Impact of dividend policy on a firm performance

INTRODUCTION

This chapter shall introduce the research topic and discuss the background of the study,
problem statements and significance of the research.

Dividend policy is the company’s stance on how it will distribute its earnings. The distribution
of earnings to shareholders is of two forms i.e. cash dividends versus capital gains.

Dividend is the basic right of equity shareholders to get dividend from the earnings of a
company.

The set of rules and regulation followed by the management when they making dividend verdict.

Dividend policy may be define as the distribution of the firm income between the stockholders of the
firm and retain(For further investments).

The policy of a company is to retain a position of net earnings and distribute the remaining amount to
the shareholders.

Dividend may be defined as the return that a shareholder gets from the company, out of its profits,
on his shareholdings.

In other words, dividend is that part of the net earnings of a corporation that is distributed to its
stockholders. It is a payment made to the equity shareholders for their investment in the company.

When the company paid dividend in the form of cash is called cash dividend. The companies
must have enough cash in the account when declare the dividend.

If the company issue additional share to existing shareholder cause of lacking the cash in the
account. Hence, Companies may supplement cash dividend by bonus issues. Issuing bonus
shares increases the number of outstanding shares of the company. The bonus shares are
distributed proportionately to the existing shareholder. Hence there is no dilution of ownership.
Following are the advantages of Bonus shares

1) Tax benefit 2) Indication of higher future profits: 3) Future dividends may increase

4) Psychological Value
In special circumstances Company declares Special dividends. Generally company declares
special dividend in case of abnormal profits.

An extra dividend is an additional non-recurring dividend paid over and above the regular
dividends by the company. Companies with fluctuating earnings payout additional dividends
when their earnings warrant it, rather than fighting to keep a higher quantity of regular
dividends.

When the company pay dividend to its stockholders annually .Or the company declare the
dividend annually is called annual dividend.

During the year any time company declares a dividend, it is defined as Interim dividend.

Regular cash dividends are those the company exacts to maintain every year. They may be paid
quarterly, monthly, semiannually or annually

These are promises to make the payment of dividend at a future date: Instead of paying the
dividend now, the firm elects to pay it at some later date.

These dividends are those which reduce paid-in capital: It is a pro-rata distribution of cash or
property to stockholders as part of the dissolution of a business

These dividends are payable in assets of the corporation other than cash. For example, a firm
may distribute samples of its own product or shares in another company it owns to its
stockholders

BACKGROUNND OF THE STUDY

The dividend policy pays a crucial role in today business. The dividend policy of a company
reflects how prudent its financial management is. The future prospects, expansion,
diversification mergers are effected by dividing policies and for a healthy and buoyant capital
market, both dividends and retained earnings are important factors. A will define dividend
distribution policy will strengthen the company’s position in the capital market and indirectly
polishing up its corporate image. In other words, firm's present and future performance can be
indicated by how well is the dividend payment and at what level is the company potential risk.
To eliminate uncertainty and poor evaluation made by investors, it is necessary for a company
to have an effective dividend policy.

Pouring too much money into dividend payment can decreasing the retain earnings which
causes to decreases the investment opportunities which may directly causes to generate
negative income. Moreover it is very hard to form dividend policy due to legal constraints or
changes by the government time to time. As a result external financing become an option to
finance their business operations and this will charge high cost of debt.

The residual theory of dividend policy holds that the firm will only pay dividend from residual
earnings, that is dividends should be paid only if funds remain after the optimum level of capital
expenditures is incurred i.e. all suitable investment opportunities have been financed.
With a residual dividend policy, the primary focus of the firm is on investments and hence
dividend policy is a passive decision variable. The value of a firm is a direct function of its
investment decisions thus making dividend policy irrelevant.

Under certain assumptions dividend irrelevancy theory asserts that dividend policy has no
impact on the price of the firm or its cost of capital.( Miller & Modigliani).But what had
Miller and Modigliani concluded has been challenged over time and many studies after that
had revealed that dividend payment is one of important signals to the performance of firm.
Bhattacharya s(1979)

The Bird in the Hand Theory: This theory is based on a logic that “ What is available at present
is favorable to what may be available in the future”. Investors will prefer the present dividend
than the future(even if the promised dividend is larger). Hence dividend policy is relevant and
does affect the share price of a firm. (John Lintner 1962 and Myron Gordon, 1963)

Tax preference theory predicted that high dividend paid out ratio , greater the rates of returns
which ultimately decreases the value of the firm and vice versa. , (B. Graham and D.L. Dodd)

Per Cent Retention Theory (Clarkson and Eliot 1969)26

Clarkson and Eliot (1969) argued that given taxation and transaction costs dividends are that
is not afforded by shareholders as well as by companies and hence a firm can follow a policy
of 100 per cent retention. Firms can thus avail of new investment opportunities that would be
beneficial to shareholders too.

Signaling Theory: This hypothesis indicated that dividend announcements have valuable
information, known as signals, relating to future earnings of the firm. An increase in the level
of dividend payout, according to this hypothesis, sends a positive signal to the investors and
the general public that the future earnings of the firm is bright. The reverse is the case for a
firm that reduces its dividend payout or did not even pay dividends

PROBLEM STATEMENT

This study is to investigate the determinants of dividend on a firm performance. The Return
on Asset, being the dependent variable, will be examined for the impact with the following
independent variables, dividend yield, Dividend paid out ratio, Financial leverage is proxied as
the debt to equity ratio.

RESEARCH QUESTION

Is there are any significant relationship between dividend payout and ROA.

IS there are any significant relationship between DY and ROA.

RESEARCH OBJECTIVE

To examine the relationship of dividend payout and a firm performance.

To examine the significance relationship of DY and ROA.

SCOPE OF THE STUDY

This study will beneficial to the management of the firms . Which will improve the dividend
policies on the market prices of their company’s share which will in turn effect the financial
performance of the firm. This also help the potential investors to make informed investment
decision as they invest in companies that practice dividend policies that maximize their wealth.
 CHAPTER TWO

LITERATURE REVIEW
INTRODUCTION

This chapter reviews literature relating to dividend policy and future financial performance. It
focuses on previous studies done by various authors in relation to dividend policy and firm
performance .

THEORETICAL FRAMEWORK OF DIVIDEND

In a simple explanation dividend policy is the process to allocate some portion of money from
earnings to the investors or shareholders. It is very difficult verdict to find out how much
distributed among the investors and the rest for the reinvestment. Both these two portions can
actually affect stock price, investors' level of confident and company's opportunity in
generating income.

There are many reasons that can be used by the mangers in companies “to pay dividend or not
to pay dividend” to the investors. Increasing dividend can affect the company positively in the
eye of the investors but at the same time managers need to look into their financial performance
and economic environment as well.

MODLIGIANI AND MILLER IRRELEVENCE THEORY

The MM irrelevance theory assert that given the firm’s investment option, the amount allocate
to each share has no effect on wealth. The above statement explain that the dividend payout
policy has no impact on the dividend earned by the shareholders. The theory further argues that
the valuation of any firm is dependent on the revenue generated and not the dividend allocated
to shareholders. The model is found on the assumption that the market it operates in is
characterized by perfect information.

But what had Miller and Modigliani concluded has been challenged over time and many
studies after that had revealed that dividend payment is one of important signals to the
performance of firm. Bhattacharyas(1979)

BIRD AND HAND THEORY

Bird in hand theory proposes that a relationship exists between firm value and dividend payout.
It states that dividends are less risky than capital gains since they are more certain. Investors
would therefore prefer dividends to capital gains (Amidu, 2007). Because dividends are
supposedly less risky than capital gains, firms should set a high dividend payout ratio and offer
a high dividend yield to maximize stock price.

Hence the Bird and Hand theory is suggested available at present is favorable to what may be
available in the future”. Investors will prefer the present dividend than the future(even if the
promised dividend is larger). Hence dividend policy is relevant and does affect the share price
of a firm. (John Lintner 1962 and Myron Gordon, 1963)

TAX PREFERENCE THEORY (B. Graham and D.L. Dodd)

Tax preferences theory state that high dividend payout ratio decrease firm value. Because
dividends are taxed at higher rate than capital gains. Investors require higher rates of return as
dividend yields increase.

PER CENT RETAINTION THEORY (Clarkson and Eliot)

Clarkson and Eliot (1969) argued that given taxation and transaction costs dividends are
immensely expensive for the investors as well as for the companies .Therefore the firm will
follow a policy of 100 per cent retention . Through which the firm can avail investment
opportunities that would be beneficial to shareholders too.

Agency Cost Theory

In today’s corporate world, principal-agency relationship exists between the company’s

shareholders (principal) and managers (agents). The managers are expected to act in the best
interest of the shareholders at all times. The theory suggested that payment of dividends can be
used to mitigate this agency costs in two ways. Firstly, by paying dividends the firm will also
have the opportunity to access additional funds from the capital market. This will make it
possible for the new investors, stakeholders and the general public to scrutinize the financials
of the firm, thereby reducing the agency cost. Secondly, paying dividends will reduce the
amount of excess fund available to managers which may not be utilized in the best interest of
the owners of the business (shareholders).
Signaling Theory

According to this theory , An increasing in the level of dividend payout will send a positive
signal to the investors and the general public that the future earnings of the firm is bright. And
if the firm reduces its dividends or even did not pay dividends causes to send a negative signal
which causes to stop investors to invest in that firm. . For the signal to be significant, theory
suggested that the signal being sent by the firm through dividend announcements should be
true. Thus a bad firm (low or no dividends) should not be able to mimic a good firm( high or
increase dividends)

DEPENDENT VARIABLE

Return On Assets

Return on assets can be calculated by dividing net income with total assets .

=Net Income /Total Assets

Return on assets measure the firm ability to utilize its to create profits by comparing profits
with assets that generates profits.

INDEPENDENT VARAIBLE

Dividend yield

Dividend yield indicates the relationship between the dividend per common share and the
market price per common share .

= Annual Dividends Per Share/ Market Price Per Common Share

The yield depends on the firm’s dividend policy and the market price. If the firm did not
distribute the dividend among the investors and successfully invest the money, The price
should rise. If the firm holds the dividend at low amounts to allow for reinvestment of profits
the dividend yield is likely to be low. Investors that want current income prefer a high dividend
yield.

H1: There is no significant relationship between DY of the firm and firm performance .

Dividend Payout
 The Dividend payout measure the portion of current earnings per common share being paid out
in dividends. Dividend payout ratio as follows.

Dividend payout=Dividend per Common share/ Earning per share

No rule of thumb exists for a correct payout ratio. Some investors prefer high dividend while
some prefer to have the firm reinvest the earnings for the high capital gains.

H2: . There is a positive relationship between the dividend payout ratio and ROA.

FINANCIAL LEVERAGE

Financial leverage is term used to refer to the level to which the firm uses borrowed fund to
finance their operations specifically investments. When the firm has a high debt ratio , it
determined that it will incur high expenses on interest as the cost of capital which reduces the
revenues which directly causes to low the dividend payments. The lower the ratio the better
firms debt position.

Debt to Equity Ratio=Total liabilities / Total Equity

Debt ratio also determine how well creditors are protected in the case of insolvency.

H3:FL and shareholders wealth are not statistically significantly correlated.

RESEARCH FRAMEWORK

DEPENDENT VARIABLE INDEPENDENT VARIABLE

Financial Performance Dividend Policy

ROA Dividend payout
Mode of Dividend

 Dividend yield
 Dividend payout
 Financial Leverage
 Size of the firm
 CHAPTER THREE

INTRODUCTION

This chapter sets to explain the research design, the population of interest, the basis of sample
selection, the type of secondary data used, the sources of data, the techniques of analysis used
and the data analysis.

RESEARCH DESIGN

Research design gives a generalize plan and arrangement of the study. Which help the
researcher to solve the research questions. This study adopted a descriptive research approach.
Descriptive study was deemed suitable for this study. And used correlation research design.
Where a correlation is a procedure to determine whether there is relationship exist between the
variables or not.

POPULATIONN OF THE STUDY

Population is a collection of measurements, items or individuals that make up the total of all
possible measurement within the context of the study.

The population of interest in this study is selected all the firms of Pak cement industry listed
on Pakistan stock exchange between 2014 to 2018. As at December of 2018 there were 18
listed companies in the cement industry.

SAMPLE OF THE STUDY

This study selected top 10 companies from Pak cement industry listed on Pakistan Stock
Exchange used as a sample for this study.

DATA COLLECTION

The study used secondary data which is collected using data collection form. The secondary
data was extracted from the Annual Statement of Financial Position and income Statement of
individual firm listed at Pakistan Stock Exchange. The extracted data was on , Total Assets
Net Income , Annual Dividends Per Share , Market Price Per Common Shar , Dividend per
Common share , Earning per share , and Total liabilities and Total Equity. The data cover a
period of sex years from 2014 to 2018.

The data is obtained from the website of different companies as well as Pakistan Stock
Exchange for the period of five years.

DIAGNOSTIC TESTS

Several Diagnostic tests is undertaken among them multicollinearity , Autocorrelation and

normality tests. Multicollinearity will be determine through correlation , Variance inflation
factor and Tolerance level. Autocorrelation will be determine through Durbin Watson statistics
while normality will be testing through Summary statistics.

DATA ANALYSIS

The collection data was entered into the an excel work sheet and all appropriate calculation
was done to obtain the desired results. Data analysis tool STATA version 13 was used for the
descriptive data. Descriptive statistic was applied in carrying out data analysis. Descriptive was
used to summarize the data. Correlation was used to measure the relationship between
variables. Regression was used to hypothesized the particular direction of the relationship.

MODEL SPCIFICATION

The regression model is adopted is the analytical model of the study. The regression model is
generated as follows

ROA=β0+ β1(DPR)+ β2(DY)+ β3(FL)

Where

ROA = Return on Assets determine using the ratio of net income to total assets

DPR= Dividend Payout Ratio determine using the ratio of total dividend to earnings

DY= Dividend Yield determine using the ratio of annual dividends per share to market price
per common share

FL= Financial Leverage determine using debt to equity ratio.

TEST OF SIGNIFICANCE

The F and t test statistics is used to test the significance of the whole equation and the individual
significance of the study variables. The significance test was carried out 95% of confidence
level.