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Copyright by R. S. Pradhan All rights reserved.


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Effects of Dividends on Common
Stock Prices: The Nepalese Evidence

Research in Nepalese Finance
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Copyright by R. S. Pradhan All rights reserved.
Effects of Dividends on Common Stock Prices:
The Nepalese Evidence
Empirical Results
MPS = 1709.62 + 4.57 DPS 12.54 RE .. (4)
(2.41) (4.72*) (1.71)
R-bar
2
=0.43 F = 7.6 SEE = 225.9 DW = 1.29

MPS = 1701.37 + 4.54 DPS 12.43 RE + 0.09 PE
t-1

(2.38) (4.71*) (1.69) (0.28)
R-bar
2
=0.42, F = 5.04, SEE = 229.13, DW = 1.3
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Copyright by R. S. Pradhan All rights reserved.
Log-linear model:
ln MPS = 3.62 + 0.60 ln DPS + 0.24 ln RE
(0.92) (5.28*) (0.29)
R-bar
2
= 0.63, F=20.91, SEE = 0.86, DW = 1.44


ln MPS=3.96+0.63 ln DPS0.05 ln RE+0.32 lnPE
t-1

(1.10) (5.75*) (0.06) (3.70*)
R-bar
2
= 0.56, F=13.04, SEE = 0.787, DW = 1.42

ln MPS=3.73+0.01 ln DPS0.51 ln RE+0.77 ln MPS
t-1

(1.38) (0.07) (0.91) (8.55*)
R-bar
2
= 0.64, F=39.84, SEE = 0.591, DW = 2.28
xxx

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Copyright by R. S. Pradhan All rights reserved.
Effects of Dividends on Common Stock Prices:
The Nepalese Evidence
Purpose: to explain share price, dividend and
retained earnings relationships in the context of
Nepal.
Whether there is customary strong dividend or
retained earning effect on market price of share
in Nepal.
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Copyright by R. S. Pradhan All rights reserved.
Literature review
In USA, studies indicated that shareholders are
indifferent towards dividends and retained
earnings.
More favorable tax rate on capital gains favors
retention of earnings (Elton and Gruber, 1970).
If there exists a net preference for capital gains
as opposed to dividends, then the firms
dividend policy would be a residual decision.
In India, studies conducted during 1960s and
early 1970s concluded that the retained
earnings had no effect on the share price.
However the studies conducted after late 1970s
started revealing impact of retained earnings.
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Copyright by R. S. Pradhan All rights reserved.
Those who believe that dividend payment
affects share price base their arguments on the
following hypotheses:
1. Shareholders prefer current to future income.
2. Dividend has information content & the
payment of dividend indicates that company
has a good earning capacity.
Those who believe in retention of earnings base
their arguments on the following hypotheses:
1. If earnings are retained in the business, it
indicates that the company has good
investment opportunities.
2. Dividend in the form of capital gain is subject
to lower taxes.
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Copyright by R. S. Pradhan All rights reserved.
Methodology: The Basic Model
The model to be estimated is the one most
commonly applied to cross-section data such
as the following (Friend and Puckett, 1964):
MPS
it
= a + b DPS
it
+ c RE
it
+ e
it

Where,
MPS
it
= Market price per share
DPS
it
= Dividend per share
RE
it
= Retained earning per share
The above model assumes the following
reasonable a priori hypothesis:
DPS
it
> 0
RE
it
> 0
Market price per share is the average of high, low
and closing prices of the year.
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Copyright by R. S. Pradhan All rights reserved.
This study also takes into account a partial
adjustment or flexible accelerator model.
For the purpose, lagged price variable has been
included in the above model:
MPS
it
= a + b DPS
it
+ c RE
it
+ MPS
it-1 +
e
it
This model hypothesizes that each company
has a desired target level of increasing market
price per share, and that each company, finding
its actual market price per share not equal to
optimum or desired level, attempts only a
partial adjustment towards the optimum or
desired level within any one period.
The model indicates the speed with which firms
adjust their actual share price to the desired
share price.
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Copyright by R. S. Pradhan All rights reserved.
Empirical Results
Regression of dividends & retained earnings on
average market prices produced the following:
MPS = 1709.62 + 4.57 DPS 12.54 RE .. (4)
(2.41) (4.72*) (1.71)
R-bar
2
=0.43 F = 7.6 SEE = 225.9 DW = 1.29
The results show the customary strong
dividend & very weak retained earnings effect.
The dividend coefficient is statistically
significant at 5 percent level of significance
indicating attractiveness of dividends among
Nepalese investors.
The negative coefficient obtained for retained
earnings as indicated above is questionable.
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Copyright by R. S. Pradhan All rights reserved.
The linear regression of market price per share
on DPS, RE, and PE
t-1
produced the following:
MPS = 1701.37 + 4.54 DPS 12.43 RE + 0.09 PE
t-1

(2.38) (4.71*) (1.69) (0.28)
R-bar
2
=0.42, F = 5.04, SEE = 229.13, DW = 1.3
Results indicate that dividends are relatively
more attractive.
The sign of retained earning coefficient is not
as per priori hypothesis indicating the absence
of its effect on share price which is
contradictory to the findings of Friends and
Puckett, etc.
One of the issues in dividend models is
whether linear or logarithmic models explain
better relations.
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Copyright by R. S. Pradhan All rights reserved.
A re-computation of the regression equations
utilizing logarithms produced the following :
ln MPS = 3.62 + 0.60 ln DPS + 0.24 ln RE
(0.92) (5.28*) (0.29)
R-bar
2
= 0.63, F=20.91, SEE = 0.86, DW = 1.44
The equation confirms earlier result indicating a
higher dividend effect rather than retained
earnings effect.
Dividend coefficient is significant with a priori
expected sign.
Coefficient of retained earning has a correct
sign though it is not significant.
A one percentage point increase in dividends
led on the average to about 0.60 percent
increase in share price, holding the other
variables constant.
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Copyright by R. S. Pradhan All rights reserved.
The estimate of other equations by using
logarithmic forms produced the following:
ln MPS=3.96+0.63 ln DPS0.05 ln RE+0.32 lnPE
t-1

(1.10) (5.75*) (0.06) (3.70*)
R-bar
2
= 0.56, F = 13.04, SEE = 0.787, DW = 1.42

ln MPS=3.73+0.01 ln DPS0.51 ln RE+0.77 MPS
t-1

(1.38) (0.07) (0.91) (8.55*)
R-bar
2
= 0.64, F = 39.84, SEE = 0.591, DW = 2.28
Again, the two equations confirm higher
dividend effect than the effect of retained
earnings.
The dividend coefficients are significant with a
priori expected signs.
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A one percentage point increase in dividends
led on the average to about 0.63 increase in
share price, holding the other variables
constant.
Looking at the overall results, higher investor
valuation may be placed on dividends than on
retained earnings.
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Copyright by R. S. Pradhan All rights reserved.
In the last equation, the coefficient of the lagged
dependent variable has been observed to be 0.77.
Since the coefficient of lag dependent variable is equal
to 1 minus the adjustment coefficient, the adjustment
coefficient is equal to 0.23.
Thus the speed of adjustment between desired and
actual share prices as implied by this value is therefore
slow.
It seems that only 23 percent of the adjustment, of
actual to desired share price is completed within a year.
In the partial adjustment model, the estimated
coefficients of the independent variables are equal to
the elasticities of these variable times the adjustment
coefficient, e.g., c
1
= b
1
& c
2
= b
2
, b
1
=c
1
/ & b
2
=c
2
/.
These coefficients are thus .01/.23=0.043 for DPS &
.51/.23=2.2 for RE which again support the conclusions
drawn earlier.
The capacity utilization as a significant variable
affecting the demand for inventories is doubtful.
Thanking you

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