CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Dividend decision in corporate finance is a decision made by the directors of a

company`s about the amount and timing of any cash payment made to the company`s

shareholders. Dividend decision is an important part of the present day corporate world,

one for the firm as it may influence it capital structure, stock price and corporate

performance. The firm has to balance between the growth of the company and the

distribution to shareholders. So many factors affect the performance of corporate

organization and one of those factors is dividend policy. Dividend policy serves as a

mechanism for control of a managerial opportunism. A dividend decision are an

important aspect of corporate financial policy since they can have an effect on the

availability as well as the cost of capital. The pattern of corporate dividend policies not

only varies over time but also countries, especially between developed, developing and

emerging capital markets. If the values of a company is the function of its dividend

payments dividend policy will affect directly the firm`s cost of capital. But is there any

significant relationship between dividend policy and corporate performance in form of

profitability investment and earning per share. Dividend is the return that accrues to

shareholders as a result of the money invested in acquiring the stock of a given company

(Eriki & Okafor 2002). While dividend policy on the other hand is concerned with the

division of net profit after taxes between payment to shareholders and retention for
1
reinvestment on behalf of the shareholders (Kemper, 1980). The existence of some share

price reactions on dividend announcement prompts an analysis of the evidence for both

shareholders clienteles and possible interaction of firm`s dividend polices with key

activities such as internal investment. An aspect of the theory of dividend policy is part of

a continuum of control allocation between managers and investors, and hence cross-

sectional variations in dividend policy are driven by an underlying factor. The allocation

of controls between the manager and investor is important not because of agency or

private information problems, but because of its potentially divergent beliefs that can lead

to a disagreement about the value of project available to the firm.

Corporate performance is at the heart of the managerial function of an organization

(Samuel, 1989). Analysis of corporate performance is mainly concerned with the

development of a modelling methodology to help in the diagnosis of past performance

and thus provide a framework for evaluating the effect of changes in operating

parameters as a guide for future planning. The performance of an organization is

measured by the choice of the management form of wealth to be held. If the performance

of an organization is good there will be little or no disagreement between the

management and shareholders. In evaluating corporate performance, the emphasis is on

assessing the current behavior of the organization in respect to its efficiency and

effectiveness. To measure overall corporate performance goals are set for each of these

perspective and specific measure for achieving such goals determined, each of these

perspective is critical and must be considered simultaneously, and to succeed in the long-

2
run. Any area is either over-emphasized or under-emphasized performance evaluation

will become unbalanced. In this way, the aim of the concept is to establish a set of

measures both financial and non-financial, through which a company can control its

activities and balance various it’s measure to effectively track performance. Investment

and dividend decision are an integral part of corporate financial management policy.

Investment decision requires an appropriate choice and combination of internal and

external sources of finance, which decision regarding dividends involves about

determining portion of profit to be distributed among shareholders consequently

restricting the internal sources of finance. If the amount dividend paid is large, the

residual funds retained for reinvestment purposes will be reduced and consequently the

firm will have to depend upon alternative sources of long term finance like further issues

of equity and/or debt capital to finance current and new project. Earning is a main target

and major source of internal funds.

Therefore, for investment and dividends decisions, the internally generated funds that is

profitability needs to be a top priority for firms. Dividend policy remains one of the key

issues in corporate finance since it affect the firm`s value and shareholders wealth.

Dividend policy is the financial policies regarding paying cash dividend and are of the

most enduring issues in financial research, many controversies regarding large number of

conflicting hypothesis, theories and explanations have attracted many academic interest

on dividend policy (Frankfurter & Word, 1997). Dividend is a payment either in cash or

other forms that corporations pay to their own shareholders. They are regarded by

3
shareholders as the return on the investment made in the corporation. The Board of

Directors has primary responsibility for drafting the dividend policy and decides whether

to pay dividends or not? We raise a very basic question: Why should corporations have a

strategic policy for dividend payment? "Players in the market", shareholders and

investors do not prefer surprises. If the corporation does not have a stable dividend

policy, the corporate shareholders will not have any more interest to keep their capital in

such corporations. Consequently, the stock price will fall. When shareholders do not

receive the expected return (dividend), they express dissatisfaction by selling shares.

Therefore, corporations should pay special attention on dividend policy

1.2 Statement of the Problem

Dividend is the return that accrues to shareholders as a result of the money invested in

acquiring the stock of a given company (Eriki & Okafor, 2002). While dividend policy on

the other hand is concerned with division of net profit after taxes between payments to

shareholders (ordinary shareholders) and retention for reinvestment on behalf of the

shareholders (Kempner, 1980). Dividend Policy is the main explanatory variable in the

empirical analysis since it capture the amount of dividend payment the firm makes on an

annual basis. The variable shows the direction of dividend policy of a firm since it gives

information on the pattern of dividend activities in the firm. According to Davidson

(1990), the existence of some share price reactions on dividend announcement prompts

an analysis of the evidence for both shareholder clienteles and possible interaction of

firms’ dividend policies with key activities such as internal investments. Modigliani and

4
Miller (1961) observed that the theoretical principles underlying the dividend policy and

its impact on firms can be described either in terms of dividend irrelevance or dividend

relevance theory. Therefore, dividend policy is irrelevant for the cost of capital and the

value of the firms in a world without taxes or transaction cost. This shows that when

investors can create any income pattern by selling and buying shares, the expected return

required to induce them to hold firm’s shares will be invariant to the way the firm

packages its dividend payments and new issues of shares. It is to be observed that a

firm’s assets, investments opportunities, expected future net cash flows and cost of

capital are not affected by the choices of dividend policy. In evaluating corporate

performance, the emphasis is on assessing the current behavior of the organization in

respect to its efficiency and effectiveness. To measure overall corporate performance

goals are set for each of these perspectives and specific measure for achieving such goals

are determined. Each of these perspectives is critical and must be considered

simultaneously, to achieve overall efficiency and effectiveness, and to succeed in the

long-run. If any area is either over-emphasized or underemphasized, performance

evaluation will become ‘unbalanced’. In this way, the aim of the research is to establish a

set of measures on financial performance, through which, a company can control its

activities and balance various measures to effectively track performance.

1.3 Research Questions

1. Is there any significant relationship between dividend policy and dividend yield?

5
2. To what extend is the impact relationship between dividend policy and dividend

payout? 3. Is there any significant relationship between dividend policy and earning per

share?

1.4 Objectives of the Study

The main objective of this study is to examine the relationship between dividend policy

and corporate financial performance. The specific objective are to

1. Ascertain if there is any significant relationship between dividend policy and

dividend yield

2. Determine the impact of dividend policy on dividend payout

3. Determine if there is any significant relationship between dividend policy and

earning per share

1.5 Statement of Hypotheses

The hypotheses are started below;

Ho1: there is no significant relationship between dividend policy and dividend yield

Ho2: there is no significant relationship between dividend policy and dividend payout

Ho3: there is no significant relationship between dividend policy and earnings per share

1.6 Significance of the Study

6
The study exist on the relationship between dividend policy and corporate financial

performance of a quoted companies in Nigerian, it is important for academic matters,

shareholders, investor, government, organization and policy making. Dividend policy in

place it will enhance their profitability and attract investment to the organizations. The

allocation of controls between the managers and investors is important not because of

agency or private information problems, but because of its potentially divergent beliefs

that can lead to a disagreement about the value of project available to the firm. Corporate

performance is at the heart of the managerial function of the organization. The value of a

company is the function of its divide payments, dividend policy will affect directly the

firms cost of capital.

It is important for academic matters, for prospective researcher stand to benefit from the

study because it would be available for literature review, thereby serving as a basis for

identifying the missing gap in literature. The study will assists policy makers,

organization and government on corporate performance and dividend policy. The firm

has to balance between the growth of the company and the distribution to the

shareholders and it has critical influence on the value of the firm, it has to also to strike a

balance between the long term financing decision and wealth maximization. Retained

earnings helps the firm to concentrate on the growth, expansion and modernization of the

firm.

1.7 Scope and limitation of the Study

7
The scope of the study cover sixty randomly selected listed companies of the eleven (11)

Sectors in Nigeria economy, to accomplish this objective, the Nigeria Stock exchange

fact book and annual reports and account of companies will be analyzed best on dividend

per share, dividend yield, dividend payout, earning per share and growth and it limited to

the relationship between dividend policy and corporate performance.

This is a case when the company pays dividend in the form of assets other than cash. This

may be in the form of certain assets which are not required by the company or in the form

of company's products.

8
 CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter cover the literature review conceptual framework prior studies theoretical

framework and models concerning the study, the relationship between dividend decision

and corporate performance of quoted companies in Nigeria

2.2 Conceptual Framework

Dividend is the return that accrues to shareholders as a result of the money invested in

acquiring the stock of a given company (Eriki & Okafor 2002). While dividend policy on

the other hand is concerned with division of net profit after taxes between payments to

shareholders (ordinary shareholders) and retention for reinvestment on behalf of the

shareholders (Kempner, 1980). A difficult decision for both public and private limited

companies is to determine the appropriate level of dividend to be paid to shareholders,

and to decide whether or not to offer non-cash alternatives such as scrip dividends

According to Davidson (1990). The existence of some share price reactions on dividend

9
announcement prompts an analysis of the evidence for both shareholder clienteles and

possible interaction of firms’ dividend policies with key activities such as internal

investments. An aspect of the theory of dividend policy is part of a continuum of control

allocations between managers and investors, and hence cross-sectional variations in

dividend policy are driven by an underlying factor. The allocation of controls between the

manager and investors is important not because of agency or private information

problems, but because of its potentially divergent beliefs that can lead to a disagreement

about the value of project available to the firm. This underlying factor is “Corporate

Performance”. ‘Corporate performance is at the heart of the managerial function of an

organization’ (Samuel 1989). Analysis of corporate performance is mainly concerned

with the development of a modeling methodology to help in the diagnosis of past

performance and thus provide a framework for evaluating the effect of changes in

operating parameters as a guide for future planning. The performance of an Organization

is measured by the choice of the management form of wealth to be held. If the

performance of an organization is good there will be little or no disagreement between

the management and the shareholders. (Ghosh & Subrata, 2006)

In evaluating corporate performance, the emphasis is on assessing the current behavior of

the organization in respect to its efficiency and effectiveness. To measure overall

corporate performance goals are set for each of these perspectives and specific measure

for achieving such goals are determined. Each of these perspectives is critical and must

be considered simultaneously, to achieve overall efficiency and effectiveness, and to

succeed in the long-run. If any area is either over-emphasized or underemphasized,

10
performance evaluation will become ‘unbalanced’. In this way, the aim of the concept is

to establish a set of measures both financial and non-financial, through which, a company

can control its activities and balance various measures to effectively track performance.

Eniola and Akinselure (2016) the study consider the impact of dividend policy and

earnings on selected quoted companies in Nigeria and it covers the period from 2004 –

2013, the findings revealed that there was a significant relationship between dividend and

market value but this relationship can only be established between earning per share and

dividend yield because, it is the only proxies of dividend polices that had a P-value

(0.020) which is less than the alpha value of (0.05) which implies that there is

relationship with market value proxy( i.e. earnings per share) while the other proxies of

dividend policy did not show any relationship. Charles, Joseph and Jane (2014) Effect of

dividend policy on firm`s financial performance econometric analysis of listed

manufacturing firms in Kenya, the findings indicate that: there is a significant positive

relationship between dividend policy and investment, earning per share. Ahmed et al

(2014) the study consider the Impact of Dividend policy earning per share return on

equity profit after tax on stock prices, a sample of sixty three companies listed at Karachi

stock exchange was analyzed for the period of 2006 – 2011, methodology ordinary least

square regression model has been applied on panel data, findings the results indicate

dividend yield and dividend payout ratio which are both measure of dividend policy have

significant impact on stock price.

11
Ikram (2013) stated that there are many evidences showing that firms with high earning

management will encounter negative abnormal return, also they show that earning

manipulation for more dividends id seen more in these firms than the others. Chen and

Dhiensiri (2009) studied determining factors in dividend policy in New Zealand found

out that dividend has a positive relationship with ownership dispersion and a negative

relationship with internal ownership degree. They also concluded that growth of sales

results in a reduction in dividends. Ghadimifardzanjani and Makrani (2015) the effect of

earnings quality on cash dividend within sample of 150 firms enlisted in Tehran stock

exchange during the 8 years period of time 2006 – 2013. Results show that there has been

a meaningful relationship between earnings quality and cash dividend. Variables such as

operating cash flows firm size debt ratio and the ratio of earnings to asset have a

meaningful relationship with cash dividend.

Gavandre and Darabi (2015) in a study that examines the relationship between firm

growth and dividend policy is R7 years period from 2007 – 2012, the sample is obtained

by elimination method comprises 142 companies, result show that there is a significant

relationship between the growth of company assets and dividend policy. Monogbe and

Ibrahim (2015) the study shows that there is a strong and positive significant relationship

between return on capital employed and dividend policy. Foong, et al (2007) observed

that although firms do not have obligations to declare dividends on common stock, they

are normally reluctant to change their dividend rate policy every year as the firms strive

to meet stockholders’ expectation, build a good image among investors and to signal that

12
the firm has stable earnings to the public. Many researchers have tried to uncover issues

regarding the dividend dynamics and determinants of dividend policy but we still don’t

have an acceptable explanation for the observed dividend behavior of firms (Black, 1976;

Brealey & Myers 2005). Rozeff (1982) is one of the first to propose a role for dividends

in reducing agency-related losses, substituting for other bonding and auditing costs

incurred by the firm. He finds that ownership concentration is negatively related to

payout, which is consistent with the argument that greater insider concentration results in

better monitoring thus reducing the need to pay dividends. Kale and Noe (1990) in a

related study opined that a firm’s dividend basically indicates the stability of the firm’s

future cash flows. A review of related prior studies shows further that the main factors

that influence a firm’s dividend decisions include cash flow considerations, investment

returns, after tax earnings, liquidity, future earnings, past dividend practices, inflation,

interest, legal requirements and the future growth projection. Dividends are compensatory

distribution to equity shareholders for both time and investment risks undertaken. Such

distributions are usually net of tax and obligatory payments under debt capital and they

represent a depletion of cash assets of the company (Lipson et al., 1998). Amidu (2007)

Investigated that dividend policy affects firm performance as measured by its

profitability. The results showed a positive and significant relationship between return on

assets, return on equity, growth in sales and dividend policy. Oskar, Ivan, Oleksandr, Diw

(2007) pointed that two perspectives. First, explore the determinants of the dividend

policy in Poland. Second, test whether corporate governance practices determine the

dividend policy in the non-financial companies listed on Warsaw Stock Exchange. The
13
findings are based on the period 1998-2004. Quantitative measures on the quality of the

corporate governance for 110 non-financial listed companies. These results suggest that

dividends may signal the severity of conflicts between controlling owners and minority

shareholders. Those dividends in Poland have less of a signaling role than in the

developed capital markets. Zeckhauser & Pound (1990) revealed that found out that there

is no significant difference among dividend payouts with or without large block

shareholders. Dividend policy is the regulations and guidelines that a company uses to

decide to make dividend payments to shareholders (Nissim & Ziv, 2001).

Modigliani and Miller (1961) observed that ‘The theoretical principles underlying the

dividend policy and its impact on firms can be described either in terms of dividend

irrelevance or dividend relevance theory’. Therefore, dividend policy is irrelevant for the

cost of capital and the value of the firms in a world without taxes or transaction cost. This

shows that when investors can create any income pattern by selling and buying shares,

the expected return required to induce them to hold firm’s shares will be invariant to the

way the firm packages its dividend payments and new issues of shares. It is to be

observed that a firm’s assets, investments opportunities, expected future net cash flows

and cost of capital are not affected by the choices of dividend policy.

Agrawal and Jayaraman (2004) observed that Dividend payments and leverage policy are

substitute mechanism for controlling the agency cost of free cash flow hence, improves

performance. If a firm’s policy is to pay dividend each year end to shareholders, the level

of activity in the organization will increase to obtain more income and have excess

14
retained earnings to meet the standard set. Brockington (1987) observed that ‘Dividend

policy has the effect of destabilizing dividend as only a prolonged increase or decrease in

profits will affect the average sufficiency to have any appreciable effect on the size of the

distribution’. Since it is a conservative dividend policy-in the long run, only one half of

all profits will be distributed and there will be substantial buildup of retained earnings.

This will certainly reinforce further, the consistency of dividends, which could for a

while, be maintained even in the face of actual losses. It may also relieve the company of

having recourse to external sources of finance. The retention under this policy bears no

relationship to the availability of profitable investment opportunities. The risk is that

projects yielding less than the true cost of capital will be undertaken in order to absorb

funds which would otherwise lie idle. Samuels and Wilkes (2005) stated that the

shareholders are entitled to a revenue stream of dividends. The value of the share

corresponds to the present value of this stream of dividend payments.

Nissim and Ziv (2001), Amidu (2007), Howatt et al. (2009), Ajanthan (2013) and Leon

and Putra (2014) also empirically indicate a positive and significant relationship between

profitability and dividend policy. However, findings of Farsio et al. (2004) and John and

Muthusamy (2010) conflict with these results. Farsio et al. (2004) argue that there is no

significant relationship between dividends and earnings in the long-run, and previous

studies supporting this relationship are based on short periods and therefore misleading to

potential investors. Because firms paying high dividends without considering investment

needs may therefore experience lower future earnings. And according to John and

15
Muthusamy (2010), profitability (return on assets) is negatively related to dividend

payout ratio. While firms with larger profits tend to pay more dividends, ones facing

uncertainty about (expected) future profits adopt lower dividend payments. Another

determinant of dividend policy of firms is liquidity (requirement), also discussed in terms

of firms’ free cash flows. Alli et al. (1993) and Mahapatra and Sahu (1993) arguing that

dividend payments depend more on cash flows than on current earnings, and Amidu and

Abor (2006), Afza and Mirza (2010), and Thanatawee (2013) find out that there exists a

positive relationship between cash flow and dividend payout ratio. This is because

relatively liquid firms with stable cash flows tend to pay higher dividends as compared to

firms with unstable cash flows. However, Barclay et al. (1995) find negative relationship

between liquidity and payout ratio suggesting that increase in payout ratio reduces firm’s

liquidity level, therefore lowering dividend payments. Ahmed and Javid (2008) confirm

the same finding; while Adedeji (1998) does not find any relationship between liquidity

and dividend policy. Growth (in net sales) is another determinant of dividend policy.

Higgins (1972) points out that there is a negative relationship between dividend payout

ratio and firm’s need for funds to finance growth opportunities. Later then studies of

Rozeff (1982), Lloyd et al. (1985), Collins et al. (1996), Amidu and Abor (2006), and

Gill et al. (2010) all indicate a negative relationship between dividend payout ratio and

sales’ growth. This is because firms either experiencing or expecting higher growth rates

may need to keep dividend payouts lower to avoid the costs of external financing. This

explanation may be so rational, but findings of Arnott and Asness (2003) surprisingly

conflicts with usual, pointing a positive relationship between dividend payout ratio and
16
growth. Gwilym et al. (2006), Ping and Ruland (2006) and Vivian (2006)

also support further evidence to findings of Arnott and Asness (2003). The confliction

here may be due to choice of growth variable and sample, and empirical methodology

undertaken. In empirical studies searching for the determinants of corporate dividend

policy, variability of earnings, equity beta coefficient and leverage ratio have been used

as indicators of risk. Pruitt and Gitman (1991) reveal that risk in terms of year-to-year of

earnings is also a determinant of dividend payout ratio. Firms with stable earnings tend to

pay out a higher amounts of dividend than firms with unstable earnings, because their

future earnings are more predictable. Estimating betas for 307 US firms, Beaver et al.

(1970) find significant correlation between beta and dividend payout ratio. Then Rozeff

(1982), Lloyd et al. (1985) and Collins et al. (1996), again using beta coefficient to proxy

for risk, point out that firms with relatively high betas will pay out lower amounts of

dividend. Studies of D’Souza and Saxena (1999), and Al-Najjar (2009) argue that

leverage affect dividend payout ratio negatively and firms with higher debt tend to reduce

their dividend payments. Market-to-book value ratio indicates the value that the market

places on the common equity or net assets of a firm (Lee and Makhija, 2009) and is a

reflection of the ability of firm managers to use assets effectively and to grow the firm.

Omran and Pointon (2004) points out its importance as a determinant of dividend payout

policy. Agyei and Marfo-Yiadom (2011), Gul et al. (2012) and Priya and Nimalathasan

(2013) conclude that there exists a positive relationship between dividend policy and

shareholders’ wealth (firm value). They find out that firms paying higher dividends

consequently increase the wealth of their shareholders. Contrary to their findings,

17
D’Souza and Saxena (1999), and Amidu and Abor (2006) posit a negative relationship

between market-to-book value and dividend payout ratios.

2.2.1 The Information Content of Dividends

The dividend information theory is based on the fact that capital markets are not fully

efficient since there are market parities that are more informed than others. The

assumption that managers, in individual cases, are more informed than the market is

coherent with market efficiency theory; according to dividend information theory, the

firm uses its dividend policy not only as an earnings transfer mechanism but as an

information carrier as well. The firm uses its dividend policy in order to reveal

information concerning the value of the firm, its potential earnings and the quality of the

investments that has undertaken. We can consider information content of dividend as an

important justification for the firm to pay dividends even in markets where taxes operate

against dividends

The use of dividend as information vehicle is important when the firm has motives to

reveal its true value in the market. In such a context dividend policy is a strong

instrument to ensure the market for the quality and the value of the firm. The dividend

information mechanism can also be used by firms in order to control its financial status

and inform the market about firm’s potentials. There is a great deal of debate in literature

on the importance of dividend signaling theory since empirical evidence support both the

validity and Balachandran and Nguyen (2004)

18
2. 2.2 Agency Theory

Dividends can be seen as a tool to reduce agency costs. Agency problem simply refers to

the principal-agent problem where the principle is the holder of the stocks or shareholders

and the agent is the manager. The main duties of the manager would be to run the firm

effectively and efficiently so as to maximize firm value and also maximize returns to the

shareholders. However, agency problem arises when managers’ and shareholders’

interests are not in line with each other. This may arise since the manager is not acting in

the interest of the shareholders, for example, the manager is not investing in projects that

the shareholders consider to be worth investing. Hence the cost of monitoring the

managers is referred to as the agency costs. However, another problem that exists in this

case is that the managers are involve in the daily running of the business and they are

more aware about which investment should bring higher positive returns. However, in

past literature, it has been observed that if managers are not monitored properly, they tend

to surround themselves with luxury products and also tend to pursue their personal

interests which in most cases would be to maximize their wages instead of returns to

shareholder (Jensen & Ruback, 1983). Hence one method which can be argued to help

overcome the agency problem is through dividend payouts. It can be said that firms

would have to stay in capital markets to keep raising funds. Funds raised are mostly

through loans from banks, insurance companies and other credit institutions. These

institutions will be acting as a control since, by giving credit, they would be able to

monitor the activities of the company to determine whether the company is being able to

repay its debt obligations. In this case, Easterbrook (1984) argued that since the credit
19
institutions are actually monitoring the firm, shareholders accept to pay higher tax rates

as they do not incur or incur less costs in monitoring the activities of the managers to

ensure that firm value is being maximized. On the other hand, with such monitoring, the

firm will have to produce positive cash flows thereby generating profits. Hence it can be

said that dividend payout not only reduce the agency problem but also convey some

information about future earnings.

Given that firm is a complicated organization where numerous parities participate we

expect that a conflict among these parities is probable. In such a context, we address two

main bunches of conflicts. On one hand, there are differences between investors and

firms, which are expressed by management team, and on the other conflicts between

firms and firm’s debtors. Dividend agency theory refers to these conflicts and argues

that dividend policy can be used as a conflict manipulation tool. The first bunch of

conflicts explores the relationship between the investor, who wants to maximize his

investment utility, and the firm’s objectives, as they are implemented by the management

team’s aims and intentions. The collision between these two parities concerns the

manipulation of the free cash flow. The management team wants to use the free cash in

order to serve its corporate goals, which may not be in line with investor’s utility. The

management team wants to increase the available capital because free cash boosts its

flexibility. On the contrary, the investor does not want an independent management team

since it is more difficult and expensive to control it. A high dividend helps to control

management team easily and inexpensively because without free cash the firm has to

borrow from the markets; that is how the investor transfers the monitoring costs to lender.
20
Jensen and Meckling (1979) state that dividend minimizes the free cash flow, it also

minimizes the interest conflicts among the principal and agent. Kalay (1982) highlights

that debt financed dividend can be paid by the stockholders, thereby maximizing the

outstanding bonds risk. Harris and Raviv (1990) argue that the

disciplining device is debt because in case of default creditors will get the option to force

the companies to close the business and produce useful information for investors.

Easterbrook (1984) also argues that for the equity holders the dividends are beneficial

because equity holders can force the managers to get new capital. Agency theory predicts

that there is a positive impact of dividend on financing decision. The second bunch of

conflicts investigates the relationship between the firm, which wants to maximize its

efficiency, and the debtors, who want both, to collect their capital, and to minimize the

probability of the firm to default. Under these circumstances debtors do not want the firm

to pay dividends as this practice decreases the availability of cash and transfers their

money to shareholders. According to Kalay (1982), in some cases debtors try to impose

dividend restrictions in order to protect their money (Fildeck & Mullineaux, 1999).

2. 2.3 Economic Environment

The firm has to operate in a bounded economic environment where taxes are imposed,

corporate laws are enforced and market dynamics dominate, no matter how big, wealthy

and well organised the firm is. The firm has to adjust its corporate dividend policy

according to economic environment. An implementation of a new tax on dividends

affects the payout policy of the firm since the income of the shareholders is affected too.

21
The high importance of the economic environment is obvious in case of high inflation.

As prices increase the volume of the firm, sales, the net earnings, are increased too;

consequently the dividend payments have to be adjusted too in order to keep the

shareholder’s income in the same level

2. 2.4 Corporate Dividend Policy Decisions

Even though there is strong evidence that dividend policy affects share price, the

relationship between them can not reveal the factors that affect the corporate payout

decision making. In his influential work on dividend policy, Lintner (1956), suggests his

famous corporate behavioural model according to which changes in dividend payments

depend on the level of current earnings and the last year’s dividend payment of the firm.

Lintner’s (1956) econometric model and his findings constitute the cornerstone on

dividend policy analysis. Fama and Babiack (1969), Nakamura and Nacamura (1985),

Brittain (1966), Benartzi, Michaely and Thaler (1997) are just few of the numerous

researchers who follow the steps of Lintner by extending and adjusting his theory to their

research requirements. Explanations based on firm’s dividend choice do not only include

the two factors suggested by Lintner’s model, but also all the factors that these two

variables implicate. In more detail, the firm has a long term dividend payout target ratio

according to which the firm adjusts its payments. The fundamental assumption on target

payout ratio is that the firm does not adjust its dividend on target rapidly, on the contrary

it chooses to alter the dividend through time by smoothing the dividend payments.

According to theory, the dividend smoothing is the key on payout policy of the firm

22
which wants to minimize investor’s uncertainty about his cash returns from his

investment.

2.2.5 The Value of the Firm

It is generally accepted that the objective of the firm is to maximize the shareholders

utility, which, (under the assumption that shareholders do not participate in the

management team and their only source of satisfaction is the realized earnings) can be

expressed by the maximization of the firm’s value. There are numerous researches

(theoretical and empirical) that refer to the relationship between the value of the firm and

its dividend policy. In that theoretical context three schools of thoughts came up with

their suggestions. The first implies that there is a positive relationship between dividend

and value, the second that this relationship is negative and the third that there is no

relationship between dividend and value

In 1961 Miller and Modigliani introduce their dividend irrelevance theory explaining

why dividend policy can not affect the value of the firm. Their seminal work was

supported not only by themselves but by a series of researches conducted by Black and

Scholes and numerous researchers. Even though their irrelevance theory is proved in a

controlled economic environment, the restrictions that they imposed, concerning the

efficiency of the market and the behavior of the investors, describe the reasons why

dividend policy affects the value of the firm in our economies. Nowadays, dividend

policy research has empirically revealed that there is a strong relation between dividend

policy and the firm’s value, and the irrelevance theory seems to be only a valuable result
23
on corporate finance. A recent article by De Angelo and De Angelo (2006) reveals that

irrelevance theory stands not only because of the assumptions that Miller and Modigliani

state, but also because Miller and Modigliani follow a specific dividend policy, known as

residual theory according to which the firm distributes all the free cash flow to

shareholders.

In contrast to dividend irrelevance theory, a series of empirical investigations has been

contacted supporting that there is a positive relationship between dividend and firm’s

value. Lintner (1962) and Gordon (1963) are the primary supporters of the theory which

suggests that the more money the firm pays as dividend the more valuable it becomes.

This theory is known as the bird in the hand theory and considers that earnings

distribution through dividend payments bear less risk than earnings retention. Under this

theory, the money, which is directed to shareholders, is more valuable than the money

that is reinvested. More than that, dividend payment reduces the investor’s transaction

cost since the investor does not have to sell in the market the correspondent amount of

share increased value as result of the retained earnings. Recent empirical studies in

relative areas indicate that according to managers dividend payment is positively related

to the value of the firm. Additionally, Dyl and Weigand (1998) find that when a firm

starts to pay dividends the firm’s earnings and cash flows become less risky.

High dividend payments reduce the value of dividend when tax on distributed earnings is

imposed. Since the majority of countries’ tax system involves taxes on dividends, the

assumption that dividends affect negatively the value of the firm is a realistic one. It is

true that when dividend is taxed its real value is decreased and the investor faces a
24
reduction on his potential income. We cannot support that when tax on dividend is

imposed, a strictly negative relationship between share price and dividend exists. It is

common on developed countries to tax not only the dividend payments, but the capital

gains, as well. Under this situation, we recognize that when dividends tax is greater than

the capital gains tax plus the transaction cost of share selling, the negative relationship

between dividend and firm’s value must be hold. An additional argument supporting the

negative impact of dividend is that even though the sum of capital gains tax and the cost

of share selling is greater than the dividend tax, the investor can chose the appropriate

time to liquidate his dividend through share selling.

2.2.6 Relationship between Dividends and Earnings

A firm that earns profit faces the choice of allocation of its profits between dividends and

reinvestment. Miller and Modigliani (1961) theorem says that investment policies are the

main determinants of firm value and therefore dividend payments must be made out of

the earnings in excess of the required capital expenditure. However, dividend payments

are necessary and at least current dividends must be maintained (Lintner,

1956).According to Linter dividends must be paid out of earnings and not from residual

earnings. In order to find out the relationship between dividend payouts and only

permanent part of earnings or stable earnings, earnings were decomposed into permanent

and transitory parts by Lee (1996) in a time series analysis. The study of dividends in

relation to only permanent part of earnings supported the notion that dividends show

strong behavior towards the permanent change in earnings- which is also called

25
permanent earning hypothesis in literature. On the other hand there is a hypothesis called

partial adjustment hypothesis which states that managers have a target dividend and they

partially adjust their dividend to that target dividend over time (Lee, 1996). They only

make adjustments if they have reasonable indications to believe that the change in

dividends will not have to diminish in near future. These inferences were made using

vector auto regressive models and co integration regression and suggested that permanent

adjustment hypothesis is true only in case where target dividends are in particular

proportion of permanent income rather than current earnings. Fama and Babiak (1968),

Pettit (1972) and Watts (1973) view earnings as the possible causation of dividends

particularly in case of micro behavior of individual firms. Their analysis and finding

support the notion that managers increase dividend payments only to increase in

unanticipated and non-transitory changes in earnings, which is also propagated by Lintner

(1956).

According to the theory of dividend stabilization in practice most of the firms adopt

stable dividend policies that do not adjust their dividend policies straight away when their

earnings change (Lintner, 1956) because firms are reluctant to decrease dividends thus

they only increase dividends when they have reasonable evidence that the earnings will

increase in future with stability (Miller & Modidliani, 1961).

Higher dividend payouts are associated with higher future earnings. Higher dividends and

higher future earnings relationship was found in a company level or individual analysis.

Zhou and Ruland, (2006) analyzed this relationship under various conditions and results

have strong association between dividend payouts and future earnings for example in
26
case of different measures of earnings, after Controlling mean reversion in earnings,

different sub-periods, taking into account different industry effects and impact of share

repurchases. Zhou and Ruland, (2006) also tested Free Cash Flow Theory; relationship

between payouts and earnings was found stronger for low growth companies or for

companies which have tendency towards over-investment. Future earning information

plays an important role in the determination of dividend policy. Hsu et al. (1998) tested

the impact of future earning information on dividend policy by decomposing earnings

into two parts namely transitory and permanent earnings and found that permanent part of

earnings plays an important role in explaining the dividend behavior. Further dividend

adjustment model performed better in case when target dividends were taken as

proportion to the permanent component of earnings. Supporting the hypothesis of

information content of dividends Nissim and Ziv (2001) investigated the relationship

between dividends and future earnings or abnormal earnings. Following the change in

dividends, earnings were found positively related to dividend for two years while

controlling the expected change in earnings. Further dividends were also positively

related to profitability when measured in terms of future earnings and future expected

earnings and results get stronger in case of abnormal earnings. And the above findings

were non- symmetric in the sense that dividend increases had relationship with

profitability, even up to four proceeding years: but dividend decreases did not have any

relationship with the profitability. However, Nissim and Ziv (2001) attributed this non-

symmetry of results to accounting conservatism.

27
There exist some theoretical arguments about the importance of taxation and firm

prospects as determinants of dividend policy. Sarig (2004) used vector auto regression

models, and found that increase in profitability lead to increased number of repurchases

and then payouts but over time increase in taxation on capital gains has increased the

dividend payouts and decreased number of repurchases. Sarig (2004) supported that

investment decisions guide the way to dividend policies and opposite is not true.

Information content of dividends was also supported by him i.e. corporate payouts show

the increase in future profitability. Many diagnostics checks like re-estimation with

shorter sample and larger sample and controlled legal changes yielded same results that

show that results were quite strong. Baumol et al. (1970) find insignificant relationship of

reinvestment of corporate earnings with future corporate earnings. However, Bar-Yousef

et al. (1987) identified that corporate earnings have considerable impact on future

investment of the firm but reverse is not possible. In addition, in case earnings provide an

indication of the firm’s capability to locate and exploit profitable investment

opportunities, shareholder would like to forgo dividends and prefer reinvestment, thus

implying that dividend payments will not affect investments. Kao and Wu (1994)

established a positive relationship between dividend payments and corporate earnings.

Mozes and Rapaccioli (1998), Nissim and Ziv (2001) conclude that large increases in

dividend payments lead to a decrease in future earnings and minor increase leads to an

increase in future earnings. Nissim and Ziv (2001) point out that dividend changes are

directly related to future increase in earnings for the firms listed on NYSE. Farslo et al.

(2004) conclude that there is no long run relationship between dividends and earrings
28
Time series analysis of dividends and earnings was used on Swiss companies’ data

from1982-2003, in which Linter model and Chi-square test showed that dividends depend

more on current growth. Signaling model shows that companies which with positive

increase in dividends normally have higher average earnings and firms which have

dividend cuts are not in better conditions. So it supported the signaling content of

dividends and showed that managers only cut dividends when they think they don’t have

sufficient earnings and increase dividends only when they think that their earnings have

sufficiently or permanently increased (Stacescu, 2006). Therefore, price volatility had

negative relationship with dividends because price volatility increases the

unpredictability of earnings and thus reduces the chances of dividend payouts due to

unpredictable future.

2.2.7 Relationship between Dividend and Investment

Miller and Modidliani (1961) gave an idea that dividend policy of a firm does not affect

its value in a perfect capital market. The underlying reason for this irrelevance of

dividend policy and firm value is that stockholder can reproduce any desired stream of

payments by purchasing and selling equity. Morgan and Pierre (1978) tested the idea

related to independence of investment and dividend payouts developed by Modigliani &

Miller (1961) who replicated the work of Fama (1974). Morgan and Pierre (1978) not

only replicated the work of Fama (1968) but they also tested long-run objectives of

investment rates and payouts, another addition was testing the impact of parent

companies on the payout decisions of subsidiaries. However, they restricted their study to

only transitory changes in investments and found consistent result with the optimal
29
investment behavior. Further they establish that in Canadian firms’ dividend payout

policies are not affected by parent companies particularly due to same level of access to

capital market and payouts does not restrict the availability of funds for investment.

Recent studies have found that there is a relationship between the investment, dividend

and financing decisions of a firm i.e. they go against the independence principal.

Independence principal says that there is no relationship between the financing, investing

and dividend decision of a firm. De Fuscoa et al (2007) find that firms with larger

investment opportunities show larger positive shocks in dividends. He used vector

autoregressive models; variance decompositions and impulse response function to find

the short term and long term interdependencies on investment, dividend and financing

decisions. On the other hand investment decreases mildly to the positive shocks in

dividends. Results also went against the independence principal hypothesis as dividend

and investment both show long term effect on each other and thus has bi-directional

interdependence.

Jensen (1986) presented the overinvestment theory which states that instead of paying

dividends managers may take on negative NPV projects in order to increase the size of

the firm. Larger firms are considered to be more prestigious by the managers and expect

to get more income from the larger firms. But this does not go well with the interest of

the shareholders. Black (1976) argues that dividend payments can reduce the problem of

over-investment, due to reduction in free cash flows for making investments. Analysis of

Chinese firms indicates the relationship between dividend payments and net operating

cash flow of the firms; however, firms with little investment opportunities have plenty of
30
cash flow (Liu & Hu, 2005). Bhaduri and Durai (2006), verified that in emerging

economy with imperfect market, the dividends and investment decisions are taken jointly.

According to Osuala (2005) in Anyigbo (2008), the earliest major attempt to explain

dividend behavior of companies has been credited to Graham and Dodd (1934) who were

the major proponents and founders of the school of thought referred to as the

traditionalist or right lists who offered the first explanation for the relevance of dividend

payment. Later support for the literature of determinants of dividend policy and dynamics

was given by Lintner (1956), who conducted his study on American Company and

thereafter, the work was refined by Fama and Babiak (1968).

Modigliani and Miller (1961) insisted that for firms in the same risk class, provided that

the investment program of the firm is clear, the dividend policy is irrelevant or

inadequate of the value of the firm. In Modigliani & Miller’s view, it is the firm’s

earnings as opposed to dividends that influence the value of the firm. Having viewed

dividend payment as irrelevant, they contended that,

“If the investment decision of a firm is given, dividend payout ratio does not affect

shareholders wealth”.

They argued that the value of the firm depended on the firms’ earnings or its investment

policy. The split of earnings between dividend and retained earnings has no effect on the

firms’ value. Black and Scholes (1976) posed the question, “if dividends are irrelevant,

why do corporations pay dividends”; and “Why do investors pay attention to dividends”?

Jensen and Meckling (1976) argued that dividend policy is not irrelevant because of the

important role it plays in determining a firm’s capital structure.

31
Gordon’s dividend capitalization model and Walter’s dividend model supports the

principle that dividend are relevant. This model is of the view that dividend policy of a

firm affects it value. The investment policy of a firm cannot be separated from its

dividend policy and both are inter-related. The choice of an appropriate dividend policy is

the value of an enterprise.

More recently, researchers have attempted to establish the link between firms’ dividend

policy and investment decisions. Osuala (2005) in his study, determinants of corporate

dividend policy in Nigeria found that profitability and return on equity affect dividend

payments. Nnamdi (2009) in his study of earning dividend relationship in corporate

Nigeria identified the existence of a significant relationship between dividend and current

and past earning in Nigeria. This research is of interest of banking sector because of the

structure of its dividend payout. Dividend is allocated as a fixed amount per share to

owners or shareholders of business at specific periods. Usually as a distribution of profits

and the recommendations made by its directors. Dividends are not paid when there are no

profits. When corporations pays dividend, it is obligated to pay corporate tax including

taxes to the proper government authorities. This is an essential corporate responsibility

particularly profit making companies.

2.2.8 Relationship between Dividend Policy and Cash Flow

Management considers organizations historical cash flow volatility while making cash

dividend payout decision. Jensen (1986) in Al-Kuwari (2009) defined free cash flow as

excess of funds required for all projects with a positive net present value in cash flow.

When there is increase in free cash flow, it raises the agency conflict between the
32
interests of managerial and outside shareholders leading to decrease in the performance

of the company. This leads that firms with more operating cash flow will have lower cash

dividend payout. The conflict between shareholders desire for their managers to

maximize the value of their shares while the manager may have a different interest and

prefer to derive benefits for themselves. Managers engage in wasteful practices while

improving on the inventors’ protection when a firm has free cash flow (La Porta et al.,

2000). Many researchers have offered empirical suggestions that firms with a greater free

cash flow need to pay more dividends to reduce the agency costs of the free cash flow

(Jensen, 1986; Mollah et al., 2002; Holder et al., 1998 and La Porta et al., 2000).

2.2.9 Relationship between Dividend Policy and Firms Current Profitability

The level of profitability is one of the important factors that may influence firms’

dividend policy. These studies are of the view that firm’s profitability is a significant and

positive explanatory variable of dividend policy (Jensen et al., 1992; Fama and French,

2001; Han et al., 1999 & Al-Kuwari, 2007 in Al-Kuwari, 2009). According to Glen et al.

(1995), are of the view that dividend payout rates are approximately two thirds of those in

developed countries than the developing countries. While developing markets

corporations do not follow a stable dividend policy, its dividend payment for a given year

is a based on firm’s profitability for the same year. It was found on Wang et al. (2002)

who compared the dividend policy of Chinese and UK listed companies, that UK

companies had a clear dividend than Chinese companies, which had unstable dividend

payment and their dividend ratios were heavily based on the firm’s earning for the same

year not on any other factor.

33
2.2.10 How Performance Management Increases Productivity

Managers who need to enhance level of motivation in the workforce should implement

operative performance management practices. They should to take into account that every

human being is motivated differently through the use of diverse tools and measures.

While financial rewards might affect some individuals to perform better. Other personnel

might desire acknowledgement or appreciation for work done. Literature of various

researcher that official acknowledgement is the sole major stimulus for may individuals

employers like to be appreciated in front of an audience who may be their peers, family

or friends. This humble acknowledgement transforms straight to improved efficiency

(Leimberg).

Catering to the issue of employee`s poor job performance and method to enhance the

performance is a part of performance management. If an employers has been late

occasional or his performance indicates a downward decrease, there are productive

performance management. By using a productive management scheme organization can

help stimulate employee efficiency and diminished employee for over (Crouch).

2.2.11 Legal, Contractual and Internal Constraints and Restrictions

Legal stipulations do not require a dividend declaration but they specify the conditions

under which dividends must be paid. Such conditions pertain to capital impairment, net

profit and insolvency. Important contractual restrictions may be accepted by the company

regarding payment of dividends when the company obtains external funds.

Owner's Considerations
34
 Dividend policy is also likely to be affected by the owner's considerations of the tax

status of the shareholder, their opportunities of investment and the dilution of ownership.

Capital Market Considerations

The extent to which the firm has access to the capital markets also affects the dividend

policy. In case the firm has easy access to the capital market, it can follow a liberal

dividend policy. If the firm has only limited access to capital markets, it is likely to adopt

a low dividend payout ratio. Such companies rely on retained earnings as a major source

of finance for future growth.

Inflation

With rising prices due to inflation, the funds generated from depreciation may not be

sufficient to replace obsolete equipment and machinery. So, organizations may have to

rely on retained earnings as a source of fund to replace those assets. Thus, inflation

affects dividend payout ratio in the negative side.

2.2.12 Legal Framework

The Companies and Allied matters Act 1990 part II (379-382) provides the basis which

dividends can be paid

2.3 Empirical Review

The behavior of dividend policy is one most debatable issue in the corporate finance

literature and still keeps its prominent place both in developed an emerging markets

(Hafeez & Attiya, 2009). Many researchers have tried to uncover issues regarding the

dividend dynamics and determinants of dividend policy but we still don’t have an
35
acceptable explanation for the observed dividend behavior of firms (Black, 1976; Brealey

& Myers 2005). Dividend policy has been analyzed for many decades, but no universally

accepted explanation for companies’ observed dividend behavior has been established

(Samuel & Edward, 2011). It has long been a puzzle in corporate finance.

Dividend is the return that accrues to shareholders as a result of the money invested in

acquiring the stock of a given company (Eriki & Okafor 2002). While dividend policy on

the other hand is concerned with division of net profit after taxes between payments to

shareholders (ordinary shareholders) and retention for reinvestment on behalf of the

shareholders (Kempner, 1980). A difficult decision for both public and private limited

companies is to determine the appropriate level of dividend to be paid to shareholders,

and to decide whether or not to offer non-cash alternatives such as scrip dividends

According to Davidson (1990). The existence of some share price reactions on dividend

announcement prompts an analysis of the evidence for both shareholder clienteles and

possible interaction of firms’ dividend policies with key activities such as internal

investments. An aspect of the theory of dividend policy is part of a continuum of control

allocations between managers and investors, and hence cross-sectional variations in

dividend policy are driven by an underlying factor. The allocation of controls between the

manager and investors is important not because of agency or private information

problems, but because of its potentially divergent beliefs that can lead to a disagreement

about the value of project available to the firm. This underlying factor is “Corporate

Performance”. ‘Corporate performance is at the heart of the managerial function of an

36
organization’ (Samuel, 1989). Analysis of corporate performance is mainly concerned

with the development of a modeling methodology to help in the diagnosis of past

performance and thus provide a framework for evaluating the effect of changes in

operating parameters as a guide for future planning. The performance of an Organization

is measured by the choice of the management form of wealth to be held. If the

performance of an organization is good there will be little or no disagreement between

the management and the shareholders. (Ghosh & Subrata, 2006)

Financial performance is a subjective measure of how well a firm can use assets from its

primary mode of business to generate revenues and expand its operations (Copisarow,

2000). Financial performance can be measured in many different ways, but all these ways

should be aggregated. Revenue from operations, operating income or cash flow from

operations can be used as well as total unit sales. According to Demsetz and Lehn (1985),

financial ratios from financial statements are a good source of data to measure financial

performance. Liquidity is one of the most outstanding financial ratios used a measure of

the firm’s ability to meet financial obligations as and when they fall due without

disrupting the normal business operations. Liquidity can be analysed both structurally and

operationally.

Financial performance can also be measured in terms of net earnings which are divided

into two parts, that is, retained earnings and dividends. The retained earnings of the

business may be reinvested and treated as a source of long-term funds. The dividend

should be distributed to the shareholders in order to maximize their wealth as they have

37
invested their money in the expectation of being made better off financially. According to

Maina (2000), there exists a relationship between dividend and investment decisions

since both compete for internally sourced funds and given that funds obtained by debt are

very expensive and not available to all firms. There are other theories that have been

proposed to explain the relevance of dividend policy and it is effect on firm performance,

but no universal agreement has been reached (Stulz, 2000; Pandey, 2003; DeAngelo et

al., 2006). A group of researchers: Amidu (2007), Lie (2005), Zhou and Ruland (2006),

Howatt et al., (2009), have come up with different findings about the relationship

between dividend payout and financial performance. Profitability is a type of

performance measure which focuses on the relationship between revenues and expenses

and on the level of profits with relative to the size of investment in the business (Zhou &

Ruland, 2006). Four most commonly noted measures of firm profitability are: the rate of

return on firm’s total assets (ROA), the rate of return on firm’s equity (ROE), operating

profit margin and net firm income. Different measures of firm performance have also

been employed to test agency cost hypothesis. It is argued that profit efficiency computed

using a profit function is a more appropriate measure to test agency cost theory because it

controls for the effects of local market prices and other exogenous factors. It also

provides a reasonable benchmark for each individual firm’s performance if agency costs

were minimized. Profit efficiency is superior to cost efficiency for evaluating the

performance of managers, since it accounts for how well managers raise revenues as well

as control costs and is closer to the concept of value maximization. Profit efficiency is

38
measured in two different ways, that is, standard profit efficiency and alternative profit

efficiency.

According to Arnott and Asness (2003) the positive relationship between current

dividend payout and future earnings growth is based on the free cash flow theory. Low

dividend resulting in low growth may be as a result of suboptimal investment and less

than ideal projects by managers with excess free cash flows at their disposal. This is

prominent for firms with limited growth opportunities or a tendency towards over-

investment. Paying substantial dividends which in turn would require managers to raise

funds from issuance of shares, may subject management to more scrutiny, reduce

conflicts of interest and thus curtail suboptimal investment. This is based on the

assumption that suboptimal investments lays the foundation for poor earnings growth in

the future whereas discipline and a minimization of conflicts will enhance growth of

future earnings through carefully chosen projects. Therefore, paying dividends to reduce

the free cash flows enhances the performance of a company since managers will have less

cash flow thus avoiding suboptimal investments. In evaluating corporate performance,

the emphasis is on assessing the current behavior of the organization in respect to its

efficiency and effectiveness. To measure overall corporate performance goals are set for

each of these perspectives and specific measure for achieving such goals are determined.

Each of these perspectives is critical and must be considered simultaneously to achieve

overall efficiency and effectiveness, and to succeed in the long-run. If any area is either

over-emphasized or underemphasized, performance evaluation will become ‘unbalanced’.

39
In this way, the aim of the concept is to establish a set of measures both financial and

nonfinancial, through which, a company can control its activities and balance various

measures to effectively track performance.

Velnampy (2006) examined the financial position of the companies and the relationship

between financial position and profitability with the sample of twenty five (25) public

quoted companies in Sri Lanka by using the Altman Original Bankruptcy Forecasting

Model. His findings suggest that, out of twenty five (25) companies only, companies are

in the condition of going to bankrupt in the near future. He also found that, earning/total

assets ratio, market value of total equity/book value of debt ratio and sales/total assets in

times are the most significant ratios in determining the financial position of the quoted

companies. Velnampy (2013) in his study of “corporate governance and firm

performance” with the samples of twenty eight (28) manufacturing companies using the

data representing the periods of 2007 – 2011 found that determinants of corporate

governance are not correlated to the performance measures of the organization.

Regression model showed that corporate governance don’t affect companies’ ROE and

ROA revealed that corporate governance measures are not correlated with performance

measures. Velnampy and Nimalathasan, (2009) investigated the association between

organizational growth and profitability of commercial bank ltd in Sri Lanka over the

period of 10 years from 1997 to 2006. They found that, sales are positively associated

with profitability ratios except operating profit, return on equity and number of depositors

are negatively correlated to the profitability ratios except operating profit and return on

40
equity. Likewise, number of advances is also negatively correlated to the return on

average shareholders’ funds.

Amidu (2007) found that dividend policy affects firm performance especially the

profitability measured by the return on assets. The results showed a positive and

significant relationship between return on assets, return on equity, growth in sales and

dividend policy. This showed that when a firm has a policy to pay dividends, its

profitability is influenced. The results also showed a statistically significant relationship

between profitability and dividend payout ratio. A study by Howatt et al. (2009) also

concluded that positive changes in dividends are associated with positive future changes

in mean real earnings per share. Brigham (1995) where a firm’s dividend policy is seen as

a major determinant for a firms’ performance. Similarly, Zakaria and Tan (2007) also

stressed the fact that investments made by firms’ influences the future earnings and future

dividends potential. Nissim and Ziv (2001) showed that dividend increases were directly

related to future increases in earnings in each of the two years after the dividend change

Likewise, Zeckhauser and Pound (1990) in a related study found out that there is no

significant difference among dividend payouts with or without large block shareholders.

Wang (2010) examined the casual relationship among financing, investing, dividend

policy and corporate performance analyzing the data of Taiwan and Chinese High-tech

firms during the period of 2000 – 2007. The researcher found a positive relationship of

investment with firm performance in Taiwan firms. However, financing decisions had

positive relationship with investment in Chinese firms. Baker and Wurgler (2004)

41
explicated the catering theory of dividends in this paper. Miller and Modigiliani (1961)

divulged that the dividend policy does not determine the value of firm assuming

frictionless market. The research postulated that dividends enjoy a strong relationship

with value of shares which is antithetical to MM (1961) theory of dividend irrelevance.

Magni (2007) discussed the studies conducted by DeAngelo and DeAngelo (2006) which

criticized the study by MM (1961). The results of this study did not support the results of

both of the previous studies but because retention or non-retention is not relevant to this

decision so he suggested that it is the rate of return which affects the investments

decisions or dividend irrelevance. DeAngelo et al. (2006) explored that firms pay high

dividend when business retains major part of earning. The purpose of the study was to

examine the life-cycle theory of dividend and results corroborated the life cycle theory, in

which internal and external finance define the firm’s position. They concluded the high

significant relationship between dividend payout and earned/contributed capital mix by

using regression analysis subject to controlling total equity, cash balances, firm size,

growth, profitability and dividend history.

In the context of modern organizational theory, firms can be viewed as encompassing

principles (shareholders) and agents (managers). Although Miller and Modigliani (1961)

presuppose that, in an efficient market, agents and principals have the same goal of

maximizing shareholder wealth; this is not valid in the real world. In the real world,

managers, who are authorized by shareholders to administer firm assets, may tend to take

advantage of their authority to divert firm assets to themselves through outright theft,

42
excessive salaries, or sales of assets at prices favorable to themselves, resulting in high

agency costs (La Porta et al., 2000). The payment of dividends is considered a workable

instrument to increase monitoring of managers’ performance and diminish management

agency costs. Easterbrook (1984) suggests that, as firms adapt large dividend policies

assuming that the firm is engaging in current and future premeditated investment

projects, it is obliged to depend on capital markets more often. Capital market regulation

works to monitor the behaviors of managers, since investment professionals strictly

examine firms when new securities are offered. Thus, dividend payments increase

management scrutiny by outsiders, and hence force managers to disclose new information

and reduce agency costs in order to secure requisite funds. In his free cash flow theory,

Jensen (1986) proposes that the commitment to pay dividends eliminates free cash flows,

thereby squeezing managers’ accessibility to overinvestment in projects that promote

personal interest. Rozeff (1982), one of the first to exploit the impact of inside

(controlling) shareholders, presents a model that underpins agency conflict theories and

finds that firms increase dividend payout ratios as controlling shareholders decrease

and/or the disbursement of outside shareholders increases. While Berle and Means (1932)

deduce that ownership structure is distributed extensively among small shareholders who

typically have little incentive to monitor management, La Porta et al. (1999) refute this

assumption in their examination of a developed and developing market. Beachet and

Mayer (2000) examine EU markets, Claessens et al. (2000) cover nine East Asian

markets; and Truong and Heaney (2007) examine 37 companies around the world,

indicating that corporations with large ownership concentrations and large shareholders
43
exist. Shleifer and Vishny (1986) and Grossman and Hart (1980) indicate that the

existence of large shareholders could play a role in effectively monitoring the activities of

firms’ managers and inside shareholders, thus alleviating the free-rider problem

associated with dispersed small shareholders. They explain that large shareholders have

more inducements and efforts than small shareholders to carry the cost of monitoring

since the consequences of and returns from monitoring surpass the cost. Grinstein and

Michaely (2005) and Redding (1997) explain that the largest shareholders have a strong

incentive to adopt and enhance means to advance their role of effectively monitoring the

activities of firm managers. Claessens et al. (2002) imply a positive relationship between

dividends and large shareholders. They attribute this positive relationship to the fact that,

as the largest shareholders are controlling shareholders, they can choose to pay high

dividends in order to minimize extraordinary monitoring costs. Furthermore, Claessens et

al. (2002) indicate that large shareholders adopt large dividend payouts as a mechanism

of maintaining firm value and enhancing the firm’s reputation for not expropriating the

wealth of its minority shareholders. Truong and Heaney (2007) hypothesize that firms

adopt a positive relationship between large shareholders and dividend payout decisions in

order to enhance monitoring of manager performances. These explanations are supported

by Zeckhauser and Pound (1990), Eckbo and Verma (1994). Zeckhauser and Pound

(1990) suggest that, like large shareholders, institutions are unlikely to monitor firm

managers directly. Therefore, institutions might utilize their vetoing power to induce

firms to make dividend decisions. By buying dividends, firms will be compelled to

externalize fund monitoring; thus agency conflicts will be minimized. This explanation is
44
in line with Eckbo and Verma (1994), who state that institutional shareholders can choose

cash flows to pay dividends intended to minimize the cost of free cash flows. Short et al.

(2002) also find a direct relationship between institutions as large shareholders and

dividend policy when they test a sample of 211 firms listed on the London Stock

Exchange. However, they consider the existence of tax clientele, showing that, due to

comparative tax advantages, some institutions pay higher dividends relative to individual

investors. As institutional investors are taxed lesser amounts, firms tend to pay higher

dividends. This result is supported by Khan (2006), who examines 330 large public firms

in the UK. Shleifer and Vishny (1986) and Moh'd et al. (1995) indicate that firms that

have institutions as large shareholders pay higher dividends with the aim of attracting

large shareholders. Gugler (2003) argues that government involvement can create a

complex agency conflict environment. That is, agency problems may emerge between

citizens and the government that may not serve the best interests of the citizens it

represents. Conflict might also materialize between the government and other managers,

where managers often seek their personal interests from the resources available to a firm,

allowing them to increase their salaries and accrue benefits at the expense of other

shareholders. Therefore, governments, as large shareholders, might employ dividend

payout decisions to reduce the complex setting of agency problems.

However, Gugler and Yurtoglu (2003) argue that, although large shareholders can

monitor manager performances, they also have the power to expropriate small outside

shareholders. Similarly, Pergola and Verreault (2009), Shleifer and Vishny (1997), and

Demsetz and Lehn (1985) explain that, like controlling shareholders, large shareholders
45
might use their authority to act in pursuit of their private benefits, mostly at the expense

of small shareholders. Troung and Heany (2007) and Claessens et al. (2002) explain that

large shareholders, compared with other shareholders, have distinguishing characteristics

and an influential impact on firms’ decision-allied underinvestment costs. Johnson et al.

(2000) argue that large and controlling shareholders might use their advantage to enhance

their personal interests in a way that expropriates profitable business opportunities from

the firm. Claessens and Djankov (1999) add that a concentration of ownership maximizes

the latent risk of expropriating small shareholders and the risk of descending-sloping firm

values. Gugler and Yurtoglu (2003), who examine the German market, indicate that an

increase in large shareholders results in weak small shareholders, and thus, these

shareholders are reluctant to ask for cash dividends. Gutierrez and Tribo (2008),

examining a Spanish firm, emphasize that if a large shareholder is − to a great extent −

larger than the rest, it is likely that the number of small shareholders sharing private

benefits will diminish. These explanations are in line with Renneboog and Trojanowski

(2007), who examine five European countries; Truong and Heaney (2007), who examine

27 countries around the world; Mancinelli and Ozkan (2006), who examine companies in

Italy; and Maury and Pajuste (2002), who examine dividend policies in Finland. These

authors find that large shareholders may collude in generating private advantages that are

not shared with minority shareholders as indicated by lower dividend payout levels.

Hanazaki et al. (2004) argue that banks, insurers, and non-financial corporations,

predominantly the top-five largest shareholders, do not play a role in monitoring the

managers of Japanese firms. This argument builds when they find that, as total loan and
46
real estate loans rise, firm performance drops. They believe that this negative relationship

occurs when the top-five largest shareholders collude or conspire with management.

Hanazaki et al. (2004) suggest that the reasons for such a reaction are, first, that managers

have strong business relationships with banks and insurance companies that possess

shares, and second, there is weak corporate governance in Japan.

Empirical studies on dividends policy have shown several factors influencing the

dividends decision. Existing theories on why firms pay dividends can be categorized

according to various explanations for dividends policy. Earnings Stability, Historical

Dividends, Current Earnings, Expected Earnings, Stock Price, Liquidity Constraints,

Asymmetric Information, False Signals, Investment Plans, Stockholders Wealth,

Leverage, Expected Rate of Return, and The Capital Structure have been documented in

literature as the main factors that influence the dividends policy. Identifying the most

important factors used by U.S. companies listed in New York Stock Exchange (NYSE)

that have an effect on dividends policy decisions, Baker and Powell (1999) found that

NYSE firms' managers believe that historical dividends patterns and the continuity of

current dividends are important factors when setting dividends policy. Studying US

companies listed in NASDAQ, the result of Baker and Powell (1999) was supported by

the study of Baker and Powell (2001) which documents that the pattern of past dividends,

earning stability, and the level of current and expected future earnings to be significant

factors in determining the level of current dividends and the dividends policy. Tse (2005)

examining the UK dividends payout patterns, Baker et al. (2006) surveying how

Norwegian managers view dividends policy, McCluskey et al. (2007) investigating the
47
Irish financial directors‟ views about dividends, and all document that historical, current

and earnings stability are the main factors that determine the dividends policy decision.

Also, Baker et al. (2007) find that Canadian managers consider the future earnings when

making their dividends decisions. Results from developed markets were supported by the

results from emerging markets. Al-Twajiry (2007) identifying factors with an expected

influence on dividends policy on Malaysian firms listed in Kuala Lumpur stock exchange

and Al-Malkawi (2008) exploring factors influencing corporate dividends decisions of

publicly quoted companies in Jordan, found evidences of the association between current

dividends and past and expected earnings. Investigating the impact of liquidity

constraints on dividend decision, Baker and Powell (1999) find the cash level to be

important factor in determining the level of the current dividends. Studying industrial

sectors firms traded in NYSE and AMEX. Deshmukh (2005) documents positive

relationship between higher-dividends paying firms and level of cash. On the other hand,

Baker et al. (2007) document that cash is a significant factor on the level of the payout

ratio. Examining publicly held companies in US, Khang and King (2006) document that

high-dividends firms have large cash balances as they are mature firms. However,

McCluskey et al. (2007) find that Irish financial directors don't value cash when setting

their firms' dividends policy. Although firm mangers send signals to shareholders, these

signals may be interpreted incorrectly depending on the life cycle of the firm. Baker and

Powell (1999) find firm mangers to significantly value the signals they send to the

financial market as they tend to justify any changes in the dividends policy. The same

result is confirmed by Baker et al. (2001) and Baker et al. (2007). On the other hand,
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Khang and King (2006) and Deshmukh (2005) provide results that are not consistent with

the traditional dividends signaling models. They evidenced that dividends are negatively

elated to the insider trading return and growth rate. The residual dividends model

recommends paying dividends after all investment needs are fulfilled. In this regard, Al-

Malkawi (2008) document those dividends-paying firms in Jordan are more likely to have

less investment. The same result was established by Baker et al (2007), Khang and King

(2006), and Deshmukh (2005). Usually, large stockholders influence the dividends policy

especially if they own large stake in the firm. However, Deshmukh (2005) finds that the

insider ownership is unrelated to the level of the current dividends. Similarly, Baker et al

(2007) give the stockholders characteristics a lower rank in influencing the dividends

policy. When incurring high leverage, firms' dividends decisions might be affected by its

creditors. Among others, both Al-Malakawi (2008) and Al-Twajiry (2007) document a

negative relation between dividends payments and corporate leverage. Baker et al. 2001

evidenced that firms' managers consider their firms' capital structure when setting

dividends levels in their efforts to maintain an optimal level of capital structure.

2.4 Theoretical Framework

Theoretically, corporate dividend policies are known to be a function of many factors.

Van Horne (1977) and Weston and Brigham (1981) assert that these relevant factors

include legal considerations, liquidity position, repayment of debt, restrictions on debt

contracts, re-investment opportunities, profitability of operations and stability of

earnings. Other factors include access to the capital market, cost of raising new funds,

need for ownership control, national income policies as well as the tax positions of the
49
stockholders. The interplay of these factors remains a critical issue in distribution of

corporate after tax earnings between retained earnings and dividends. Uzoaga and

Alozienwa (1974) in their study highlighted the pattern of dividend policy pursued in

Nigeria firms and found little evidence to support the classical determinants of dividend

policies in Nigeria. Inanga (1978) and Osyode (1975) insisted that the problem arising

from the change in dividend policy could be attributable to the share pricing policy of the

capital issue commission (CIC) which seem to have ignored the classical factors that

should govern the pricing of equity shares issues; an action which has led companies to

abandon all classical forces that determine dividend policy. Oyejide (1978) however in

his study found a statistical significant relationship between current year dividends and

past year net profit. Adelegan (2003) pointed out that factors such as after tax earnings,

economics policy changes, firm’s growth potentials and long term debts influence the

dividends policy of quoted firms in Nigeria.

In Nigeria context, dividends are often paid twice: the first is the interim dividend and the

final dividend. The amount to be paid out as dividend is regulated by the government in

the monetary and fiscal policies announced every year (Okpara, 2010). For instance in

1976/77 fiscal year, the distribution of dividends in excess of 30 percent gross was

prohibited. In 1978/79 fiscal year the ceiling on dividends was raised from 30 to 40

percent and in 1979/80 fiscal year it was further raised to 50 percent. A company as a

first step might make a forecast of an amount of dividends to be paid out provided it was

not in excess of the stipulated percentage before the accounts are audited. After the

accounts have been fully prepared, depending of course on the level of earnings, payment
50
of dividends will be made, so long as it was below the prescribed percentage

(Emekekwue, 2005). Because of the relative tax disadvantage of dividends compared to

capital gains, investors require a higher before tax risk adjusted return on stocks with

higher dividend yield (Berennam, 1970 in Al-Malkawi, 2007). Many studies have

provided different explanation on the relationship of tax, dividend policy, agency costs

and capital gain such as Litzenberger and Ramaswamy (1982), Poterba and Summers

(1984), Barday (1987), Black and Scholes (1974), Miller and Scholes (1978) and Morgan

and Thomas (1998).

Berzins et al. (2013) reported a higher and more stable dividend from operating

companies than from holding companies when the operating companies face more severe

agency conflicts.

2.5 SUMMARY

This chapter cover the literature review and the conceptual framework, Agency theory

Economic environment corporate dividend policy decisions, the values of the firm and

relationship between dividend and earnings per share profits investment decision free

cash and firms current productivity, Managers who need to enhance level of motivation

in the workforce should implement operative performance management practices. Legal

contractual internal constraints and restrictions

Empirical review examined the casual relationship and financing, investing, dividend

policy and corporate performance analyzing the data of Taiwan and Chinese High-Tech

firms during the period of 2000-2007.

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Theoretical framework, corporate dividend policies are known to be a function of many

factors and assert that these relevant factors include legal considerations. Liquidity

position, repayment of debt, restrictions on debt contracts, re-investment opportunities,

profitability of operations and stability of earnings.

CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

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This chapter will generally discuss the essential research methods and procedures which

would be employed in addressing the research objectives and the propositions stated in

chapter one of this study. It will look at the detail of the research design, population and

sampling technique of the study, method of data collection, procedure for analyzing data

and model specification, justification of methods to be employed in the analysis of data

and summary of the chapter

3.2 Research Design

The research design is multiple correlation regression model since it sought to establish

the relationship between dividend decision and corporate financial performance. Sixty

(60) quoted companies were randomly selected across the eleven sector of the economy

based on the data availability

Amidu (2007) in his study that sought to establish whether dividend policy affects firm’s

performance used a panel regression equation to meet his objectives. His method differs

from a regular time series or cross section regression by the double subscript attached to

each variable. The panel pooled crossed-section regression data was used to gain the

maximum possible observations. The dependent variables were return on assets and

return on equity as the main accounting measures of performance. Dividend payout was

measured by the dividend payout ratio. In his model, he controlled for the variables that

were also controlled by Zhou and Roland (2006).

3.3 Population and Sampling Technique

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The population of the study are sixty (60) companies listed on the floor of Nigeria Stock

Exchange (NSE). Hence, in selecting the sample size for this research work, the

researcher will select only sixty(60) listed companies from the eleven (11) sector of the

economy listed on the Nigeria Stock Exchange (NSE) as at 31 st December, 2014/2015.

And the company must have been listed on the floor of Nigeria Stock Exchange (NSE)

on or before January 1st, 2010.

3.4 Method of Data Collection

The study will use secondary data to be collected from the annual reports and account,

and websites of sixty companies listed on the Nigeria Stock Exchange. The use of

secondary data in this study is informed by the fact that the study is based on the

quantitative research data methodology that requires quantitative data to test the research

hypotheses

3.5 Procedure for Data Analysis and Model Specification

Multiple regression analysis models would be used to determine the relationship between

dividend decision and corporate performance of the sixty companies listed on the Nigeria

Stock Exchange. The data well be analyzed in line with the model using, the use of SPSS

software. Using the T-ratio to test for their statistical significant. Apart from using the R-

squares, Adjusted R-squared, S E of regression, Durbin-watson statistic and F-statistic

will also be adopted in order to address multiple regression. All these analyses are to be

done by using SPSS software. Regression models will be used because they are flexible,

powerful and produce optimal results predicting numeric output when properly

54
structured. They also examining the effect of many different factors on some outcome at

the same

3.6 Model Specification

The multiple regression analysis with the aid of SPSS software and the model for the

regression analysis is stated below

DIVP = f(DY,DPR,EPS)

Specifying in econometric format we have

DIVP = ao + a1 (DY) +a2 (DPR) + a3 (EPS) + ε

DYit = a + βDIVPit + εit--------------- 1

DPRit = a + βDIVPit + εit------------- 2

EPSit = a + βDIVPit + εit-------------- 3

Where:

DIVP represent dividends paid to shareholders

a = intercept term

ε = error term respectively

55
DY = Dividend Yield

DPR = Dividend Payout

EPS = Earnings Per Share respectively.

Dividend (DIVP)

It is distribution, generally of assets, made by a corporation to its stockholders.

The formula is given as

Total Ordinary Dividend__

Number of Ordinary Share

Earnings per Share (EPS)

The portion of a company's profit allocated to each outstanding share of common

stock. Earnings per share serves as an indicator of a company's profitability. Calculated

as:

___________________Profit After Tax__________________ × 100

Number of Ordinary Share in Issue and Ranking of Dividend

OK

56
When calculating, it is more accurate to use a weighted average number of shares

outstanding over the reporting term, because the number of shares outstanding can

change over time. However, data sources sometimes simplify the calculation by using the

number of shares outstanding at the end of the period. Diluted EPS expands on basic EPS

by including the shares of convertibles or warrants outstanding in the outstanding

shares number. Earnings per share is generally considered to be the single most important

variable in determining a share's price. It is also a major component used to calculate the

price-to-earnings valuation ratio. For example, assume that a company has a net

income of N25 million. If the company pays out N 1 million in preferred dividends and

has 10 million shares for half of the year and 15 million shares for the other half, the EPS

would be N 1.92 (24/12.5). First, the N 1 million is deducted from the net income to get

N 24 million, then a weighted average is taken to find the number of shares outstanding

(0.5 x 10M+ 0.5 x 15M = 12.5M).An important aspect of EPS that's often ignored is the

capital that is required to generate the earnings (net income) in the calculation. Two

companies could generate the same EPS number, but one could do so with less equity

(investment) - that company would be more efficient at using its capital to generate

income and, all other things being equal, would be a "better" company. Investors also

need to be aware of earnings manipulation that will affect the quality of the earnings

number. It is important not to rely on any one financial measure, but to use it in

conjunction with statement analysis and other measures.

3.7 Summary

57
The chapter examines the research methods which will be adopted by the research work

coupled with the population and the sampling design. Due to the nature of the research

content analysis and descriptive correlational design will be employed. As regard

techniques of data analysis, the tool to be adopted for this study is Multiple Regression

Model. SPSS software will be used in analyzing the data.

58