Abstract

Purpose - This paper aims to examine whether the catering incentives of dividends can influence to firms
dividend payment decisions in Thailand.
Design/methodology/approach - The sample includes all listed stocks in Stock Exchange of Thailand
during the year 199 ! ""9 excluding the firms from financial industries and the firms with incomplete
information. The catering incentives are measured #y dividend premium. The firms dividend payment
decisions are measured #y propensity to pay dividends and decision to change dividends.
Findings - The findings yield $ualitatively consistent with the previous research. %fter controlling for the
effect of %sian &risis during 199'-1999( the result shows that the firms decision to pay dividend could #e
affected #y the catering incentives. )urthermore( dividend premium will reduce the pro#a#ility that firms
will decide to cut dividend payment from previous year.
Research limitations/implications - The result is limited to the availa#ility of historical data. The Stock
Exchange in Thailand has *ust esta#lished for +, years. -ith the lack of availa#ility and completeness of
data( the historical data could #e gathered for only 1. years.
Practical implications - /nvestors in Thailand show their preference for dividend incomes. This could #e
the catering incentive of the firm to decide to pay dividends. 0anagers can do the market-timing #y
changing firms1 dividend payment decision according to dividend premiums.
Originality/value - This paper can attri#ute to #e the evidence of catering incentives of dividend proposed
#y 2aker and -urgler 3""4a5 in the emerging market. Even the result is not strong #ut it can #e the
evidence supporting the catering theory of dividend( not only in well-developed market( in emerging
market like Thailand.
CATERING THEORY OF DIVIDEND
EVIDENCE FROM KARACHI STOCK EXCHANGE
1. Introduction
In dividend policy theory, Miller and Modigliani, described that in perfect and
efficient market dividend policy is absolutely irrelevant to share value or
stock price. Due to this irrelevancy, no rational investor has a preference
between dividend and capital gain. MM indicated that value of firms share is
not dependent to dividend payout ratio only. Dividend and share (buying and
selling) are substitute to each other. This means that either dividend or
share purchase or repurchase, which ever is greater, it contributes to the
value of a firm.
This theory was given by them in !" and was critici#ed time to time.
$bout forty years later, the assumption made in MM theory i.e. of market
efficiency has been proofed thoroughly. The theory called as %atering theory
given by &aker and 'urgler (&') in ())*. In this theory, the assumption of
perfect and efficient market was rela+ed. This theory states that
management of a company initiate , declares dividend when they sees that
the investor-s relatively high preference is those stock which is dividend
payer and management omit dividend when they think investors are now
preferring non.payers.
%atering theory proposed that managers, in order to meet the preference of
investors, consider ,chooses the dividend policy. It also suggests that when
there is a dividend premium e+isting in the stock, managers tends to pay
%ash Dividend. In other words firms distribute cash dividends only when
investors put higher prices on dividend payers and when investors prefer
non.payers manager omit cash dividend.
%atering theory does not build a relationship between dividend policy and
investor as we can see in usual that provide emphasi#es on irrelevancy of
dividend on investors preferences. %atering theory strictly suggest that the
demand for dividend is directly concern with the investors sentiment. $lso
catering theory preferred those share which are dividend payers i.e. catering
focuses on those shares that pays the dividend. It does not prefer all the
shares trading in the stock e+change.
2. Pro!"# St$t"#"nt%
In common practice, researcher all over the world has done a lot of research
on dividend and its declaration. /ormally they found the impact of dividend
announcement on share price, company-s performance, calculating earning
per share, dividend policy impact on company and others. In precise, every
research conducted on dividend was impact after the declaration of dividend.
&ut no or some work has been done on declaration of dividend as what
factor drives the company to declare the dividend. 0imilarly1 how, when and
why management declares the dividend.
2n talking and consider the behavior finance issue, management also
consider the behavior of investor towards declaration of dividend. In this
paper we investigated how management declares the dividend by
considering the behavior of investor.
&. R"'"$rc( )u"'tion%
Does the Management declare dividend by keeping its stock holders
perspective in their mind or they 3ust declare dividend as and when
profit occurs4
*. O+"cti," o- t(" R"'"$rc( P$."r%
The ob3ective of this paper is to find out1
. 5ow the management declares the dividend. 6ither they declare it
when
o $ company earns profit,
o $ company have high retained profit and want to distribute it
into shareholders or
o Management reads the mind of investors and they conclude that
its time to declare the dividend.
(. 'hat is the percentage of payers and non.payers in the sample of
financial sector of 7arachi 0tock 6+change4
/. Si0ni-ic$nc" o- t(" Stud1
This type of research work has not been carried out previously. $lthough
there is a lot research work done on dividend to get the share price, growth
of the company, market value of the company etc. &ut in perspective of
declaration of dividend on catering basis of share holders, this research is
being done for the first time as in the case of 706.
This would have huge significance over future research work, as this will
open the doors for researcher to deliver the dividend theory in a new
perspective.
2. R"!$t"d T("ori"'%
Theories related to this paper are
. %atering Theory of Dividend8 developed and presented by M.&aker 9
:.'urgler in :un ())( in his paper titled ;$ %atering Theory of
Dividends<. In this theory, the author , researcher concluded that the
decision to pay dividends is driven by investor demand. This means
that the Dividend =ayer firms are dependent to the investor-s demand
for dividend. This theory satisfies our assumption and hence related to
our research.
(. 0econd theory that relate to this paper is, %hoice &ehavior Theory. This
theory was developed and presented by D.I.Maditinos, >el3ko ?evi@, in
())A in his paper, ;Individual Investors- =erceptions towards
Dividends<. In this paper the researchers assumed that there e+ists a
strong preference for dividends among individual investors. In this
theory, they concluded that ma3ority of investors did show a strong
preference for dividends in their case of Breece 0tock 6+change.
5ence the theory satisfies that management has to consider the
preference and demand of investors and declares dividend accordingly.
C. Dividend signaling theory, suggests that the announcement of dividend
payout is a strong indicator of strong future prospect of the company.
This paper satisfies this research paper to some e+tent that
management, for strong future prospect of the company and getting
the trust of the investors, declares the dividend.
3. 4it"r$tur" R",i"5
:effrey 'urgler (())() developed a theory, %atering Theory of Dividend, in
which he described that the decision to pay dividends is driven by investor
demand. Managers cater to investors by paying dividends when investors
put a stock price premium on payers and not paying when investors prefer
non.payers. To test this prediction, we construct four time series measures
of the investor demand for dividend payers. &y each measure, non.payers
initiate dividends when demand for payers is high. &y some measures,
payers omit dividends when demand is low. Durther analysis confirms that
the results are better e+plained by the catering theory than other theories of
dividends.
=aola 0apien#a (())) tested catering theory and described how stock
market mispricing might influence individual firms- investment decisions and
found a positive relation between abnormal investment and discretionary
accruals. 5e concluded that abnormal investment is more sensitive to
discretionary accruals for firms with higher E9D intensity (opaFue firms) or
share turnover (firms with shorter shareholder hori#ons) $lso he described
that firms with high abnormal investment subseFuently have low stock
returns and the larger the relative price premium, the stronger the abnormal
return predictability. 5ence he concluded that patterns in abnormal returns
are stronger for firms with higher E9D intensity or share turnover.
Malcolm &aker 9 :effrey 'urgler (())C) proposed that the decision to pay
dividends is driven by prevailing investor demand for dividend payers. To
test this prediction, they constructed four stock price.based measures of
investor demand for dividend payers. &y each measure, non.payers tend to
initiate dividends when demand is high. &y some measures, payers tend to
omit dividends when demand is low. Durther analysis confirms that these
results are better e+plained by catering than other theories of dividends.
%hikashi Tsu3i (())) tested the catering theory of dividends using data from
firms in the :apanese electrical appliances industry. Their empirical results
suggested that in the :apanese electrical appliances industry, corporate
managers do not consider catering behavior in either their dividend initiation
decisions or their continuation decisions. This finding is different from
e+isting evidence for the G0 and other countries. :apanese electrical
appliances industry firms is the value.weighted dividend yield in the industry
as the value.weighted dividend yield declines, :apanese firms in the industry
tend to initiate dividend payments.
:oseph Hagil (())*) e+tended the paper of &aker and 'urgler-s (&')
;%atering Theory of Dividends< and addressed by their model is whether or
not to pay dividends, the e+tended model offered here, in contrast,
incorporates other dividend related issues such as the e+pected cash
dividend and the dividend payout ratio. Their e+tended model predicts a
negative relationship between the e+pected dividend per share and the ratio
of information about the cost of the dividend (%) held by ;category<
investors and ;arbitrageurs<, the percent of stock ownership held by
;category< investors as well as the risk, ta+ and investment premiums. 5e
also suggested that one implication of his e+tended model is that the
dividend sum depends on its short.term and long.term effect on the stock
price, and also depends on the financial leverage and investment
opportunities.
The cost of the dividend includes of three types of premiums i.e. ta+, risk
and investment. (:oseph Hagil (())*). The ta+ premium is due to the
personal ta+es paid upon receiving dividends. The risk premium consists of
two components. The first is the increase in the financial leverage resulting
from the dividend payment, and the second is the semi contractual
obligation of the dividend.paying firm to maintain the dividend payment. The
investment premium involves the opportunity cost associated with the
re3ection of profitable investments in order to pay dividends.
The dividend initiation decisions of :apanese electrical appliances industry
firms have no predictive power for relative future negative returns of payers
over non.payers. This evidence is inconsistent with the suggestions of
catering theory of dividends by &' (())*a), %hikashi Tsu3i (())).
%hikashi Tsu3i (())) tested the catering theory of dividends in the :apanese
electrical appliances industry and derived the results as () The dividend
initiation decisions of :apanese electrical appliances industry firms have no
predictive power for the relative future returns of payers over non.payers.
'hile &' (())*a) documented that G0 firms- dividend decisions for both
initiations and continuations have strong predictive power for relative
negative future returns, their results were different from them. (()
Determinants of the dividend initiations, the first difference between the G0
and :apan is that the value.weighted dividend yield is a strong determinant
of one.year.ahead dividend initiations in the :apanese electrical appliances
industry firms. Most importantly, the dividend premium is not a determinant
of the dividend initiations of the :apanese electrical appliances industry
firms. This means that these firms do not behave as predicted by catering
theory.
5afee# $hmed 9 $ttiya H. :avid (())A) e+amined the dynamics and
determinants of dividend payout policy of C() nonfinancial firms listed in
7arachi 0tock 6+change. Their results consistently support that =akistani
listed non.financial firms rely on both current earning per share and past
dividend per share to set their dividend payments. The listed nonfinancial
firms having the high speed of ad3ustment and low target payout ratio show
the instability in smoothing their dividend payments. Durthermore the
ownership concentration and market liFuidity have the positive impact on
dividend payout policy. &esides, the investment opportunities and leverage
have the negative impact on dividend payout policy. The market
capitali#ation and si#e of the firms have the impact on dividend payout policy
which shows that the firms prefer to invest in their assets rather than pay
dividends to their shareholders.
Day.Hang Iiu 9 Hen ()( described that managers cater to investor
demands by paying cash dividends when investors put a dividend premium
on payers. In contrast, when investors put a dividend discount on dividend
payers, managers choose to distribute no dividends. Investors are willing to
pay a premium for cash dividends for several reasons. () $ clientele effect
e+ists in that the capital market prefers cash dividends. (() 0ome investors
believe that dividend paying firms are less risky. (C) Investors may be highly
risk averse so that the distribution of cash dividends is preferred
Hordying Thanatawee (()() developed a theoretical model to demonstrate
that the firm-s payout,investment decision may be affected by the relative
magnitude of dividend and repurchasing premia. The model he used showed
that the manager of high.Fuality firm may pass up a positive /=J pro3ect in
order to cater to investors- demand for dividends or share repurchases if the
catering premia are substantial. 2n the other hand, the manager of low.
Fuality firm may have strong incentives to return free cash flows to
shareholders if the catering premia are higher than the private benefits from
investing in a negative /=J pro3ect. Gnder this case, the agency costs of free
cash flows are mitigated.
'ei Ii, 6rik Iie (())K) e+tended &aker and 'urgler-s L())*aM catering
theory of dividend to include decreases and increases in e+isting dividends.
They found that the decision to change the dividend and the magnitude of
the change depend on the premium that the capital market places on
dividends. The stock market reaction to dividend changes depends on the
dividend premium. Thus, the capital market rewards managers for
considering investor demand for dividends when making decisions about the
level of dividends.
There is more to the story than dividend catering. 'hile the dividend
premium has significant e+planatory power in our analyses, so do individual
firm characteristics, suggesting that both internal and e+ternal factors affect
decisions to change dividends and the capital market-s reaction to such
decisions. The role of other non catering factors is especially apparent in the
negative stock market reaction to dividend decreases, which the dividend
catering theory cannot e+plain by itself. Thus, it would be unwise for
corporate managers to look solely to the capital market for guidance in their
dividend policy. '. Ii, 6. Iie (())K).
Ming.5ui, Iin ()(, e+amined the dividend policy with a prediction to
catering theory of dividend. They e+amined the consistent results that
managers choose a dividend policy to cater to the demand of investors which
:effrey 'urgler (())(), defines as the catering theory. They e+plained that
Dividend payers e+perience higher market.to.book ratios than those for non.
payers. Moreover, among dividend payers, firms distribute more stock
dividends than other types of dividends when the dividend premium for
stock dividends is positive. In contrast, firms shift from stock dividends to
other types of dividends such as mi+ed dividends and cash dividends when
the dividend premium for stock dividends is negative.
2. D$t$ S$#.!" 6 M"t(odo!o01
2. T("or"tic$! Fr$#"5or7
2ur independent variable i.e. dividend payer, measures there worth , market
value through market.to.book ratio. In theory, those companies who are
dividend payers e+perience higher market.to.book ratio. This aspect is
measured in sample of 7arachi 0tock 6+change.
%onsidering the dividend types, dividend payer companies issues more stock
dividend than any other dividend types as and when there dividend premium
of stock is positive. $nd when the dividend premium is negative, firms
(dividend payers) shift this type of dividend from stock dividend to other
types of dividend i.e. %ash Dividend or Mi+ed Dividend.
To measure the catering effect of dividend, we measure the stock price
premium, an independent variable. In theory, when stock price premium is
high or positive, management declares the dividend and when the stock
price premium is negative, this means investors prefer the non.payers of
dividend. This is measured through the market.to.book ratio of dividend
payers and non.payers.
Di,id"nd .$1out r$tio i' $!'o #"$'ur"d to 7no5
3. D$t$ 6 M"t(odo!o01
Data for this study has collected from the 7arachi 0tock 6+change (706), a
%ompanies financial report, which was also obtained from companies- official
websites for the period ())K to :un ()(.
In the sample, data of two sectors is taken i.e. &anking 0ector and Te+tile
0ector for the period ())K to :un ()(.
'e follow &aker and 'urgler (())*b) in order to test the catering theory.
a. Dirst of all we measure the dividend premium. This is measured by
taking the log of dividend payers and non payers and then divides it
with average market to book ratios.
b. $part from this, we also measure dividend premium between the
companies those who pays dividend (payers) and those do not (non.
payers).
'hen considering the dividend payers, it is notified that there are
different types of dividend payers- i.e. stock dividend, cash dividend and
mi+ed dividend which include both cash and stock dividend.
c. In order to e+amine whether the dividend premium is related to the
dividend policy, we use the multivariate regression model, to measure
the different types of dividend payers i.e. cash dividend, stock dividend
and both cash and stock dividend payers. 'e count the total payers by
the following method1
d. $fter measuring the relation, we then e+amine the significance of
correlation coefficient of dividend premium.
e. 'e also measure dividend payout ratio of all the firms included in both
the sector by the formula1
'e measure the dividend payout ratio to get an idea of how well
earnings support the dividend payments.
8. D"."nd"nt $nd Ind"."nd"nt V$ri$!"'%
Ind"."nd"nt V$ri$!" D"."nd"nt V$ri$!"
Market.to.&ook Eatio
Dividend =remium
Tot$! Di,id"nd P$1"r'9
%ash dividend payers N 0tock dividend payers N Mi+ed dividend payers
Dividend =ayers
0tock =rice =remium
Dividend =ay out Eatio
:. H1.ot("'i'%
H;% Management does not cater the demand of investors when declaring the
dividend.
H1% Management caters the demand of investors when declaring the
dividend.
OIntro%
The performance of firms as well as the financial strength of a company can
be 3udged by its share price. 5igher the share price of the firm, higher will
be its share value and vice versa. 6ffect of dividend on share value and price
volatility has been researched by the researcher in =akistan freFuently. Most
of this research has been carried out in the prospect of 7arachi 0tock
6+change (706). In the conte+t of investor-s perception, there is rare any
research being conducted on this point in =akistan. In this paper investor-s
perception towards declaration of dividend has been focused and measured
through a regression model in a sample of two sectors of 706.
In =akistan, more firms are family owned which means they are not
interested in declaration of dividend as the profit is being distributed within a
family as and when needed. $lso the share price is not affected by its
declaration, as other investors are interested in %apital gain by fluctuation of
share price.
The announcement of dividend is an important in corporate industry because
it does not only create cash out flow from company to share holders but also
represents the company-s performance and its future plans in the industry.
MM theory has described this phenomenon in this way that the declaration of
dividend does not add value to the company. 2n the other hand, investment
policy clearly represents the value of the company and its trust over share
holders.
P