Dividend Policy is a subject that is quite normally utilized by the researchers in the area of Financial Management and Investment, especially in corporate finance from the Joint stock Companies started to be. The British East India Company was the first Joint Stock Company who issued its share in 1613, which led to the declaration of first dividend in 1661 (Davis, 1917). This act formed a custom of paying dividends and the guidelines of dividend policy developed. Booth & Cleary (2010) has described dividend policy as a selective choice by the management to choose what rate of profit is allocated between the shareholder and what rate of profit is hold to satisfy its internal requirement.
Dividend Policy means to the payout strategy, which managers follow in choosing the size and plan of cash allocation to shareholder as time goes. Management essential target is shareholders wealth maximization, which turn into maximizing the values of the company as find out by the price of company�s regular stock. By giving the shareholder a fair payment on their investment, which led to the accomplishment of the goal. But, the effect of firm�s dividend policy on shareholder wealth is still unresolved.
The field of corporate dividend policy has pulled the heed of management scholars and economists concluding into theoretical modeling and exact examination. In this manner, dividend policy is without any doubt the mot complex viewpoint in finance. A couple of decades back, Black (1976) in his investigation on dividend wrote. �The harder we look at the dividend picture the more it seems like a puzzle, with pieces that just don�t fit together�.
There are some essential elements that company thinks about in composing their dividend policies like managerial and behavioral environment, firm�s profitability ratio, ability of company and so on. Denis & Osobov (2008) empirically tested the trends of company for composing their dividend policy. Effect of their research demonstrate that general trend in US, Canada, UK, Germany, France and Japan is that the companies having higher profitability ratio and higher portion of retained income to total equity pay dividends to their investors and the companies having flatter profitability ratio and lower portion of held income to equity either do not pay dividend or to pay at less rate. However, still everything depends on the managerial and behavioral nature of the countries to choose if they feel distinct desire to pay dividend or not.
Dividend policy got consideration in 1956 just because of Linter research over it. Linter (1956) highlighted the issue, which is still critical, �what choices made by managers do affect the size, shape and timing of dividend payments?� Following the significant support of Linter in the area of finance, Miller & Modigliani (1961) gave a different belief regarding dividend policy, they expressed that dividend policy gave no effect over the firm value; the just thing which might influence value of firm is investment policy. Gordon (1963) gave contentions in opposite to Dividend Irrelevance Theory by furnishing proof that dividend policies do influence value of firm. The concern is still remain arguable around managers, Policy producer and researchers or analysts that do dividend policy influence stock price or not, which will be discussed in Literature review.
1.2 Indian Market 2012
As Indian stock market is the most volatile stock market in the world. The number of private corporates are developing day by day, & financial market ending up being more advanced, there requirement of the inquiry of different policy suggestion by corporate segments.
Around then when progressive economies are stressed to rise from continued slowdown, India Inc. has been developing robust and compensating its shareholders with a steady increase in dividends.
As per an analysis by Pune � based research and consulting firm ValueNotes, the dividend paid has been increased by an average of 12% in the last fiscal year ended March 31, which was paid by the 30 bellwether groups constituting the Bombay Stock Exchange�s benchmark Sensitive Index, or Sensex.
But the payout wasn�t across the board: 17 of the 30 Sensex companies have raised dividends, six kept it unaffected whereas the remaining seven reduced dividends. However, the last fiscal year gave stakeholder a reason to cheer, this financial year the payouts are predicted to be lower as the economy drops in an unstable area between increasing economies stress in some debt � trapped Eurozone countries while the continuous increase in domestic interest rates creases demand.
"We are expecting dividends to rise a maximum of 5% this year," said Nitin Gianchandani, financial analyst at ValueNotes.
Infosys, of the Sensex 30 companies, doubled the 2011 payoff from the preceding year�s level with the highest increase in dividend in the last financial year. In 2010-2011 India�s software outsourcing sector saw a massive reappearance and was reflected in company�s balance sheets. State Bank of India and Tata Steel were the next in line with 50% more in 2011. Which doesn�t mean that all companies were able to distribute dividends openhandedly. ITC, the Indian conglomerate, paid 56% lesser with Cipla and the all pharmaceutical company paid 60% lesser than 2010.
On the basis of industry, the software pack, carrying three companies in the directory, raised the highest dividend of all major groups by 37%. On the other hand the four banking and financial services companies in the Sensex also showed the increase in dividend payoff by about 36%.
In Indian banking sector, the loan payouts remain strong without being affected by higher interest rates, which helped the Indian Banks to maintain high growth. As per the central bank data, loans provided by banks increased by more than 20% in the last financial year. The metal space had raised dividend by 29% in 2011. Immediately following were the heavy engineering and infrastructure companies with a 21% increase. The great government push to renovate the country�s rusty infrastructure helped the both sector in gaining.
On the other hand, the automobile sector, which carrying five companies in the index got up a marginal 2% in dividend payout. Nevertheless, the average of two-wheeler manufacturers sector reached to 26%. But, the consumer goods and telecommunication firms reduced the dividend by 33% and 19% respectively.
Figure: Shareholder payout for fiscal year ended march 2012
The growth of dividend payments to shareholders has been tied up with the development of corporate society itself. Corporate managers acknowledged early the significance of dividend payment in fulfilling shareholders wants. The frequently leveled dividends mostly believing that dividend diminishment may have unfavorable impacts on share price and in this way, utilized dividends as gadget to sign informative data to the business sector. Besides, dividends strategy is thought to have an effect on share price. On account of 1950�s the impact of dividend policy on firm esteem and different issues of corporate dividend approaches have been subjected to an extraordinary civil argument around finance researchers. The literature area of research thinks about the development from the both a speculative and exact perspective.
1.3 Research Objectives
There are various researches existing on the factor of dividend conduct in Indian context. Dividend behavior is determined on the basis of factors affecting the dividend behavior in the short run and additionally in the extended run. Anyhow the quite few writings catch the intricacies of market response to the dividend announcement by Indian corporate division.
The objective of this paper is to investigate the relationship between dividend policy andmarket value of share. While investigating the main objective this paper will highlight the possible factors, which are used for dividend policy and theories, which different business sector uses while making decision over dividend policy. During the way to achieve objective, dissertation will also cover the effect of dividend policy on share price with the support of different studies of financial researchers as a secondary objective.
1.4 Structure of Dissertation
This dissertation compromise of six chapters. From which, first chapter is Introduction. This chapter will emphasis on the meaning of research topic, Indian market condition on shareholder�s payout and will sum up with drawing an attention research objectives and structure. The following chapter of Literature Review I will cover the studies by different researchers over this subject, theories in favour and against the subject and some for and against reviews of researchers in order to give advance knowledge about the topic of research. The third chapter is Literature review II, which is a part of Literature Review. The main emphasis of this chapter is to show the link between dividend policy and share price with the support of international researchers view. This chapter will sum up with highlighting the Indian Scenario, which means research by different Indian researchers over Indian firms in relation the topic. The next chapter will be the chapter 4 Methodology. In this chapter, which method is used for research and how the research is done will be familiarized. Research Finding & Analysis will be the chapter 5. In this chapter, finding by the three different researchers over Indian firms by their proposed models will be analyzed by comparing them. This dissertation will sum up by final chapter 6 Conclusion. This chapter will show the summarized part of dissertation supporting the most favorable model used by researchers among three researchers.
Chapter 2: Research Literature Review I
This chapter will bring the light over the definition of Financial Management of which dividend policy is a part, given by different authors.
2.1 Introduction
Financial Management is an area for Business Finance and Corporate Finance. Financial Management helps in controlling firm�s financial resources effectively. Its main area of work is within the firm managerial decision making on acquiring of adequate finance, profitable allocation and capital mix.
According to Solomon (1978) Financial Management is �concerned with the management decision that result in the acquisition and financing of long term and shot term credit of a firm. As such it deals with the situation that requires selection of specific assets as well as the problem of size and growth of an enterprise. The analysis of these decisions is based on the expected inflows and outflows of funds and their effects upon managerial objectives.�
According to Charles L. Parther (1967), financial management is �the finance activity which in volves acquiring and administering the funds of a firm.�
According to Joseph and Massie (1983), the concept of financial management is �the operational activity of a business that is responsible for obtaining and effectively utilizing the funds necessary for efficient operations.�
Shareholder Wealth Maximization is the primary objective of financial management. There are three categories of decision making which helps to achieve decision making namely, investment financing and dividend decision.
a) Investment decision: - Determine types of assets and total value of firm.
b) Financial decision: - Determine source of investment and capital structure of firms.
c) Dividend decision:- Involves the decision for dividend policies for the determination of policy payout which management follows to determine the size and pattern for cash distribution to shareholder overtime(Lease, John, Kaley, Lownenstein and Saring 2000)
In reference to the shareholder wealth maximization the management should manage their profit in such a way so that shareholder receive a good combination of dividend and increases the market value of the firm.
In research by lease (2000:19) of valuation process actual and financial value of asset is resolved by the timing size and hazard of anticipating future cash flow that accumulate to the owner of the asset for the shareholders this refers that quality of a share in addition to any dividend payable during the time of be in possession of shares. Share price in this manner a nexus determinant of the worth of the firm. In the event that dividend are the crux pointer of the stake value and stake value is crux maker of the firm value, it make a sense that to maximize shareholder wealth, shareholders might as well be managed the most towering mixture of shares and the build in stake price.
Firms are ordinarily unhindered to select the level of dividend they desire to pay to holder of customary shares even through elements for example legitimate necessities, deferred payment agreements encroach some restriction on this choice. A large number of researchers have given their special writing inspection on this choice. A large number of researchers have given their special writing inspection, which turns to the amazing certainty that dividend behavior demonstrate a deliberate difference hinge on the firm, nation, time and sort of dividend.
In this section of literature review different models and theories relevant to topics has been bought in focus. Following are some famous literatures on dividend policy depending upon the different views from different researches. This section carries different theories from which firstly highlighted the irrelevant theories and relevant theory to the dividend policy impact over share value of firm and secondly the all rest theories related to topic.
2.2 IRRELEVANCE THEORY- DIVIDEND POLICY AND SHAREPRICES
The dividend irrelevant hypothesis is dependent upon the reason that a company�s dividend policy is autonomous of the worth of its stake price and that the dividend determination is an aloof leftover. The value of the firm is dead set by its speculation (i.e. investment) and financing determination within perfect capital structure. A regular payment strategy ought to have the capacity to serve all firms for the reason that the share strategy is immaterial in figuring firm esteem. Following is the famous irrelevance theory by M&M (1961):
M&M (1961)
In 1961, Merlon & Miller and Franco Modigillani demonstrated that under certain disentangling suppositions, a firm profit approach does not influence its value. The fundamental commence of their contention is that immovable value is dead set by picking optimal contribution. The net payout is the contract among wages and investment and essentially a residual. Being as how the net payout includes payments and shares repurchase and a firm can change its dividend to any level with a counter balancing update in share outstanding for the view of speculator, dividend policy is irrelevant, since any sought stream of installment might be repeated by suitable buys and deals of equity. The suggestion rest on a few suspicious:
� There are no taxes, or the tax rate on cash dividend and tax rate on capital progress are level with
� There is no transaction cost for the methodology of buying and selling share. So if the speculator requires money he/she can offer his/her shares without losing requisitions and charges as a substitute for cash dividends.
� The investor is categorically objective in his/her decision
� No agency cost
� The association manages under a full and proficient market. This is to state, which implies that the qualified information is ready and approachable to all the same time without any prices and stake cost reflect this qualified information and is controlled by it at the instant furnished.
� There is no informative content gap and the company works in a full and effective market. The destiny view point on the appearance of the company is homogenous near all investors, incorporating informative data anticipating among investor and manager.
The M&M (1961) declared that the real value of the firm was swayed by its financing changes and the profit ability of the asset and not by the dividend policy.
�M&M �Values are determined solely by �real� considerations-� the earning power of the firm�s assets and its investment policy and not by how the fruits of the earning power are �packaged� for distribution.�
Various researchers uphold M&M �theory of irrelevance� (Black and Scholes, 1974; Miller & Scholes, 1982; Uddin, 2003)
In 1974, Black and Scholes supported the irrelevance theory of dividend by �M&M (1961)� Black and Scholes(1974) contemplated the effect of dividend policy on the anticipated benefits of a company share. The creator reported that the co-efficient of the dividend yield variable was irrelevant at 0.0009 with a t-value of 0.94 supporting the M&M dividend irrelevance theory Uddin (2003) uphold M&M (1961) theory, by stating that companies might as well put abundance fund in the positive net present value undertaking in place of paying out them to the stakeholder. His literary work moreover infers that market valuation of stock relies on the anticipated future dividends. Assuming that if company pay out every last trace of the earning money for fate financing decline and dividend would not be able to expand in the future. Besides, when dividend is taxable, paying out additional money could build the shareholders tax obligation. Regardless of speculative contentions for not paying dividends, outfits regularly pay money dividend to their shareholder probably to sign qualified information concerning the future profit prospects.
2.3 RELEVANCE THEORY
Moreover, a large number of analysts denied the M&M theory on the groundwork of speculative contemption (Petit, 1972; Lonie 1996; Baker and Powell 1999; Brav 2005; McCluskey 2007). They contended that in the presence of taxation and transaction cost, the contention of the dividend irrelevance speculation may appear farfetched.
Baker and Powell�s (1999) study about US firms� state of mind, demonstrated that on mean, 90.0% of these respondents dismissed M&M�s (1961) hypothesis that dividend were superfluous and di not influence firm value. Indeed, above and beyond 88.0% concurred that a firm�s dividend, investment and financing choice were interrelated. The review additionally dismissed the suspicion of M&M (1961) that the dividend was remaining following all gainful ventures had been undertaken.
Botha (1985) characterizes dividend approach under the relevance theory, as follows: �The dividend policy is a practical approach which treats dividends as an active decision variable and retained earnings as the residue; dividends are more that just a means of distributing net profit, and that any variation in dividend payout ratio could affect shareholders� wealth; a firm should therefore endeavor to establish an optimal policy that will maximize shareholder�s wealth.�
Pettit (1972) directed the research to study the informative data of dividend updates so as to figure the association between dividend announcement and share price. The author gathered monthly information for about 1000 advertisement of dividend updates by 625 NYSE firms from January 1964 to June 1968; he likewise gathered everyday information for 135 reports over the 1967-1969 with a specific end goal, which is to examine the �recognized changes� on unusual share return at the period of dividend affirmation. He categorized the dividend announcement in to seven bunches and perceived their effects on the bizarre performance of the shares taken as sample; he found that noteworthy price change occurred at the same time as the proclamation month (day) and the accompanying month (day).
Lonie (1996) investigated the signaling attribute of dividend announcement of 620 UK firms from January 1991 to July 1991. An event concentrate on was directed to figure the odd return around a dividend announcement day and one day prior to announcement day. The finding demonstrated a noteworthy unusual return of 0.6% and 1.4% on the declaration day and one-day prior of it respectively. In addition, the effect indicated a critical positive unusual return of 2.0%for dividend expanding firms; a noteworthy negative unusual return of -2.4% for dividend diminishing firms and noteworthy positive abnormal return of 1.4% on one-day prior announcement day for the dividend-no-change firms. Likewise McCluskey (2006) computed abnormal return and overabundance return for 41days around the dividend declaration date. The figures demonstrated a noteworthy positive anomalous (excess) return of 0.82% on the day when news of dividend was circulated. Furthermore, the average, overabundance and unusual were critically positive for dividend expanding firms, in consequential for dividend-diminishing firms and positive for dividend-no-change firms.
2.4 Theories of Dividend Policy
2.4.1 Bird in Hand Theory
The point looked for by the supporters of the irrelevance recommendation theory contends that money dividend arrangement has no impact on the company value or the capital cost. Subsequently, cash dividend strategy should not influence the return on capital needed. A considerable number of different theorist (Linter, 1962, Gordan, 1963) think that the returns on capital needed ascent when the money dividend proportion reduces since investor are less confident of their coming about capital increase than the return income and the climbing stock costs from acquiring the proposed money dividend. These theorists feel that investor assess the dollar, which they appropriated from cash dividend today above and beyond the dollar they gain from capital addition. The explanation is that the dollar appropriated from cash dividend today is less unsafe than the future dollar accepted from capital addition. It is known that investor assess share price through a predictable destiny money course for every stake and after that rebate it at a rate reflecting the perils. This discount rate has a positive connection with risk, consequently the markdown rate, which is utilized to figure share cost to future capital gain, can be more fantastic. Thus, the company�s share price, which has low cash dividend and heightened return earning for future capital gain, should be less than the stakes value, which has heightened cash dividends. Consequently the share price will drop when held profit increase for future capital gain.
A preparatory reading of the bird in the hand speculation indicates that it appears worthy on the foundation that shares to elevated money dividend are less risky. With the stability of different components influencing share value, less risky stocks are more costly.
Nonetheless, consistent with one of their presumption, Miller and Modigliani (1961) do not embrace this concept and express it is a Bird in the Hand Misrepresentation. Bhatcharaya(1979) declares that the future cash flow hazard for any task figures its risk; therefore, any incremental build in cash dividend now will decline share price following the cash dividend is paid and ledge in addition the abatement in future cash flow risk which should not expand a company�s value.
An exact perusing of the Bird in the Hand hypothesis, as stated by Gordon(1959), indicates that this speculation will almost always acknowledge investment strategy as opposed to cash dividend policy as it appears from a starting perusing. The outcome that might be drawn from this hypothesis is that companies disseminate low cash dividend are regularly heightened risk investment companies. Because of heightened investing risk, investor could discount fate cash flow of low cash dividend at a higher discount rate when they assess the companies share price. Hence, they are ready to pay a lower price for share of association that has the stability of different elements. Therefore, the cash dividend policy is the unavoidable consequence of the company�s risk level, and not the explanation behind it.
2.4.2 Tax Effect Theory
In short this speculation posits that if there is no tax for capital increase or if the capital gain tax is less than the cash dividend tax, investors incline toward companies that do not circulate cash dividend and the retain profit in the type of undistributed profit. Whenever the cash dividend rate declines at the overhead of undistributed profits, the owners� wealth will amplify with different elements being unvarying. Along these lines, investor will inquire that allot high cash dividend for a more stupendous return, in observation to the profit of team that have no cash dividend so as to blanket the taxes they will pay for cash dividends (Brennan, 1970, Litzenberger and Ramaswamy, 1982). In different expression, investor receives returns earlier to taxation, which are easier in instances of companies that furnish capital gain rather than cash dividends. The investors, moreover, could pay a higher cost for the company�s share that furnish returns in the mode of capital gain rather than conveying them as cash dividend if the different factors influencing the stake price are fixed. This is where the part of dividend strategy and its affect on a company�s esteem(value) and shareholder wealth becomes possibly the most important factor. Though the maintenance of profit and changing over them into capital gain, the company�s value and shareholder wealth might be influenced positively.
We could probably confirm the positive and negative effect of cash dividend on shareholder�s wealth in view of the tax distinction between cash dividend and capital gain as follow (Levy and Sarnat, 1994):
� If the deterioration in the share price following the part has ended up being dividend unlimited is break even with to the value of cash dividend or capital gain, and there is no tax impact on the shareholders� wealth.
� If the downfall in the share price following the share has come to be without dividends is less than the cash dividends, then the tax rate on cash dividend should be more fantastic than the tax rate on capital gains, and the investor can be in the best equipped position if the profit take the for of capital gain.
� If the decay in the share price following the share has come to be without dividend is more excellent than the cash dividends, then the tax rate on capital gain should be more stupendous than taxes on cash dividends, and the investor will be in the best position if the returns takes form of cash dividend.
Apart from this what could be the situation if the company would aim to hold profits and reinvested them as a substitute for appropriating them to shareholders? Could this lead to a boosting shareholder�s wealth?
The amplified wealth shareholders� through a company dividend strategy that have a surplus of funds hinge on the private tax rate level of distinct shareholders, and the tax rate encroached on the company�s gain. It is assumed here that both the company and the shareholders can reinvest the gains at the similar return rate. Any how, if the private tax rate for shareholders is less than the company�s tax rate, the shareholders could be in a preferred position if the company�s looks to disperse cash dividend and shareholder reinvest their dividend by there own. On the other hand, if the company�s tax rate is less than the shareholder tax rate, and then shareholder could be in a preferred position if the company holds the profit, reinvest them, and after that conveys the dividend with the come back to shareholders, collecting that risk and rates of return are levels in both cases.
Likewise, the analyst is not in favour of the view that cash dividend give to harming shareholder wealth as the tax rate on cash dividend is higher than the tax rate on capital gain. This is for the reason that there are shareholders who purchase shares of companies that makes cash dividend. Joined with this, the specialist thinks that there might as well be more fabulous profits than harms that animate investors to purchase those stakes, the most drastically critical of which is stood for by the level risks connected with cash dividends; here and there the risk end up being nil.
2.4.3 Clientele Effect Theory
In their research, Black and Scholes (1974) found that every investor has his/her possess implied calculation noticing inclination between high cash dividend profit or their holding consistent with the factors he/she is encountering for example the tax classification into which he/she falls. Therefore, some investors lean toward companies with high cash dividend, while others lean toward companies with level cash dividends or without any cash dividends and holding of gain for investment. In different expression, investor will put just in companies, which have dividend policy dependable with their uncommon longings, prerequisites and conditions. This is known as Clientele Effect Theory.
Pettit in his academic work, which examined 914 investment portfolios(Pettit, 1977), it has been found that older investors and more low pay investorhave a tendency to procure companies share to high cash dividend above and beyond younger investor with additional income. The elderly and low-income investors are uncovered to a level tax classification or they appreciate tax exception. The cash dividend may stand for the foremost cause of income for them to blanket their cash flow necessities or they could prefer to enjoy their wealth before the expire; accordingly, they have a tendency to sink money into high cash dividends companies when contrasted and the aforementioned younger and more well-to-do investor who comes in high tax class. In their tries to maintain a strategic distance for paying from paying taxes on these dividends, the recent will almost always invest money in companies with flat or without cash dividend, specially depending on if we know that young people have not yet gotten to the retirement period. Consequently, the cash dividend frequently do not constitute an origin of financing prompt customer necessities; also, they are more vulnerable to preserve the questionable matter risk of capital gain and their aspiration and lifelong projects foe example educating children, owning lodging and so on.
The Clientele Effect Theory includes a few significant thoughts:
1. The company will almost always decide on customers (investor) through a cash dividend strategy unwavering with their yearnings. In this manner, investor could not punish the company, or work to decrease company�s share value due to that policy as it blends with their wishes. On that premises, the speculation course of action is performed in that ensemble.
2. Because the community decides on its clients through the cash dividend policy. Moreover, the company can transform from a dividend approach to a different with out affecting the company�s value (if the update in the dividend rate does not effect in future financial troubles). In the event that the company diminishes the cash dividend rate, investors who needs a higher dividend rate will sell their shares and turn to a different company. Besides, investors who incline toward low dividends rate will take their place.
This inferred implication of Clientele Effect Theory may be worthy in hypothesis. Be that as it may, from a practical point of view, it may contact some problems. The company�s capacity to decide on clients without influencing the company�s value is probably dependent upon the presumption that the market is profound and the company will spot enough clients to blanket their share price to keep the share price equalized.
2.4.4 Signaling Effect Theory
An increasingly influencing argument in favour of dividends is the signaling hypothesis, which is associated with suggestion advanced in Bhattacharya (1979), Miller and Rock (1985), John and Williams (1985), and others. It is dependent upon the thought of qualified information asymmetries between the participant in the market and specifically in middle of manager and investor. Under such condition, manager to marked information concerning the company�s prospects to the business sector utilizes the costly payment of dividend. For instance, in John and Williams� (1985) model the firm may be for a time under-valued when investors need to meet their liquidity needs. Assuming that investors sell their possession when the firm is undervalued, then there is a wealth transfer from old to new brand shareholders. Then again, the companies can recovery losses to existing shareholders by paying dividends. In spite of the fact that investor pay taxes on the dividends, the profit from holding on to remember undervalued firm more than compensate these additional tax costs. An unfortunate value firm could not copy the dividend behavior of an undervalued firm for the reason that holding-on to over-valued share does not does not build wealth.
The signaling theory can describe inclination for dividend over stock repurchase regardless of the tax benefit of the latter. Particularly, as recommended in Jagannathan, Stephens and Weisbach (2000), Guay and Harford (2000) and DeAngelo and Skinner (2000) around others, the regular dividend indicator has a continuous responsibility to pay out cash. This indicator is steady with Linter (1956) recognition that managers are ordinarily hesitant to lessening dividend levels. Then again, unlike normal dividends, repurchases and unique dividends might be utilized to sign prospects without lifelong responsibility to higher payouts. Along these lines affirmation of increase in consistent dividends signal changeless improvement in performance and ought to be translated as trust in the firm for manager in this way triggering a price ascent. Conversely, report of dividend decline ought to be deciphered as signaling oppressed performance and absence of managerial confidence and ought to in this way trigger drops in prices.
Assuming that updates in the levels of dividend discharge informative data to the business sector, then firms can decrease price volatility and influence share price by paying dividend. Yet it is just surprising change which have a useful value and which can subsequently affect costs. Thusly, the worth of the signal relies on the level of informative contents asymmetries in the business sector (market).
2.4.5 Agency Theory of Dividend
A different contention in favour of liberal dividend payments is that this switch the reinvestment decision again to the possessors. The underlying surmise is that manager would not unavoidably consistently function as to maximize shareholder wealth. This situation here is the partitioning of possession and control, which gives ascent to agency conflicts as described in Jensen and Meckling (1976). Likewise, when the level of retained income are high, manager are looked for to channel finance into bad projects either with a specific goal, which is to develop their particular interest or because of incompetency. Subsequently, generous dividend policy upgrades the firm value in light of the fact that it can be utilized to decrease the sum of free cash flow in the carefulness of management and in this manner controls the over investment problem.(Jensen, 1986)
Another agency theory based description of how dividend build value is portrayed in Easterbrook (1984). While the transaction cost theory of dividend suggest that dividend payment decrease value for the reason that they leads to the raising of costly external finance, Easterbrook (1984) contends that it is this procedure which diminish agency problems. The thought is that the payment of is one feasible solution to the situation of aggregate activity that will consistently advance to under-monitoring of the firm and its management. Along these lines the payment of dividend and the consequent raising of external finance encourage investigation of the firm by fiscal mediators for example investment bank, regulators of securities exchange where the firms stock is traded, and potential investor. This capital market observing minimizes agency cost and leads to rise in the market value of firm. Besides, total agency cost as outlined by Jensen and Meckling (1976), is the sum of agency cost of equity and agency cost of liability. The last is part of the way because of potential wealth transfer from bond to equity holder through asset substitution. Hence Easterbrook (1984) note that by paying out dividends then afterward raising debt, new debt contracts might be transacted to decrease the potential for wealth transfer.
This section examined different definition related to topic such as financial management, shareholder wealth maximization, and dividend model hypothesis and highlighted the exact outcome different dividend models carried out by various researchers.
Chapter 3: Research Literature Review II
3.1 Introduction
This section highlights the relationship between dividend policy and share price with the views of various researchers in order to specifyconsiderateregarding the related studies. The next following part will feature the intense research by financial academic on company dividend policy to determine a link between dividend policy and value of firm. This section will get sum up after showing different researchers outlook over Indian Scenario.
3.2 Dividend Policy and Share Price
When year 1980�s numerous share market literatures saw the present value of dividends to be prevailing determinant of market return on stocks. As per LeRoy and Porter and Shiller (1981), they reasoned that under surmise of consistent discount component, stock costs were excessively volatile to be steady with the movement of future dividends. Wohar and Mark (2006) stated that the corrosion of stock price movement is quit sensitive to real dividend growth as well. Though, Cochrane (1992) and Timmerman (1995) contended that stock price changes might be described by time- varying markdown rate and future abundance return. The founding build by Cochrane (1992) on variability of abundance return is to be more essential than the variability of dividend growth.
Nishat and Irfan (2003) investigated the dividend policy and stock price movement in Pakistan. Both the dividend policy measures, dividend yield any payout proportion, have noteworthy effect on the share price movement. Moreover, their outcome also upkeep the arbitrage realization effect, duration effect and information effect in Pakistan. The approachability of dividend yield toward stock price movement expanded but payout ratio is having noteworthy effect at a lower level if importance only.
An auspicious firm earns income. The profit spread to shareholder as dividends. In this way, the link between company�s profit and dividend payout is explored by Amidu and Abor (2006) in Ghana. They thought that dividend payout proportion furnished firm with no usually accepted recommendation for the level of dividend payment that will boost share value. In this sense, share price movement is act contrariwise with the dividend payout ratio. Amidu and Abor (2006) believe is reinforced by the recognizing that they done in Ghana, in which their examination consequences demonstrated a statistically meaningful and positive connection between profitability and dividend pay out ratio. In the interim, the theory on the negative connection between share value and dividend payout ratio is affirmed as well.
As per Graham and Dodd (1951) and Gordon (1959), they contended that an increase in dividend payout advances to higher stock price (company�s value) and bring down the cost of equity. Though, some experimental indicated the inverse position. Peterson (1985) reported that with high-elevated dividend payout ratio, heightened returns are needed by firm�s shareholder, and this is lead to lower share price. Baker, Powell and Veit (2002) have researched the link between dividend policy, firm value and share price movement. They found an optimal dividend policy strikes an offset in middle of present dividends and future growth that maximize stock price. They also found that stock price volatility is low if dividend approach is stable.
Additionally, the smoothing theory suggest that the dividend determination is the outcome of past and current earning which manager modifies firms dividend payout to some target level. In the mean time, the indicating speculation indicates that dividend have projecting power of future earning and share prices (Goddard, McMillan and Wilson, 2006). In different statement, there is a positive relationship between dividend, earning and share price. Dividend decisions are joined to company�s future anticipated income, and dividend updates ought to indicate future earning updates and price changes as well. This moreover upheld by the consequence of the study work of Goddard, McMillan and Wilson (2006) in which there is a strong proof of a contemporaneous connection between share price, dividend and profit for 137 United Kingdom Production and Utility groups.
Amidu and Abor (2006) analysis infer that, profitable firms will almost always pay high dividend. The outcome additionally demonstrates negative relationship between dividend payout and risk. Firm which encountering earning volatility identify, its difficulty to pay dividend, along these line, the firm may pay less or no dividend to their shareholders. In this sense, the outcome indicates the vital relationship between dividends and earning and this connection could straight control that movement in share price. The firm may encountered high share price volatility if the firm�s earning volatility is influenced the decrease of dividend payment.
3.3 Selective review of Literature
After highlighting the correlation between dividend policy and share price, this part feature the review from various researchers over the subject:
Experimental researches led to see the impact of dividend policy on stock price first incorporate the work of Linter. Linter (1956) reviewed the different determinants of corporate dividend policy and its impact on firm�s market value by managing the interview of top management of 28 firms. Effect of his investigation indicates that Firm Market Value relies on the Dividend Payout. His outcome further demonstrate that firms wish to follow the stable dividend payout policies and for this reason they need to alter their profit. Baskin (1989) thought about the effect of dividend policy on stock price volatility and found converse connection between stock price and dividend strategy. Further in his study, he demonstrated that there is noteworthy connection among Dividend Yield and price volatility. Profit, Firm�s size, Debt Level, Growth level and Dividend Payout in addition have a noteworthy effect on stock returns and dividend yield. Gordan(1963) gave the notion of dividend relevance and outcome of his research demonstrate that dividend policy have huge positive influence on stock price. Further he determines that the firm those pay higher amount of dividend to their shareholders, encounters less risk in terms of stock price volatility. Allen & Rachim (1996) likewise focused the connection between dividend policy and stock price but found no connection in the middle of Dividend yield and stock prices.
Fama and French (2001) analyses the issue of lower dividend paid by corporate firm over the period 1973-1999 and the components answerable for the downfall. Specially they examine whether lower dividend were the outcome of changing company�s characteristics or lower tendency to pay on the part of the company. They recognize that proportion of firm paying dividend has dropped from a crest of 66.5 percent in 1978 to 20.8 percent in 1999. They ascribe this decay to the modifying characteristics of firms: �the decline in the incidence of dividend payer is in part due to an increasing tilt of publicly traded firms toward the characteristics � small size, low earnings, and high growth � of firms that typically have never paid dividends�
Baker, Veit and Powell (2001) analysis the reasons that are supporting dividend policy decisions of corporate firms traded on the Nasdaq. The investigation, is grounded on the sample survey (1999) response of 188 firms out of the total of 630 firms that dividends in every quarter of calendar years 1996 and 1997, considers that the following four factors have a noteworthy effect on the dividend determination: pattern of past dividends, stability of earning and the level of present and future projected earning. The research project additionally identifies statistically important difference in the importance that managers connect to dividend policy in different businesses for example financial vs. non-financial.
Travlos, Trigeorgos & Vafeas (2001), analyzed the conduct of Cyprus stock Market toward the declaration of dividends. Consequences of their academic work demonstrated that the declaration of cash or stock dividends has positive impact on stock price. An analysis led by Ho (2002) applicable to the dividend policy indicated the positive connection in middle of Dividend policy and size of Australian firm and liquidity of Japanese firms. He further found negative connection in middle of dividend policy and risk, which occurred in case of Japanese firm only.
Pradhan (2003) illustrated the impact of dividend payment and retained earning on Stock Market of Nepalese firms. His consequences indicated that dividend payment has convincing connection with stock price whereas retained earning has quit weak connection with stock price. Nepalese stockholders give additional weight to dividend income than capital gain. Adefila, Oladipo &Adeoti (2004) thought about the reasons that can influence the dividend policy of Nigerian firms and its influence on stock price and companies value. Outcome of their investigation demonstrated that Nigerian shareholder do not utilize their stock for hypothetical purpose. They purchase stock for prestigious explanation and for get credit from banks. Their outcome in addition inferred that there is no connection between dividend payment, net earning and stock price. Nigerian firm pay dividends to their stakeholders paying little respect to their level of benefit for satisfaction of their shareholders. Additional analysis directed by Raballe & Hedensted (2008) in Denmark for the period of 1988 to 2004 distinguished the position connection between cash dividend and return o equity, retained earning, size of firm and the previous year profit. They were unable to recognize any connection in middle of debt equity ratio and dividend decision of firm.
Chen, Huang & Cheng (2009) studied the impact of cash dividend on share price for the period of 2000-2004 in china. They discovered that cash dividend has quite positive impact on stock prices. When cash dividend expands stock price also increase and when the cash dividend decrease, share price decreases. Al-Kuwari (2010) studied that payout decision of the companies catalogued at GCC (Gulf Cooperation Council) stock exchange, his outcome indicated that payout decision have positive impact on company size, profitability and ownership but have negative effect on Growth Opportunities.
Ali & Chowdhury (2010) investigated the price movement of private commercial banks catalogued at Dhaka Stock Exchange towards the dividend announcement. The took a sample of 25 banks and their outcome indicated that stock price for 11 bank diminished, 6 bank stock price increases, whereas 8 banks stock price remained unchanged when dividend were declared. In all sum outcome of their study indicated that there is insignificant connection among stock prices and dividends.
Hussainey, Mgbame & Chijoke-Mgbame (2011) examined the effect of dividend policy on stake price. Consequences of their investigation demonstrated a positive connection between Dividend Yield and stock price change and negative connection between Dividend Payout ratio and stock price changes. Their outcome further showed that the firm�s earning, Growth rate, level of debt and size also causes the change in stock prices of UK.
3.4 Indian Scenario
There are vey few researchers who gave their studies in India over dividend behavior. This section summaries briefly some of these studies:
In Indian connection, a few findings have examined the dividend behavior of corporate firms. Among all the researchers the main contribution in Indian studies was given by Bhattacharya (1979).Bhattacharya (1979) develop a two-period model. His model determine that it is rash for bad-prospects firms to promise high level dividends, and just good-prospects firm can promise high level dividend without hurting log-term operation. Signaling hypothesis and asymmetric information holds an essential implication � that is, unanticipated dividend updates ought to be gone with by stock price change in the same direction. Krishmurty and Sastry (1971) examined dividend behavior of Indian Chemical Industry for the period of 1962-1967 and undertook crossectional information of 40 Public Limited companies. The outcome disclosed that Linter model gives exceptional demonstration of dividend behavior. Dhameja (1978) in his research tested the dividend behavior of Indian companies by ordering them into size group, industry group, growth group and control group. The research found there was no statistically noteworthy connection between dividend payout, on the other hand and industry and size on the other. Growth was contrariwise related to dividend payout and was found to be noteworthy. The prevailing finish was that dividend decisions are preferable described by Lintner�s model with current profit and lagged dividend as informative variable. Mahapatra and Sahu (1993) found cash flow as a major determinant of dividend emulated by net earning.Bhat and Pandey (1994) undertook a review (survey) of managers� view to dividend determination and found that manager notice current profit as the most noteworthy variable. Narsimhan and Asha (1997) recognized that the uniform tax rate of 10% on dividend as recommended by union budget 1997-98, adjust the interest of investor in favor of high payouts. Mohanty (1999) found that the firm, which issued bonus shares, have either upheld the payout at the pre bonus level or just diminished it marginally thereby expanding the payout to shareholders. Narsimhan and Vijaylakshmi (2002) investigated the impact of ownership structure on dividend payout of 189 production firms. Regression analysis demonstrate that promoters holding Sujata Kapoor, JBS, JIIT, Dec� 2009 of September 2001 has no impact on average dividend payout for the period 1997-2000.
Anand Manoj (2002) examined the outcomes of 2001 survey of 81 CFOs of Business today-500 companies in India to figure out the determinants of the dividend policy decisions of the corporate India. He used factor analytic framework on the CFOs� reaction to catch the determinants of the dividend policy of corporate India. The findings uncovered that large no. of firms have target dividend payout proportion and were in agreement with Lintner�s study of dividend policy. CFO�s utilize dividend policy as an indicating tool to pass on qualified information on the current and future prospects of the firm and therefore influence its market value. The managers outline dividend policy following thinking seriously about the investors� preference of dividend and clientele effect. Sen and Ray (2003) have illustrated a noteworthy phenomenon observing the key determinants of stock price in India. The research work is based upon the stocks covering BSE index over a period 1988-2000. The experimental research uncovered dividend payout is clearly the single essential factor affecting stock price. The second factor comes earning per share, which has particularly powerless effect on stock price. So the research investigated one of the important factor dividend payout ratios having effect on Indian stock price. Reddy Y.Subba and Rath Subhrendu (2005) examined Dividend trends for huge samples of stocks traded on Indian market showed that the rate of firms paying dividend declined from over 57% in 1991 to 32% 2001, and that just a few firms paid customary dividends. Dividend � paying companies were less likely to be larger and additional profitable than non-paying communities, however growth opportunities do not appear to have essentially influenced the dividend policies of Indian firms. The ascent of the number of firms not paying dividend is not supported by the necessities of cash for investments. Sharma Dhiraj (2007) observationally examined the dividend behavior of select Indian firms listed on BSE from 1990 to 2005. The study investigated whether or not the dividend are still in trend in India and attempted to judge the applicability of one of the two extremely inverse schools of thoughts relevance and irrelevance of dividend decision. The study also examined the applicability of tax structure in the Indian perspective. The finding offered mixed and uncertain outcomes about tax theory showing that the alteration in the tax structure does not have a significant impact on dividend behavior of firm.
Thirumalvan & Sunita (2005) analyzed the effect of share repurchases & Dividend announcement on stock price in the connection of Indian corporate sector throughout the period (2002-2004). They examined the signaling effect of stock repurchases and dividend announcements. The research studied examined abnormal returns across various repurchase level. They have taken the firms recorded in the BSE index for the motivation behind experimental studies. The study blankets the effect on stock price five days prior and after the dividend declaration. The outcome displays the upward trend of share price movement after the dividend declaration. The essential purpose of their finding is that existed just for a day following the declaration. After which the degree of positivism of allotment begins declining. Their conclusion indicates the market reaction in the Indian context to events or declaration for example share repurchases and dividends for the most part vary around day or a few.
Various clashing theoretical models, all needing strong experimental support, outline latest attempts by examiners in finance to describe the dividend phenomenon. However to come with strong result an serious study of all theoretical models together with experimental evidence is required. The noteworthy literary work on dividend policy have been unable to get a accord on study on the general dividend hypothesis in the last five year that can either illustrate the method of dividend decision making or foresee an optimal dividend policy. Consequently it ends up being essential to study dividend behavior of Indian companies utilizing the outline of empirical models.
The main objective of this study is to compare the study done by different researchers in Indian context over the impact of dividend policy on market value of firm. The next chapter will demonstrates the different methodologies used by these researchers in order to study.
Chapter 4: Research Methodology
This chapter highlights the methodology adopted in the research has been discussed here. It frame out the different measurements of the research and the method keep on for the comparison of researches of different researchers in the reference of Dividend Policy and Share value for the study. For this purpose the study has collected the data from the research paper of the researchers and demonstrated the different methodologies by different researchers. Further tools and techniques followed by the researchers for understanding the subject are also bought in this part. The main approach followed in this paper is qualitative research in which comparison has been done between the researches of three researchers. The comparison is basis on availability of data through website and journals. The comparison study has been performed because of the expensiveness and free unavailability of data of different sectors, which led to approach a qualitative research rather than quantitative. By following comparative study this paper aim to find out the most favorable research among three. The data used in this research is all secondary data.
4.1 Introduction of Research Methodology
Research Methodology is a way to discover the consequence of a given situation on a particular matter or situation that is likewise pointed as research problem. In Methodology, researchers utilizes distinctive criteria for solving/searching the given study problem. Diverse origins utilize distinctive sort of techniques for tackling the problem. Assuming that we consider the expression �Methodology�, it is the way of looking or tackling the study difficulty.
But every research is incomplete without designing it. This research design is conducted on two approaches: Qualitative and Quantitative.
� Qualitative research: Qualitative research is the methodology for the most part connected with the social constructivist standard, which highlights the socially built nature of actuality. It is in regards to recording, examining and endeavoring to reveal the deeper importance and meaning.
� Quantitative research: Quantitative research is usually connected with the positivist/post positivist paradigm. It normally includes gathering and changing over information into numerical shape with the intention that statistical figuring could be made and result drawn.
Research Paradigm means a purpose by which researchers think about how they develop knowledge. The terminologies of research paradigm are positivism, interpretivism and realism.The main components of a paradigm are ontology, epistemology and methodology.
Mainly the researches are done on the basis of certain collective data. These data are of 2 types: primary data and collective data. Primary data are those data that are collected from questionnaires, observations, interviews, data processing and so on. Whereas secondary data are those, which are collected from journals, internet, government publication, published books, newspapers and magazines etc. The data collected for this research is mainly basis on secondary data, which are gathered from journals and websites.
4.2 Research Strategy by Different Researchers
The research is comparative study of different researchers over different sectors of Indian firms. The study compared the different methodologies used by Pani (2008), Sujata Kapoor (2009), R. Azhagaiah & Sabari Priya (2008). The studies of these researchers are chosen because of availability of their data and they have given revolutionary results in this reference. These researchers have contributed a lot in the research of dividend policy and share value over Indian firms. Following are outline of the different dimensions used by these researchers:
4.2.1 Pani (2008)
Pani (2008) in his research discussed the classical linear regression model and other tests. In his research he represents the hypothesis that dividends affect stock price or market value of the firm. The market value of the firm can be represented as:
Market value of the Firm = f net profit, Dividends
. Retained Earning
The market value of the firm here is essentially acted for on the core of accounting Earning Analysis. Net profit in this equation is determined from the current investment of the firm. As higher the net profit the higher can be the stock price. The ratio of dividends to retained earnings is the factors on which market value of the firm also depends for the reason that the profit is mainly discriminated either dividend or retained earnings.
In his research, he focuses over the context-specific Panel-Data models including the control variable like leverage ratio and the size of the firm. He has observed firm effect and time effect through the panel data estimation during the sample period. For his research purpose he derived the proposed model to analyze the impact of dividends on stock return. He has analyzed the issue over his proposed derived model. Instantaneously he has discussed other option, which were available for the analysis. He has analyzed the result of different industry aggregately in his study.
The proposed Model is here:
Where, SZ = Ln (total Assets)
�i = Firm Specific component
Eit= Disturbance Term
Then he divided the null hypothesis or D/R ratio affects stock returns i.e. Ho: D/R affects Vit. Firstly he examined the result of the classical linear regression model and secondly panel data estimation. He defined four basic models, which he has estimated earlier continuing toward final examination.
1. yit= a+ Eit(No group effect or xs)
2. yit=ai +Eit(Group dummies only)
3. yit =a+ß’Xit + Eit(Repressors only)
4. yit =ai+ß’Xit +Eit(Xs and group effects)
Model 1 on 2: H0: (no group effects on the mean of y)
Model 1 on 3: H0: (no fit in the regression of y on xs)
Model 1 on 4: H0: (no group effects or fit in regression)
Model 2 on 4: H0: (group effects but no fit in regression)
Model 3 on 4: H0: (fit in regression but no group effects)
He has examined the set of data for using the panel data models with the help of above five different hypotheses. For the Food and Beverage, Mining Industry and Non-metallic Industry, the LR, F and LM test along with Hausman Specification Test supports the use of fixed effect models however for other services, Textile Industry and Mining Industry, the diagnostic test rejects the use of fixed effect models.
Data Gathering
In study he gathered all the data to achieve his objective from Prowess database of the CMIE (Centre for Monitoring on Indian Economy) in India. A sample of 500 companies from �A1� and �B1� groups of shares is chosen for experimental analysis. These samples were dividend into six different industries namely Electricity, Food and Beverage, Mining, Non�metallic, textile and service sector. His motive behind choosing these companies is the consistency with the dividend payment history for the study period 1996-2006.
Though, his study has theorized the dependent variable(market value of firm) and the descriptive variables for example size of the firm, dividend to retain earning ratio and debt to equity ratio. The stock return is reflected as proxy for the market value of the firm as dependent variable and Ln (total assets of the firm) have been occupied as a proxy for rest of following variable.
4.2.2 Sujata Kapoor (2009)
Sujata Kapoor (2009) in her research has utilized several different tool and techniques and models namely Lintner model and event study to accomplishresearch objectives.
a. Linter Model
Linter(1956) introduced a model to concentrate on the determinant of the dividend behavior of American corporation considering that the dividend payout is a role of net current earning after tax(PAT) and dividend paid during the previous year i.e. lagged dividend (Div t�1). Companies choose to payout a settled proportion of their net profit as dividend to regular stakeholders; however in the view of their well known preference for constant dividends may attempt to succeed the target level just by a fraction of the amount demonstrated by the target payout ratio whenever profit changes. The above speculative definition of Lintner has been utilized as an estimating equation for corporate dividend in her study, which is as follow:
D*it = aiEit
Dit �Di(t-1) = ai + Ci {D*it �Di(t-1)}+uit
Where,
D*it = desire
