CHAPTER-2

REVIEW OF LITERATURE

In this chapter a brief review of various research studies is made. The review of literature is
divided in the following sections:

 Review of Literature related to Lintner‟s Model

 Review of Literature related to Determinants of Dividend

 Review of Literature related to Dividend Distribution Tax

 Review of Literature relation between Dividend Policy and Value of Firm

2.1 Review of Literature related to Linter‟s Model

Behavioral models of dividend policy assume that the change in dividends can be
explained by the last period‟s dividends and the target dividends, which can be expressed as a
fraction of this period‟s earnings. Lintner (1956) first published the basic model for that kind
of dividend policy. Lintner John (1956) surveyed and conducted the interviews of CFO of
USA firms. He suggested that the current earnings and past year dividend are associated with
dividend payment behavior.

Brittain A. John (1967) Brittain‟s most successful model uses these factors along with cash
flow instead of profit to explain changes in dividend. The study found that profits are not as
good a measure of ability to pay dividends as are cash flows. A sizable part of the rise in
payout ratios between 1947 and 1960 can be attributed to increased depreciation liberality.

Fama and Babiak (1968) examines the causal factors of dividend payments by individual
firm during 1946-64 and concluded that net profits provides a significant measure of dividend
than either cash flows or net profit. Depreciation was also included as separate variable in the
model.

Mahapatra and Sahu (1993) analyze the determinants of dividend policy using the models
developed by Lintner (1956), for a sample of 90 companies for the period 1977-78 to
1988-89. According to the study, cash flow is a major determinant of dividend followed by
net earnings. Further, their analysis shows that past dividend and not past earnings is a
significant factor in influencing the dividend decision of companies.

13
Pandey (2003) examines corporate dividend policy and behavior of the Kuala Lumpur Stock
Exchange (KLSE) companies, the Malaysian evidence. The Lintner framework and panel
data regression methodology by over viewing eight year period of study from 1993 to 2000
was used for the analysis. The study found that the model is in favor of regular, but less
stable, dividend policies being pursued by the KLSE companies.

C.Justin Robinson (2005) study the Lintner model and dividend policy among publicly
firms in Barbados. The findings indicated that the computed target payout ratio is 33 percent,
which is somewhat lower than the sample dividend payouts over the sample period. The
speed of adjustment is 0.48 indicating that is significant level of dividend smoothing. The
results therefore suggest that publicly traded firms in Barbados engage in a dividend
smoothing and follow stable dividend policies inclined the lines suggested by Lintner (1956).

Bodla B S, Karam Pal, and Sura (2007) examines the application of Lintner‟s Dividend
Model. They carried out a cross-sectional analysis from the year 1996 to 2006 in banking
sector in India. The result indicate that the current earnings and previous year dividend is the
major determinants of current year dividend payment. The results are found incline to the
Lintner model.

Naceur Samy, Mohhammad and Belanes Amel (2007) conducted a study on the
determinants and dynamics of dividend policy. This study used Lintner Model in a dynamic
setting. And the study found that Tunisian firms rely on both current earnings and past
dividends to decide their dividend payment. However, neither the ownership concentration
nor the financial leverage seems to have any impact on dividend policy in Tunisia. Besides,
the liquidity of stock market and size negatively impacts the dividend payment.

Kanwal Anil, kapoor Sujata (2008) attempted to validate Linter dividend policy model in
Indian Information Technology Sector. An effort has been made to find the applicability of
dividend signaling and smoothing approaches in IT sector by empirically testing the Linter
model throughout study. The findings suggest that a current year profit is the major
determinant of dividend decision in IT sector.

Bitok Kibet, Tenai Joel Thomas Cheruiyot, Loice Maru (2010) determined the level of
corporate dividend payout to stockholders and establish if the optimal dividend policy exists
for the firms quoted at the Nairobi Stock Exchange (NSE). According to the findings of this
study, the aggregate dividend payout ratio for the Kenyan market was obtained to be 44.14%
for the period between 1991- 2003. The findings of this research suggest that the average

14
corporate dividend payout to stockholders for 40% of the firms is low and stable and that
28% of the firms are high and stable dividends.

Dogra Balram, A.K. Vashisht, Gupta Shveta (2013) study was aimed to Examining
Validity of Known Dividend Models in Indian Companies. This study investigates whether
these models can be used to explain Indian companies‟ dividend payments or not. This study
found that out of all the models, Lintner‟s model does have a good fit in the selected Indian
companies.

Parasuraman N.R, Janki, Nusrathuunisa (2013) investigated whether Lintner model of

dividend payout holds good? The study tested the hypotheses if the dividends paid depended
on basic earnings, lagged dividend, cash earnings and capital expenditure. The result and
finding of the study support the prevalence and relevance of Linter model of dividend policy.
Depreciation and capital expenditure did not have and significant impact on dividends paid.

2.2 Review of Literature related to Determinants of Dividend

Kasim L. Alli, A. Qayyum Khan (1993) conducted a study concerning on the determinants
of corporate dividend policy using factor analysis. The two step-procedures were used for
analyzing the results, factor analysis at first stage and regression analysis on second. Strong
support was found for the transaction cost/residual theory of dividends, pecking order
argument, and the role of dividends in mitigating agency problems. They found the role of
managerial consideration in affecting the firm‟s payout policy. It found that firms that enjoy
financial flexibility and maintain stable dividend policies pay higher dividends.

Anand Manoj (2004) analyzes the determinants of dividend policy decisions of the corporate
India. The factor analysis has been used for analyzing the determinants of dividend policy.
The study found that management of corporate India believes that dividend decisions are
important as they provide signaling mechanism.

Amidu Mohammed (2007) examines whether dividend policy influences firm performance
in Ghana. The analyses are performed using data derived from the financial statements of
listed firms on GSE during the period 1997-2004. They ordinary least square method of
regression analysis is used for estimating the results. The positive relation was found with
return on assets, and growth in sales with dividend policy, while negative relation with
leverage.

15
Dimitrios L. Papadopoulos et al. (2007) investigate the present status and determinants of
dividend policy of firms listed in Athens Stock exchange. The analysis is based the data
covering the period from 1995-2002. Regression analysis is used to find out the effect of
determinants for dividend payments. The study finds that payout policy is subjected to minor
changes through years; differences between dividend policy of retail firms and that of
industrial firms are minor; the variables used explain only a small proportion of dividend
policy‟s variability and cash flow is the main determinant of dividend policy.

Kapoor Sujata, Kanwal Anil (2008) attempt to identify the various factors that influence the
dividend payout policy decisions of IT firms in India. The multiple regression analysis is
used for the analysis of pooled data for seven years i.e. 2000 to 2006. The study suggests that
dividend payout ratio is positively related to profits, cash flows and it has inverse relationship
with the sales growth and market to book value ratio.

Husam-Aldin Nizar Al-Malkawai (2008) analyses the factors influencing corporate

dividend decisions of publicly quoted companies in Jordan. The analysis is based on 15-year
unbalanced panel data covering the period between 1989 and 2003.They estimate the
determinants for a given firm to pay dividends to its shareholders through Probit
specifications. The study finds that the factors affect dividend policy such as size,
profitability, and age increase the likelihood to pay dividends. Financial leverage decreases
the probability to pay dividends. The findings support for the agency costs hypothesis and are
broadly consistent with the pecking order hypothesis.

Gupta Amitabh and Banga Charu (2010) bring out the determinants of corporate dividend
policy using factor analysis and the multiple regression. Results of factor analysis indicate
that leverage, liquidity, profitability, growth and ownership structure are the major factors.
According to the regression analysis on these factors shows leverage and liquidity to be the
determinants of the dividend policy for Indian companies.

Gill Amarjit, Biger Nahum (2010) perform a study on the determinants of dividend payout
ratios of American service and manufacturing firms. Profit margin, sales growth and debt to
equity ratio are the major determinants of dividend policy in services firm whereas profit
margin, tax and market-to-book ratio are the function of dividend payout ratio in
manufacturing firm.

Kapoor Sujata, and Mishra Anil (2010) explore the various factors that influence the
dividend policy decisions of firms in Services sector in India. The literature suggests that

16
dividend payout is positively related to profits, cash flows while Capex, retained earnings,
sales growth, share prices, beta, interest paid and debt equity ratio have inverse relationship.

Talat Afza, and Hammad Hassan Mirza (2010) examine the impact of ownership structure
and cash flows on corporate dividend policy in Pakistan. The reference period of the study
cover from 2005 to 2007 of 100 companies listed at Karachi stock exchange (KSE). The
ordinary least square (OLS) method of regression analysis has been used for the analysis. The
results show that managerial and individual ownership, cash flow sensitivity, size and
leverage are negatively whereas, operating cash-flow and profitability are positively related
to cash dividend.

Ch. Muhammad Adil, Nousheen Zafar (2011) aims at the re-evaluation of the incremental
information content of profitability and liquidity for dividend payout. The data is pertaining
to the year 2005-2009. The association between Dividend per share and Earning per share,
ROE, cash flow per share and size has been tested by applying regression to panel data. The
strong relationship has been resulted between dividend payout with EPS (Earnings per Share)
ROE (Return on equity) CFOP (Cash flow operating) and the results for these variables are
significant and the size has insignificant relation with dividend policy.

Talat Islam, Muhammad Aamir, et al (2012) research is aimed to find out the determinants
of the dividend policy among the cement industry. Data was collected from the web of state
bank of Pakistan and Karachi stock exchange from 2004-2009. To analyze the determinants
of selected companies ordinary regression (OLS) was applied. The study finds that PE ratio,
EPS growth and sales growth are positively associated with the dividend payout while
profitability and debt to equity were found to have negative association with dividend payout.

Singhania Monica, Gupta Akshay (2012) aims to determine the determinants of dividend
policy in India. Tobit regression model has been used for empirical result. The study focuses
on and seeks to answer the question: What are the significant determinants of dividend
decision as far as Nifty 50 Index companies in India are concerned? The firm-level panel data
of NSE companies from 1999-2000 to 2009-2010 is taken for this purpose. The findings
suggest that firm‟s size (market capitalization) and firm‟s growth and investment opportunity
are significant determinants of corporate dividend policy in India. Profitability, debt structure
and experience do not show the significant determinants in the Indian scenario.

Mistry S. Dharmendera (2012) focuses on dividend payment decision of Indian two

wheelers industry. The reference period of the study is of 8 years from 2001-02 to 2008-

17
2009. The multiple linear regression analysis has been used for the analysis. The study
consisting of one dependent variable (dividend payout ratio) and five independent variables
(profitability, liquidity, operating activities, turnover and capital market activities). The study
finds that profitability and liquidity have been found favorable to increase dividend payout
ratio in Indian two wheeler industries; while operating activities, turnover and capital market
activities affected dividend payment decision of Indian two wheeler industries adversely.

Abdul Rehman (2012) examines the factors affecting dividend payout ratio of the companies
listed at Karachi Stock Exchange (KSE) of Pakistan. One year of data i.e. 2009 is referred for
the analysis by using regression analysis. The study found the positive relation of debt to
equity, profitability, current ratio with dividend payout while market to book value ratio and
operating cash flow per share were found to be significant determinants of dividend payout
ratio in Pakistan.

Mehta Anupam (2012) investigates the determinants of dividend payout for all firms in the
areas of real estate, energy sector, construction sector, telecommunications sector, health care
and industrial sectors for the period of 2005-2009. Two step analyses were done to analyze
the effect of dividend policy. At first stage correlation analysis and then backward multiple
linear regression analysis was carried out at second stage. Profitability, Risk, Liquidity, Size
and Leverage of the firm range the determinants of dividend policy. Size and the profitability
were considered as the most important determinants of dividend policy.

Zameer Hashim, Rasool Shahid (2013) identify the determinants of dividend policy of
Pakistani banking sector. The coverage is restricted to the period of 2003-2009. The stepwise
regression analysis is conducted. The study finds that Profitability, last year dividend and
ownership structure show positive impact on the dividend payout and liquidity show negative
impact on the banking industry. The insignificant relationship has been found with size,
leverage, agency cost, growth and risk.

Ebenezer Agyemang Badu (2013) examines the factors influencing dividends payout policy
of listed financial institutions in Ghana using fixed and random effects. Panel data (regression
analysis) covering 2005-2009 from the selected companies is used for the study. The results
shows statistically significant and positive relationship between Age and liquidity but saw
statistically insignificant relationship between profitability, collateral and dividend payment.
Therefore, the major determinants of dividend policy of financial institutions in Ghana are
age of the firm, collateral and liquidity.

18
Boamah Kofi Baah, Richard Tawiah (2014) examines the determinants of dividend policy
and also its effect on share prices of companies listed on the Ghana Stock Exchange. The
reference period covers from 2006 to 2011. The ordinary least square (OLS) regression
model is used in this study. The Price Volatility, Profit After-Tax, Earning per Share, Size,
and Growth in Assets, Return on Equity, and Liquidity as explanatory variables and the
Dividend Payout as the dependent variable uses these factors for the study. The study reveals
that return on equity, profit after tax and size of the company are the main determinants of
dividend policies of companies listed on the GSE. Profit After-Tax happens to be most
important variable that is considered by most sectors in paying their dividend. Thus
Profitability is a key determinant of dividend policy of companies across the various sectors
on the GSE.

2.3 Review of Literature related to Dividend Distribution Tax

Abrutyn Stephanie & Robert W. Turner (1990) attempt to identify the motives underlying
their payout behavior. Surveys were sent to the Chief Executive officers of 550 of the biggest
1000 corporations in the United States to try to distinguish among four competing
explanations of why firms pay dividends. The study reveals that no change has been
expected in the dividend payout ratio of the eighty five percent of the respondents due to the
Tax Reform Act 1986. The survey result strongly suggested that no single theory consistently
explains the behavior of all firms. Calculations of the cost of capital or the effect of capital
gains tax changes that are based on an assumption that one particular theory of dividend
behavior is correct should be viewed with caution. Empirical investigations attempting to
identify the single „correct‟ explanations of dividend behavior are unlikely to succeed, since
no single explanation is correct for all firms.

Roni Michaely (1991) analyzes the behavior of stock prices around ex-dividend days after
the implementation of the 1986 Tax Reform Act that dramatically reduced the difference
between the tax treatment of realized long term capital gains and dividend income in 1987
and completely eliminated the differential in 1988. Closing prices for the 50 days surrounding
the ex-day (-25 to +25) were collected for all firms listed on the NYSE which paid dividends
during the 1986-1989 period. The study revealed that the tax change had no effect on the ex-
dividend stock price behavior.

Collins H. Julie and Deen Kemsley (2000) study focuses on capital gains and dividend
taxes in firm valuation. The sample for the empirical tests consists of all domestic companies

19
reported on the 1995 or 1998. The study suggested that investors implicitly extend entity-
level accounting to the proprietary level when they value the firm. The findings also
suggested that when fully accounting for the effects of implicit dividend taxes, reinvested
earnings appear to be subject to three levels of taxation- corporate, dividend, and capital gains
taxes. Paying earnings out as dividend eliminates the capital gains layer of tax and may
provide a net wealth benefit for shareholders, rather than a tax penalty as commonly assumed.

Kalay Avner and Roni Michaely (2000) re-examines the impact of the differential taxation
of dividends and capital gains on assets prices. The result indicated that most of the return
variation previously attributed to dividends is not because of cross-sectional variation in
returns, but due to the time-series variation in returns around the dividend payment. In light
of the lack of cross-sectional return variation, interpreting the higher return around the
dividend distribution as a tax effect is problematic.

Dhaliwal Dhan et.al (2005) investigate whether dividend taxes affect firm‟s cost of capital
by testing the relation between the implied cost of equity capital and a measure of the tax-
penalized portion of dividend yield. The sample includes the New York Stock Exchange
(NYSE), American Stock Exchange (AMEX), and Nasdaq firm years from 1981 to 2001. The
study found that a positive relation between the implied cost of equity capital and the tax-
penalized portion of dividend yield that is decreasing in aggregate institutional ownership.

Chetty Raj and Emmanuel Saez (2005) analyze the effects of dividend taxation on
corporate behavior using the large tax cut on individual dividend income enacted in 2003.
The data span was used 1980-Q1 to 2004-Q2. The response to the tax cut was strongest in
firms with strong principals whose tax incentives changed (those with large taxable
institutional owners or independent directors with large share holdings), and in firms where
agents had stronger incentives to respond (high share ownership and low options ownership
among top executives). Hence, principal-agent issues appear to play an important role in
corporate responses to taxation.

Zeeshan Hamid (2011) study is aimed to explore the impact of taxes on dividend policy of
banking sector in Pakistan. The data obtained from the financial reports of 21 banking
companies listed on Karachi Stock Exchange over a period of years (2006 to 2010) is used in
this study. Pearson correlation and regression was used to find the relationship of tax and
dividend income of the banks and also suggest that the tax-rate is an important determinant of
dividend policies of banking sector.

20
2.4 Review of Literature on Dividend Policy and Value of Firm

A number of studies have been reviewed to analyze the relationship between dividend policy
and value of firm.

Elton Edwin and Martin Guber (1968) examine the effect of share repurchase, as a method
of cash disbursement, on the value of firm. The study found that heterogeneity decreases
stock-transaction costs associated with share repurchase and increases the transaction
associated with cash dividend. And, even though stockholders are heterogeneous with respect
to their desire for current income, the firm need only be concerned with its aggregate
dividend policy when share repurchase is used as the method of cash disbursement.

Shepherd P. Andrew (1977) surveyed current theories concerning dividend policy, and seek
to reconcile them under a common set of assumptions. The relationship between dividend
payout and price/earnings ratios was analyzed for the year 1962, 1968 &1969. The study
found that dividend folklore does exist, each industry having a traditional payout range. It is
for this reason that a change in dividend policy will alter the value of the enterprise. Investors
expect a certain payout ratio from a certain industry, and if a company changes from the
norm the share price will move. Investors read too much into the level of dividend for a
change in that level not to have an effect on the share price, and although empirical evidence
does link dividends and prices, the casual relationship has still not been fully uncovered.

Marangu Kenneth & Ambrose Jagongo (2014)study was aimed to establish the
relationship between price to book value ratio and financial statement variables such as
dividend payout ratio, return on total assets, return on equity, dividend per share and growth
rate of earnings after tax for companies quoted at the Nairobi Securities Exchange (NSE).
The study concluded that price to book value ratio and return on total assets, return on equity,
and dividend per share had statistical significant relation at the NSE, Kenya. and statistically
insignificant relation was found between price to book value ratio and the dividend payout
ratio and growth rate in earnings after tax at the NSE, Kenya. The price to book value ratio,
return on total assets, return on equity and dividends per share were the best predictor
variables.

Azhagaiah and Sabari (2008) aim at analyzing the impact of dividend policy of
shareholders wealth in Organic and Inorganic Chemical companies in India during 1996-
1997 to 2005-2006. The multiple regression analysis was used for the analysis of the study.
The study found that there is significant impact of dividend policy on shareholders wealth in

21
organic chemical companies whereas Inorganic chemical companies are not influenced by
dividend payout.

Sajid Gul et.al (2012) examine the influence of dividend policy on shareholder‟s wealth of
75 companies listed in „Karachi Stock Exchange‟ for duration of six years from 2005 to 2010
using multiple regression and stepwise regression. The shareholder‟s wealth as a dependent
variable which was measured as market price per share, whereas the as dividend per share
was measured as explanatory variable. There is significant influence of dividend policy on
wealth of shareholder‟s, as far as the dividend paying companies are concerned.

Moridipour Hamid et al (2013) evaluate the relationship between price to book value ratio
with accounting variables such as liquidity ratio, assets efficiency and dividend in Tehran
Stock Exchange TSE. The data of 56 companies for a period of 2005 to 2009 was considered
for the analysis. The results reveal that there is positive significant relationship of price to
book value with these variables and it is a suitable criterion for measuring created value of
stockholder.

- -XXXXX- -

22