that may affect
dividend payments. However the regression coefficient of Div(t-1) is insignificant
showing that dividend paid during current year is not governed by dividend paid
during previous year. This also proves the fact that only one of the variables given by
Lintner has an impact on dividend declared by the firms in IT sector.
The target payout ratio in IT sector revolves around 30%. This payout ratio is lower
than target payout ratio of 50 % suggested by Lintner. As regards the speed of
adjustment coefficient the value lies between 1.16 to 1.51, which is much higher
compared to what was suggested by Lintner.This high speed of adjustment coefficient
denotes that actual changes in the dividend may be much higher than desired changes.
This low target payout ratio coupled with high speed of adjustment factor shows the
absence of dividend smoothing and dividend signaling. The IT firms’ dividend payout
fluctuates with changes in the earnings. This suggests that higher dividend payout is
witnessed in IT industry only in the case of increased profitability of the companies.
Any variation in the earnings is quickly reflected in dividend payment.
Firms in the IT sector use dividends to signal their surge in profit margins over the
years. The regularity of dividend payment and constancy of its rate is not an important
objective of the dividend policy followed by IT industry in India. These findings are
validated by the fact that IT sector is characterized by low target payout ratio and high
speed of adjustment factor.
Thus, the analysis of the first objective has unearthed the applicability of smoothing
and signaling approaches and relevance of information asymmetry models in IT,
FMCG and Service sectors in India.
Through the analysis of second objective it was found that there are sectoral
differences in corporate dividend policy determinants. The results are consistent with
the conclusion of Baker, Farrelly, and Edelman (1985) and Ho Horace (2002) that
firm’s industry type influence dividend policy. A factor which may be relevant for one
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industry becomes irrelevant for another depending upon the industry characteristics
like growth phase, ownership pattern, size, systematic risk and earnings variability.
The period undertaken for study i.e. 2000-2008 covered both recessionary and
booming phases of Indian IT sector and FMCG sector. A shift in the dividend
payment pattern was observed in the IT sector as there was hike in the dividend
payout ratios of the major companies belonging to this sector. The firms in IT sector
do not use dividends as a medium to signal their prosperity to the shareholders. The
findings reflect that there is lesser information asymmetry in this sector. The
information is becoming more and more symmetrical due to better Corporate
Governance practices adopted by IT companies.
IT sector is a human intensive sector and do not require huge capital asset base like manufacturing
companies for their operations. The major asset of this sector is manpower. The funds required for
recruitment and retention of manpower is comparatively less than funds required for purchasing
capital assets. So these firms can easily release funds for payment of dividends. Also a negative
relationship between liquidity can be attributed to the fact that agency problems are not very
relevant so that monitoring mechanism i.e. dividend payout may be less needed. A negative
regression coefficient of liquidity and Dividend Payout ratio can be attributed to the fact that in IT
sector capital gains are preferred to cash dividends.
Retained earnings are a vital variable governing the Dividend Payout ratio of IT firms.
The results show that Factor of retained earnings and Leverage is positively related to
DP ratio. Generally, higher debt equity ratio may negatively influence the dividend
payout of company. But in case of IT firms the proportion of debt in the total capital
structure of the company is relatively low as they are very low debt or zero debt
companies eg. Infosys (a zero debt company). Therefore, Bondholders do not consider
dividend payment as a way to expropriate their value. The positive relation depicts
that debt holders do not reduce the cash available for the dividend by imposing debt
covenants and related restrictions. This positive relationship between Dividend payout
ratio and Debt equity ratio is in alignment with the findings of Easterbrook(1984)
.According to him firms with high leverage are those whose value shifting is
potentially costly. Such firms are expected to pay large dividends.
The Factor of profitability and pecking order, long-term solvency, Shareholders
wealth and earnings variability, have not emerged as an imperative factors
affecting the dividend payout ratios of IT firms
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FMCG sector recovered from its prolonged slump in 2005. FMCG companies have
been known to be generous dividend distributors to its shareholders. These stocks
were known as ‘dividend yield’ stocks till 2004.The companies maintained consistent
dividend payouts to some extent even when the profits were not on surge. After 2004,
FMCG stocks were purely viewed as ‘dividend growth stocks’ since the companies
deployed their resources for sustaining larger product baskets . The FMCG companies
adopted a CAPEX mode and started ploughing profits for future expansion plans. But
the high profitability enabled the firms to continue pay encouraging dividends even
after retaining a part of the profits. HLL, Godrej, ITC are among the top dividend
payers.
FMCG companies are known to be generous payers of dividend due to their strong
cash flow and minimal Capex requirement. Indian FMCG companies like their global
peers have developed some strong brands, sustained stable growth, high dividend
payout and high return on net worth (RONW)
The analysis of the second objective showed that Profitability is a primary
determinant factor for dividend distribution. FMCG companies score high on
dividend stability and consistency, as Lagged dividend and PAT are important factors
governing dividend distribution. These findings are in alignment with the findings of
Aharony and Wary(1980),Asquith and Mullins(1983), Petit(1972) ,John and
Williams(1980), Bhattacharya(1979), Miller and Rock(1985).
The quality of cash flows, which is a measure of liquidity of the firm and firm size are
found to be a note worthy determinant of the dividend payout. According to previous
research studies larger firms face lower issuing cost and external debt financing
making it easier to raise funds. Thus, they can go for generous dividend payouts.
These findings are consistent with the findings of Smith and Watts (1992).
The opportunities for future growth and expansion are found to be negatively related
to dividend payout ratio. Larger is the growth and investment opportunities available
to the firm, lesser is the incentive to pay dividends as the firms prefer to retain larger
proportion of profits. According to Pecking order hypothesis, firms should prefer to
finance investment by retentions rather than debt. The regression results also disclose
negative and significant relationship with Retained earnings and Capital Expenditure
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during the current year. This result is in alignment with the existing literature, which
suggests that results are logically, and theoretically correct. In other words, dividend
decisions are not independent of uses of corporate funds and changes in fixed assets
i.e. capital expenditure is an important determinant of dividend payments in FMCG
sector.
The systematic risk, earnings variability and financial risk obstruct the stable dividend
payout but the results report that in case of FMCG sector in India the Dividend Payout
ratio is increasing even if the firm faces higher risk.
Dividend Payout ratio is found to be positively related to long term solvency of the
firm. But this relationship is significant at 10% level. The firms in FMCG sector
operate with very low level of debt .At the same time these firms are highly liquid
firms, therefore increase in debt proportion in capital structure do not put pressure on
firms capacity to pay dividend and consequently a positive relation can exist between
Debt Equity ratio and Dividend Payout ratio through the results Dividend are less
important to investors in high growth firms who seek out these firms in the
expectation of receiving little dividend income as these firms need outside financing
regularly and therefore are subject to the discipline of frequent capital market
scrutiny. This also indicates lesser degree of conflicts between bondholders and
shareholders. The bondholders do not reduce the cash available for dividend
distribution by imposing indenture restrictions.
Indian service sector comprises of trade hotels, transport, communication, IT and
software, banking and insurance etc. Till 2002 service sector was ignored in India and
the main emphasis was on manufacturing and agricultural sector. It was only after
2002 that service sector started growing at a healthy rate of 8-10%. Today it is the
highest contributor to the GDP of our economy.
The dividend payout of service sector in India has increased leaps and bounds in last
few years. These hefty dividend payments can be attributed to surged profitability of
firms in this sector.
The results portray that higher the earnings variability higher will be dividend paid by
the companies in Service sector. A positive relationship has also been reported
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between Dividend payout ratio and long-term solvency. Higher ICR indicates that the
firm is financially sound to meet its precommited cash outlays in form of interest
A finding of the study that refutes the existing literature is that through the analysis a
negative relationship has been found between firm’s size and the dividend payout
ratio.This finding is not consistent with Pecking order hypothesis and stands in sharp
contrast with results in Smith and Watts (1992). Larger companies despite having the
opportunity to tap easily the financial markets by issuing stocks or bonds prefer to
retain dividends so as to avoid the costly external financing. Moreover, small firms,
which are more risky, need to have a high payout ratio, in order to attract investors to
buy their stocks.
The analysis of third objective demonstrates that the influence of ownership pattern on
the dividend payout is heterogeneous. It has been observed that there are sectoral
differences in impact and influence of ownership groups on dividend payout. India is a
common Law country characterized by strong investor protection and dispersed
ownership (the role of the insider is played by the manager), hence the agency conflicts
are not so severe and cash dividends may not be essential to mitigate the agency
conflicts.
The results in terms of ownership variables in IT sector give an interesting picture.
The debt equity regression coefficient is positive which is strikingly different from the
negative linear relationship proposed by studies in the past. The positive relationship
can be interpreted in the sense that agency conflicts are not so grave in the Indian IT
sector. This relationship highlights lesser conflicts between two groups of
stakeholders i.e. shareholders and bondholders in the Indian IT sector. Stockholders
may expropriate wealth from bondholders by paying themselves dividends.
Bondholders try to contain this problem through restrictions on dividend payments in
bond indenture. Thus, the positive relation depicts that debt holders do not reduce the
cash available for the dividend by imposing debt covenants and related restrictions.
This positive relationship between Dividend payout ratio and Debt equity ratio is in
alignment with the findings of Easterbrook(1984). According his research firms with
high leverage are those whose value shifting is potentially costly. Such firms are
expected to pay large dividends. The positive relation may also exist because the debt
proportion in capital structure of IT companies is very less eg.Infosys. Low-leveraged
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firms also should negotiate looser dividend constraints relative to firms with high debt
levels to provide future flexibility. Low debt service obligations mean less debt
refinancing and discipline imposed by capital markets. Accordingly, dividends and
dividend slack are relatively more important. Moreover, since debt levels are low
anyway, wealth transfers to bondholders by maintaining slack is not a significant
concern.
The further analysis in the IT sector results are consistent with Manager Entrenchment
hypothesis depicting that institutional holding regression coefficient is positive in
level and negative in square. This implies that upto a certain threshold43, dividends act
as substitute for corporate governance. After the threshold the direct monitoring
efforts of institutional holders are insufficient or become too costly. Therefore,
dividend payments are increased so that managers are forced to raise finance from
external capital markets and acts as an external monitoring device. These results are in
agreement with the findings of Short, Zhang and Keasey 2002, and Farinha, 2003). A
non-monotonic and parabolic relationship has been established by the research in IT
sector for the period under study. This in conformity with the findings of Demsetz and
Lehn(1985) and Schleifer and Vishny(1986)
A negative sign of Institutional holding can be justified on the grounds that they act as
a monitoring device reducing the need of high dividend payments.). However, it also
suggests that institutions may influence higher dividend payouts by a company to
enhance managerial monitoring by external capital market, as their own monitoring
efforts may be insufficient or too costly. Higher dividends would thus push the firms
frequently towards capital market for raising funds. The positive relationship occurs
beyond a certain thresh hold44
Institutional investors, most of whom are banks and Financial Institutions (either as
shareholders or debt holders) are also the creditors to the firm and to protect their
credit they may hold low level of holding.They prefer paying themselves interest
rather paying dividends. However at low level of holding, their benefit from the
dividends payout may be less than that at high level of holding. Thus, institutional
43 Jayesh Kumar in his study on association between corporate Governance and dividend payout identified this threshold level to be 25 % 44 Jayesh Kumar(2006) identified this threshold level to be 25%
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shareholders have negative impact on payout at low level of shareholding and positive
impact after certain threshold level of holding.
An analysis of pooled data regression results in IT sector showed that FII holding also
has an effect on the dividend payout ratio at higher levels of holding because it is
significant negatively related to dividend payout ratio in square. However promoter
holding is significantly negatively related to dividend payout ratio in level and
positively in square. Most of the IT companies in India have high promoter holding.
In the recent scenario companies like Wipro Ltd. have been generous in rewarding
their owners with cash dividends than some of the largest business groups in the
country. In FY07, the dividend earnings of promoters grew around 20% over the
previous year more than twice the rate of earnings growth of non- promoters. Since
the dividends are tax-free for promoters in India, they prefer rewards in form cash
dividends as their controlling stake in the company increases. Thus, promoter holding
and Institutional holding have emerged as the two major ownership groups that have
an impact on dividend payout ratios of companies in IT sector.
As regards Service sector, linear relationship between ownership groups and Dividend
payout ratio is found to be a better fit. FII holding has a major influence on dividend
payout ratios. This sector became active post liberalization i.e. after opening up of the
Indian economy. The foreign institutional investors negatively influence the dividend
payout of Service sector companies. During last 8 years there has been a significant
increase in FII holding in Service sector companies chosen as sample for this research
work. But still the percentage of shares owned by this group is relatively lower as
compared to other ownership groups. According to previous research studies a
positive and significant relationship between FII and dividend payout can be expected
only at higher levels of holding. According to Jayesh Kumar (2006) beyond a
threshold of 10%, FIIs may be interested in investing only in specific firms that are
well managed and profitable or vice versa and may target such firms only for their
investments. They may be going systematically after quality or systematically seeking
out under performing assets. Thus, FII holding may be higher for firms, which are
profitable and consequently pay higher dividends.
An explanation for the negative relationship could be that according to dividend
signalling hypothesis, dividends and institutional ownership can be viewed as two
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alternative means of signalling. Since the presence of the specific investors can, by
itself, act as a signal of satisfactory profitability, mitigating the need for maintenance
of a high dividend yield for informational reasons. This leads to the conclusion that
FII holding in a firm may signal the prosperity of the firm to the shareholders.
Therefore, such a firm may not pay huge dividends. Higher is the holding lower will
be the dividend payout.
However in the FMCG sector none of the ownership groups were found to have
considerable influence on dividend payout.It has been found out that shareholding
pattern is not an important variable that influence the dividend policy of the FMCG
companies. The relationship varies for different types of shareholders and at different
levels. In other words, it can be said there is no uniform influence of the shareholding
pattern on dividend policy of the company. The results Random effect model show
that corporate holding is a major ownership variable that influences dividend payout.
A close look at the shareholding pattern of companies in FMCG sector indicates that
the level of corporate holding in total holding is comparatively less. Therefore,
Corporate bodies view dividend payment as a source to mitigate the agency conflicts.
Results indicate no significant relationship of corporate holding with Dividend Payout
ratio at higher levels of holding.The results also show that there is not much impact of
liberalization and foreign institutional investors for determination of dividend payout
ratios of the FMCG companies as this variable is found to be insignificant in all the
Models under study. The results Random effect (Model IV) also denotes a significant
negative relationship between Debt equity ratio and dividend payout at 10% level
which in agreement with existing literature. This relationship can be attributed to the
fact that high-growth firms with low leverage and broad ownership, dividends are
relatively more important in controlling potential agency conflicts between managers
and shareholders. All else being equal, dividend payments force a firm—especially a
high-growth firm—to the capital markets more regularly. The scrutiny provided by
the capital markets limits the extent of managements' self-serving behavior.
The regression results indicate that none of Models developed to study the impact
ownership groups has fitted well in FMCG sector. Thus, it can be stated that
ownership groups is not a significant factor determining the dividend payment
patterns and decisions in the FMCG sector.
272
Through the analysis of the fourth objective it has been found that cash dividends may
not always create abnormal returns for the shareholders. In the modern scenario a
gradual drift to other modes of payment of dividends has been observed. Small
abnormal returns on dividend announcement can also be attributed to the fact that the
dividend announced is below the investors’ expectations. More so, dividend income,
being a marginal constituent in investment return, may not inspire much to the over
enthused investors in rising capital markets. The findings of the research highlight that
in Service sector investors respond positively to cash dividends announcements
whether increasing or decreasing. Thus, the investors in this sector welcome cash
dividends. Considering the statistical significance of CAARs and AARs it can be said
that signaling hypothesis partially holds. However abnormal returns are created in
FMCG sector but they are not sustained over the event window and gradually CAARs
become negative. However, in the IT sector no significant abnormal returns are
generated on dividend announcement.
The results in IT sector do not strongly refute the informational efficiency of the
markets. To some extent semi-strong form of market efficiency is highlighted through
the analysis. Though positive abnormal returns of 0.83% and 1.18 % are generated on
cash dividend announcements but they are not statistically significant. The stock
prices do react positively on dividend announcement but abnormal returns generated
are not found to be statistically significant. The shareholder value could not be
sustained in the post announcement period. This can be attributed to the fact that the
corporates usually face constraints to declare lesser dividends due to the possibility of
large cash outflows on account of taxes. Therefore, dividend announced may be much
below investors’ expectations.
In FMCG sector the results showed that the investors lost more value in ex dividend
period than the value gained in the pre dividend announcement period. Thus, it can be
stated that dividend announcements do not carry information about future earnings
and cash flows of the companies. Dividend payout may not add to shareholders
wealth if the companies have positive net present value projects in hand. The findings
of the Market model strongly refute the signalling hypothesis and information content
of dividends. These results are in alignment with findings of many authors who have
dismissed the information role of dividend as unimportant. They suggest that equally
273
efficacious, cheaper alternatives exist through which managers can disseminate
information (e.g., Miller and Modigiliani; Petit 1972,Black 1976 ; Stern 1979).
In Service sector, the results cannot be taken in support and endorsement of
information efficiency because of positive incidence of AARs and CAARs and their
corresponding statistical significance. The results indicate semi- strong form of
market efficiency because any information content associated with dividend
announcements is not absorbed in the price movement on the announcement day only
but it leads to abnormal returns during post dividend announcement period also. This
is alignment with the findings of Ball and Brown (1968), Fama et.al(1969),Gupta
(2001) and Chaturvedi(2001).Thus, the results partially support the dividend-
signalling hypothesis in the Service sector. The reason for the partial support can be
attributed to the fact that not all the positive incidences of AARs and CAARs in the
event window are statistically significant .This information content of dividends
hypothesis has been formalized by Bhattacharya (1979, 1980), John and Williams
(1985), Miller and Rock (1985), Ambarish et al. (1987) and Offer and Thakor (1987).
This research work has made an attempt to evaluate the three crucial sectors of Indian
economy (IT, FMCG and Service) on the basis of four commonalities. These
commonalties are Lintner dividend Model, 21 variables affecting the dividend payout
ratios (based on literature survey) ownership patterns and agency conflicts and finally
dividend linkages with shareholders’ wealth maximization. On the whole the findings
of this research indicate that inspite of the fact that managers view dividend decisions
as important it cannot be concluded that market rewards a carefully managed dividend
policy with higher share price. In India finance managers typically view dividend
decisions as an important part of their job. The typical firm does not follow a residual
policy nor leave its dividend payout to chance. Rather, firms manage their dividends as
proposed by Lintner’s model and partially follow stable dividend policy. The results
are in support of semi-strong form of market efficiency. The study also by and large
supports the signaling and information content of dividend. A sectoral difference in
determinants of dividend payout ratios has been observed. The results also indicate
that in Indian context the impact of ownership groups on dividend payment is
heterogeneous.
274
9.2 FUTURE RESEARCH AND THINKING
The trouble of people is not that they don’t know, but that they know so much that
ain’t so- Henry Whealer Shaw; Josh Billing’s Encyclopedia of Wisdom.
No research work is complete without suggesting the directions for future research.
The research work offers numerous links that can be picked up by future researchers
in Corporate Finance more specifically in the area of ‘Dividend Policy’.
The research has primarily focused on empirically testing the validity of Lintner
Dividend model in IT, FMCG and Services sector respectively. How the various
determinants of dividend payout ratios vary across the sectors? Most importantly,
dividend announcements and its linkages with shareholders’ wealth has been
analyzed.
As revealed through the research, ownership groups influence the dividend payout of
a company. There is a significant scope for investigating further the relationship
between dividends and ownership over a longer period of time and to compare the
behavior of Indian firms with other countries’ corporations. A second possibility for
future extension of the present study is to examine the interactions between dividend
policy and other financial decisions and ownership structure. Examining the influence
of board structures on dividend payout policy can also be a future area of research.
More studies especially, in emerging economies are needed which can increase the
understanding of the relationship between block holders’ identity (ownership
concentration) on dividend policy. A well-known fact is controlling the corporation
also makes it possible to control dividend decisions. There may be controlling groups
in the organization, which may influence dividend payout ratio of a company.
However the influence on dividend decisions may depend on controlling groups’
perspective and their preferences. The three groups that are affected the most by the
firm’s dividend policy are stockholders, bondholders and managers. How the
controlling groups’ perspective and preferences change in different situations and its
corresponding impact on dividend payout policy requires more attention.
The research covers three sectors of Indian economy. Accordingly, further research is
needed to explore the issues surrounding payout policy more fully by extending the
275
research to other sectors of Indian economy. Every possible effort has been made to
make the study more intensive and practicable but the time and resources have been
the limiting factors due to which there may exist some gaps in the present study.
Hence future research may be directed to bridge the gap so as to enhance the scope of
analysis. Most of the previous empirical studies on dividend determinants done in
Indian context have focused on manufacturing sector. These studies predominantly
include Kumar Jayesh (2001); Mishra and Narender (1996). One of the sectors on
which the present research has focused is Services sector. Therefore, in future a
comparative study between Dividend policy determinants of Service and
Manufacturing sector can be conducted. This would reveal the sectoral differences in
the dividend policy determinants.
This research has examined the impact of a set of 21 variables on dividend payout
ratios of three respective sectors. Through the work done an attempt has been made to
suggest a comprehensive framework that can be useful to the companies, investors
and regulators in three chosen sectors for analysing dividend policy. The future
research on dividend payout determinants in Indian context can investigate two
possible issues. First of all, one may examine the suitability of the statistical methods
applied in studying dividend payout policy. There is no prior guarantee that the
relationship between dividend payout and its determinants is of linear form (an
assumption made in majority of the empirical studies). Furthermore, better proxies of
the existing determinants may be identified to obtain better results.
In Indian context, several studies have empirical analysed Lintner dividend Model
(1956). The present research work has tested the validity of Lintner Dividend Model
using pooled data and static panel data analysis. However, a step ahead could be to
empirically test the Lintner model using a framework of Dynamic panel data models.
The Lintner dividend model, which is a finance classic, is based on survey of CFOs of
top 28 American Corporations. Subsequently many other survey researches have been
reported which also gained popularity but till date Lintner model remains a “finance
classic”. Other survey researches include Baker et al. (1985); Farrelly et al. (1986);
Baker and Farrelly (1988); Pruitt and Gitman (1991); Lazo (1999);Mohanty (1999);
Baker and Powell (2000); and Baker et al. (2001). So far in Indian context Anand
Manoj (2002) has done a survey research on dividend policy determinants. He did
276
survey of 81 CFOs of Business Today 500 companies to find out the determinants of
the dividend policy decisions of the corporate India.
Therefore, one of the future research directions can be to do a survey of CFOs to
identify determinants having a significant bearing on dividend payout ratios of the
three sectors under study. Such research can be undertaken using a survey method
approach and a sample of corporate financial managers can be asked about the factors
they consider most important at the time of formulating the dividend policy. This will
assist assessment of management’s perception about factors governing dividend
policy decisions. Further this will also facilitate researchers to know whether
managers in different industries (categorized by age, size, investment and industry
group) in India share similar views about determinants of dividend policy or not.
It is a well-established fact the characteristics of capital markets vary according to the
difference in cultural, financial, legal and political environment of a country. These
environmental factors cause differences in the level of disclosure requirements of
stock markets in response to various levels of political, financial and economic risks,
which have implications for dividend policies. Given the diversity in corporate
objectives and environments, it is conceivable to have divergent dividend policies that
are specific to firms, industries, markets, or regions. Researchers may try to
investigate the extent to which dividend policy is affected by environmental variables,
and interactions among the environmental variables in three sectors chosen for study.
Further impact of legal systems, institutional factors on dividend policies can be
examined. Dividend policy decisions and their linkage with level of investor
protection in India could also be ascertained in line with the studies done by La Porta
et al. (2000).
However, till date little attention has been paid to the market reaction of dividend
initiation announcements, which, according to Asquith and Mullins (1983), are less
likely to be anticipated. A dividend initiation is defined as dividend payments by a
firm for the first time in its entire corporate history or after a hiatus of more than three
years. Several studies in USA and UK have been undertaken to study the impact of
dividend initiation on shareholders’ wealth. Most prominent and popular studies in the
area are Asquith and Mullins (1983), Dielman and Oppenheimer (1984), Healy and
Palepu (1988), Michaely et al. (1995), Mitra and Owers (1995), Howe and Shen
277
(1998) and Alangar and Bathala (1999). The present research focuses exclusively on
finding the impact of dividend announcement on shareholders’ wealth in IT, FMCG
and Services sector. An attempt can be made in future to study the dividend initiation
impact in these three sectors as most of studies done in Indian context have focused
stocks listed on Bombay stock exchange.
The share price reaction to dividend initiation may also differ according to the
information environment in which the firms operate. Therefore the empirical studies
may be extended to study share price reaction to initial dividend announcements
across different information environments. Conceptually, dividend information
announcement should provoke stronger price reaction to a “low information
environment” relatively to a “high information environment”. Similarly, the volatility
increase during the event period should also be higher for “low information
environment” firms due to higher uncertainty compared to “high information
environment” firms. Therefore, a study can be done in three sectors under question to
examine how initiation impact varies for a firm operating in “low information
environment” to a “high information environment”.
At the same time the estimation of post announcement stock price and profitability
performance for dividend-initiating firms across different information environments
should also be examined.
This research has made an endeavor to find the impact of cash dividend
announcements (whether increases or decreases) on shareholders’ wealth. Future
research in this area can focus on examining the impact of cash dividend increases and
decreases announcements on shareholders wealth separately. The impact of alternative
modes of dividend distribution like bonus issue and stock buybacks on shareholders’
wealth can also be investigated. This is because it is presumably a possibility that
market returns of the companies declaring dividend through alternative modes can be
higher as these alternative forms are gradually gaining popularity.
Therefore, it is well understood that despite promising theoretical and empirical work,
more research is needed to provide a satisfactory theoretical model; more explicitly
specified empirical tests, and guidance to managers concerning optimal dividend
policy.
278
Finally, according to Baket et.al (2002,p.257) “ Researchers have identified all the
key pieces of the dividend puzzle but need to focus their attention on developing firm-
specific dividend model. If this puzzle is jigsaw puzzle, different firms use different
combinations of puzzle pieces to form different pictures of the firm. This results
because each firm has different characteristics, managers, and stockholders”. In
nutshell, further work is necessary to explore the possibility of additional factors that
will suggest added guidelines in setting an optimal dividend policy.
Dividend puzzle has remained unexplained over half a century and still it can be
stated: “The harder we look at the dividend picture, the more it seems like a puzzle,
with pieces that just don’t fit together”. This research work is a humble contribution
to solve dividend puzzle existing in the field of Corporate Finance.
This thesis is an attempt to covey the true economic meaning of the dividend
phenomenon to the investors and financial decision makers. If this thesis can make a
contribution towards the better understanding of dividends, and dividend policy, the
untold number of trees that were required to print the thesis were not cut down for
naught.
279
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