Section B:

Dividend Policy and Capital Structure: Testing Endogeneity

Asad Abbas,Shujahat Haider Hashmi,Prof. Dr. Anwar Fazal Chishti
City University, Peshawar, Pakistan
Article in SSRN Electronic Journal · March 2016
Summary:
The study is aimed at exploring the relationship between dividend
payout and capital structure, and to explore the determinants of
dividend policy and capital structure of manufacturing sector of
Pakistan. Penal data ranging from 2006 to 2011 of selected 100
manufacturing firms of Pakistan is used in this study. Dividend policy
and capital structure have their own determinants. Firm’s size,
profitability, liquidity, growth opportunities, tangibility and capital
structure are used as determinants of dividend policy, while
determinants of capital structure which are used in this study are
firm’s size, profitability, liquidity, growth opportunities, tangibility,
tax saving other than debt and income variability and dividend
payout. Two stages least square is used for estimation. Size,
profitability, liquidity and leverage are found to have a positive
significant impact on dividend policy whereas growth opportunities is
found to have a negative significant impact on dividend policy and
tangibility has no impact. On the other hand growth opportunities,
tangibility and income variability are found to have positive
significant relationship with leverage (capital structure), whereas
firm’s Size, profitability, liquidity and tax saving other than debt are
found to have negative significant relationship with leverage. This
study concludes that dividend policy and capital structure are
positively correlated with each other.
1.Introduction
A firm’s capital structure means a specific combination of debt and
equity. It shows that how the assets of a firm are financed through the
combination of shareholder’s fund, debt or hybrid securities. Firms try
to maintain a specific level of capital structure which is less risky, less
costly and more beneficial for the investors (shareholders and debt
holders). Such level of capital structure is called optimal capital
structure. Optimal capital structure is difficult to maintain because
there are many factors which influence the capital structure. These
factors include firm’s profitability, size, tangibility, liquidity, growth,
income variability, tax saving other than debt, and dividend payout.
When a firm, after a year’s operations, makes profits, its management
has to make certain decisions regarding the disposal of the firm’s
previous year earnings. Whether the companies pay whole or part of
their current year’s earnings, that is generally referred to as dividend
payouts, and what is retained is called retained earnings. The
decisions of how much amount of profits is distributed among
shareholders depend upon the certain factors. These factors are called
independent or explanatory variables or determinants of the dividend
payout policy. These factors include firm’s profitability, size,
tangibility, liquidity, growth and leverage. Therefore these factors are
considered by the managers of the firms while making the dividend
payout policy of the firms
2. Methodology
This section includes the data descriptive, Econometric model and
model specification used in panel data analysis.
Dependent variables: Dividend payout, Leverage
Independent Variables: Profitability, Tangability, Growth
Opportunities, Liquidity, Tax saving other than debt, Income
variability, size.
2.1 Econometric model:
Econometric model for measuring relationship between the leverage
(DER) and dividend payout(DPO).
2.2 Model specification:
Model specification is very important in panel data analysis. Likely
hood ratio test and Housman test on both equations confirm the use of
Fixed Effect Model in this study.
3. Results and Discussion:
Data of 100 sample manufacturing firms has been analyzed using
Eviews version 7. Panel data analysis by using the Fixed Effect
Model is conducted to find out the relationship between dependent
and explanatory variables.
3.1 Profitability:
The value of Coefficient -17.35 and P Value 0.02 shows that results
are highly significant. Results of the study confirm the assertions of
Pecking Order Theory.
3.2 Tangibility:
The results of the study show that there is a positive relationship
between firm’s tangibility and its leverage (coefficient 2.93 P.Value
0.01).This positive relationship is supported by the argument that the
firms, who have larger amount of fixed assets, are more capable to
issue debt.
3.3 Growth Opportunities:
Firm’s growth and leverage are positively correlated as shown by the
values of coefficient 0.32 and P. Value 0.005. The relationship is
found to be statistically significant. This positive relationship is
supported by Pecking Order Theory.
3.4 Liquidity:
The values of coefficient -0.38 and P. Value 0.001 show that there
exists a negative relationship between liquidity and leverage.
3.5 Tax saving other than debt:
Tax saving other than debt is negatively related with the firms’
leverage. (Coefficient -38.38 P Value 0.004). The relationship is
statistically significant.
3.6 Income Variability:
The results indicate a positive relationship between income variability
and leverage. (Coefficient 0.01 P. Value 0.003). These results are
statistically significant.
3.7 Size:
Results show that size and firm’s leverage has significant negative
relationship. (Coefficient -0.44 P Value 0.002).The negative
relationship means that the larger firms tend to raise funds internally
or through the new equity issue and don’t rely on debt financing;
therefore such firms have low leverage.
3.8 Dividend Payout:
Dividend is positively related with firm’s leverage. The results are
statistically significant.
3.9 Size:
The results show that a positive relationship exists between firm’s
size and dividend payout.
3.10Profitability:
Firm’s profitability has significant positive relationship with dividend
policy, which is shown by the value of Coefficient 0.45 and P. Value
0.02.
4. Conclusion:
This study is conducted to determine the relationship between capital
structure and dividend policy and to find out the determinants of
capital structure and dividend policy in the manufacturing industry of
Pakistan. Penal data with two stages least square model is used in the
study. Descriptive statistics of the data shows that the data is normal
and the mean values of all the variables is low except income
variability; similarly the standard deviation of income variability is
also high as compare to other variables. The high value of the
standard deviation of income variability shows that there is high
fluctuation in the incomes of the selected firms of the manufacturing
industry of Pakistan, which is also indicated by the minimum and
maximum values. In this study fixed effect model is appropriate
which is confirmed by Likely Hood ratio test. Finally it is concluded
that capital structure (leverage) and dividend policy are positively
correlated with each other in manufacturing industry of Pakistan.
Similarly it is found that firm’s size, profitability, liquidity and
financial leverage are the explanatory variables of dividend payout
policy while Firm’s tangibility has no impact on dividend payout
policy