1.determinants of Corporate Dividend Policy in Emergingmarkets

Research in International Business and Finance 37 (2016) 283–298
Contents lists available at ScienceDirect
Research in International Business

and Finance
journal homepage: www.elsevier.com/locate/ribaf
Determinants of corporate dividend policy in emerging

markets: Evidence from MENA stock markets
Imad Jabbouri
School of Business Administration, Al Akhawayn University in Ifrane, Morocco
a r t i c l e i n f o a b s t r a c t
Article history: This study attempts to identify the main factors influencing dividend policy in MENA emerg-
Received 10 February 2015 ing markets during the period between 2004 and 2013. Using panel data analysis, the study
Received in revised form documents that dividend policy is positively related to size, current profit, and liquidity and
17 December 2015
negatively associated with leverage, growth, free cash flow and the state of the economy.
Accepted 6 January 2016
The negative relationship with free cash flow could be indicative of potential agency prob-
Available online 8 January 2016
lems in this region. This relationship is more pronounced in markets with high information
asymmetry and weak investors’ protection. Managers of MENA firms seem to increase divi-
JEL classification:
dend payouts during economic slumps in an attempt to reassure investors fearing insiders’
G32
G34 expropriation. These signals become irrelevant when country governance mechanisms are
powerful and investor protection is factual. Understanding dividend policy enhances the
Keywords: forecast of dividend payments and the choice of the appropriate valuation models, which
Dividend policy increase investors’ confidence and boost market activity and economic growth. Evidence
Information asymmetries
of agency problems in MENA markets could persuade regulators to instigate new and fos-
Agency problems
ter existing governance mechanisms to address this prominent issue. The results should
Emerging markets
encourage policy makers, board of directors, analysts, institutional investors as well as
other investors to scrutinize corporate governance issues to restore the integrity of local
markets.
© 2016 Published by Elsevier B.V.
1. Introduction
Dividend policy refers to the payout policy that a firm follows in determining the size and pattern of cash distributions
to shareholders overtime (Baker et al., 2011). The term policy rejects the possibility of randomness and arbitrariness in
determining its pattern and size and implies some consistency and predictability (Allen and Michaely, 2003). In spite of the
extensive research on dividend policy for many decades, no universally accepted explanation is achieved (Baker et al., 2011).
In markets that are far from being perfect, distinguished by information asymmetry, agency problems of debt and equity,
and prudent and, often, irrational investors, the irrelevance theory proposed by Miller and Modigliani (1961) is no more
a satisfactory answer. Hakansson (1982, p. 415) notes that “dividends continue to flood the empirical world with cash as
regularly and as consistently as the sun scorches the desert, and one is hard put to characterize this pattern as being founded
on irrelevance”. Therefore, more efforts should be put in place to clarify the picture and uncover the puzzle.
Another issue that contributes to the fuzzy picture of dividend policy and hinders the elaboration of new perspectives
is the consistent focus of prior research on developed markets with an extreme negligence of developing and emerging
E-mail address: I.jabbouri@aui.ma
http://dx.doi.org/10.1016/j.ribaf.2016.01.018
0275-5319/© 2016 Published by Elsevier B.V.
284 I. Jabbouri / Research in International Business and Finance 37 (2016) 283–298
markets. It is suggested that corporate finance models are developed with assumptions that are consistent with developed
countries, which causes these models to fail when tested in emerging ones (Bekaert and Harvey, 2000). In the same line,
Lagoarde-Segot (2013b) contends that managerial models are developed in Western countries, which make them poor guides
to business decisions when applied in a different institutional context. Black (1976) found substantial differences in dividend
policy between developed and emerging capital markets. For instance, it is argued that banks dominate financial systems
and control the financings channels of closely held firms in emerging markets. In this context, direct communication with
creditors and shareholders along with regular site visits enable these investors to have access to confidential information,
which limits the signaling power of dividend payments (Aivazian et al., 2003). Lagoarde-Segot (2013b) argues that these
differences raise a challenge for academics and practitioners. To overcome this challenge and develop adequate approaches
for doing business in these markets, the author suggests revisiting established models while taking into consideration the
specificities of emerging and developing countries.
The objective of this research is to explore dividend policy in Middle East and North Africa (MENA) and identify its main
determinants. The study uses a sample of firms from ten MENA countries over the period between 2004 and 2013 to gain
a different perspective on the topic. This research will use panel data analysis to test for the impact on dividend policy of
the most important factors identified in the literature. These factors include: size of the firm, financial leverage, growth,
current profit, expected future profits, historical pattern of dividends, liquidity, free cash flow and the state of the economy.
The choice of these factors is motivated by prior empirical literature that shows their influence on dividend behavior in
developed markets.
The rest of the paper is organized as follows. Section 2 delineates the motivation and background of the study. Section
3 introduces the testing environment. Section 4 presents the research hypotheses. Section 5 outlines the set-up of data
and methodology, and defines the different measures and variable used in this research. Section 6 illustrates the empirical
procedure and Section 7 discusses the results. Section 8 presents the robustness tests before concluding in Section 9.
2. Motivation and background
Dividend policy continues to retain the interest of management, shareholders, creditors, and academics. The importance
attached to this corporate decision arises from its interconnection with other corporate decisions, such as investing and
financing, and its impact on shareholders’ wealth and on the whole economy. Allen and Michaely (1995) report the influence
of dividend policy on the firm’s investing and financing policies as well as other areas of corporate finance. Several other
studies report the impact dividend policy has on the stock price through the information contents embedded in the dividend
decision (Black and Scholes, 1974; DeAngelo and DeAngelo, 2006; Grullon et al., 2002; Walter, 1956). Since both management
and insiders are reluctant to disseminate the true economic conditions of their firms (Leuz et al., 2003), investors welcome
substantial cash signals that convey relevant information and lower the estimation risk. Given the influence dividend policy
has on investors’ decisions, management pay a close attention to this critical task, setting the dividend policy (Allen and
Michaely, 1995; Baker and Powell, 1999; Baker et al., 1985). Further, dividend income is an integral part of the national
income; therefore, it helps grasp an idea about the overall performance of the economy (Papadopoulos and Charalambidis,
2007).
Dividend policy has retained scholars’ attention since the 50s of the last century (Gordon, 1959; Lintner, 1956, 1962; Miller
and Modigliani, 1961) and remains as the most debated issue (Hafeez and Attiya, 2009) and one of the most challenging
topics in modern financial economics (Black and Scholes, 1974; Frankfurter and Wood, 2002) in both developed and emerging
economies. The first study on the topic was conducted by Lintner (1956); and despite the efforts of scholars during the last
few decades to reveal the secrets of dividend policy, they were unable to provide an acceptable explanation for the observed
dividend behavior. This fact paved the way for the introduction of the dividends puzzle concept (Black, 1976). Feldstein and
Green (1983, p. 17) support black’s conclusion and note that: “The nearly universal policy of paying substantial dividends
is the primary puzzle in the economics of corporate finance.” Baker, Powell, and Veit (2000, p. 255) offer additional support
for this view: “Despite this voluminous amount of research, we still do not have all the answers to the dividend puzzle.”
This controversy makes dividend policy a topic of ongoing debate (Baker et al., 2002) in both developed and developing
countries (Hafeez and Attiya, 2009). One of the most important unanswered questions in this debate is what are the factors
that determine dividend policy? As Baker et al. (2011) note, this issue has vexed financial economists for more than 50 years.
This study focuses on MENA emerging markets. Amidu (2007) recommends, for future research, to extend the investiga-
tion on dividend policy to other emerging markets, especially those in MENA region. In the same line, Lagoarde-Segot (2013b)
highlights the importance of international business studies that should focus on reexamining established models and knowl-
edge in light of the particularities of emerging and developing economies. Baker et al. (2011) link the differences among
payout policies in emerging and developed financial markets to the availability of good projects in high-growth economies,
the difficulty in raising equity capital and the influence of controlling shareholders who may prefer reinvestment to distri-
bution. Thus, dividend policy in emerging markets is different, in nature and characteristics, from that of developed markets
(Black, 1976; Glen et al., 1995). The debate on dividend policy can gain additional insights by investigating MENA emerging
markets.
The central motivation of this study is to bridge the existing gap in the literature by exploring the factors influencing
dividend policy in MENA emerging markets. This research has important implications for both theory and practice. It will
extend the literature on dividend policy by identifying for the first time the determinants of dividend policy in MENA
I. Jabbouri / Research in International Business and Finance 37 (2016) 283–298 285
emerging markets. For practitioners, understanding dividend policy not only enhances the forecast of dividend payments and
the choice of the appropriate valuation models, but also the perception of the interrelationship among operating, financing
and investing activities. A comprehensive understanding of these interrelationships along with enhanced valuation models
and forecasts increase investors’ confidence and boost market activity and economic growth.
3. Testing environment
The region comprises some of the ancient stock markets in the world that were active since the 19th century, such as
the one of Egypt created in 1890 and Morocco in 1929. Yet, MENA markets have been considered for a long period as less
developed compared to the Asian or Latin American stock markets (Henry and Springborg, 2004). The authors argue that
the absence of derivatives and other sophisticated financial instruments, barriers for foreign investors as well as institu-
tional underdevelopment contributed to the feebleness of these markets and limited their ability to attract international
investors and foreign direct investments. They link this weakness to the relative scarcity of large private corporations, the lax
information disclosure requirements, illiquidity of debts and high transactions costs. The absence of a strong, independent
capital markets authority that strives to implement proper corporate governance mechanism and assure a sound function-
ing of the market, also, contributed to this deterioration especially in the late 1990s. These weaknesses resulted in high
transactions costs and restricted market participation by investors. Hence, depth, size, and liquidity of the market, the main
desirable qualities of a financial market, were lacking, making the enticement of domestic or foreign investors a strenuous
task. Consequently, financial markets in the MENA region are slow in terms of stimulating economic growth.
MENA region is one of the most important regions in the world that suffers from political unrest since many decades.
Economic growth that improves social welfare, education, and healthcare among other aspects of life is key for the whole
region. Lagoarde-Segot and Lucey (2010) contend that MENA countries suffer from significant demographic pressure and
rising unemployment rates, which makes these countries under the pressure to achieve an economic take-off to maintain
social and political stability. To accomplish this economic transformation and attract foreign direct investments, financial
markets have been substantially fortified and modernized (Lagoarde-Segot, 2013a; Lagoarde-Segot and Lucey, 2010). Most
of the MENA markets have evolved over the last fourteen years, which increased their attractiveness for various types of
investors in terms of the numerous market development indicators. This fact can be a result of the increase in the number
of listed firms that boosted the market activity. For instance, the number of listed firms has doubled between 1999 and
2012 in Saudi Arabia, United Arab Emirates, Qatar, Jordan and tripled in Kuwait. Morocco and Tunisia have, also, witnessed a
significant increase in the number of listed firms. Over the same period, market capitalization and liquidity have massively
improved.
Most of these markets launched a process of institutional setting and regulations that aims at establishing security market
regulation, improving investors’ protections and enhancing trading rules based on shared regulatory responsibility and the
transparency of public markets (Naceur et al., 2007). They have addressed corporate governance issues that remained a
major barrier in front of their development and capacity to attract foreign investors. Oman, in 2002 and Egypt, in 2005,
were the first countries in the region to introduce corporate governance codes and establish organizations that promote
good governance practices (Organization of Economic Cooperation and Development (OECD), 2012). Nowadays, almost all
countries have institutions in charge of fostering good governance locally (OECD, 2012). Subsequently, the main concern
of regulators becomes the enforcement of corporate governance mechanisms. In fact, the Egyptian Stock Exchange and the
Kuwait Stock Exchange have delisted a large number of firms having problems to maintain the listing requirements (OECD,
2012). Securities watchdogs and stock exchanges are giving, more often, penalties for late or inappropriate disclosures
(Boubaker and Nguyen, 2014). Furthermore, a number of MENA jurisdictions start to require a minimum percentage of
independent board members or non-executive directors (Boubaker and Nguyen, 2014).
The conviction that corporate governance is key to develop the financial system and stimulate economic growth urges
authorities in different MENA countries to strengthen the rules and implement new governance mechanisms to improve
the integrity of local markets and attain international standards. Increased markets’ transparency, improved market depth
and liquidity, enhanced governance practices, high potential growth and low correlation with international markets make
of the region an optimal destination for investors seeking growth and international diversification (Girard et al., 2003;
Lagoarde-Segot and Lucey, 2007, 2008a, 2008b).
This reorganization process has attracted researchers to examine the characteristics of MENA markets in an attempt to
provide stakeholders with the relevant information for policy and investment decisions (Lagoarde-Segot and Lucey, 2010).
Understanding its financial markets and improving them in a way that can stimulate economic growth is crucial for the
region. This research paper takes part in this endeavor by investigating one of the most debated issues in both developed
and emerging economies. A better understanding of dividend policy and its determinants in MENA markets should contribute
to the establishment of well-functioning financial markets.
4. Research hypotheses
In light of a review of the literature, key explanatory variables were identified to disclose their relationships and effects
on the determination of dividend policy. These variables are Size, Financial Leverage, Growth Opportunities, Profitability,
Past Dividend, Liquidity, Free Cash Flow, and the state of the economy.
4.1. Firm size
Size of the firm remains one of the most important factors affecting its dividend policy despite the contradicting findings
about the nature of this impact. A large number of studies investigated this relationship but no consensus was achieved. For
instance, several studies established a relationship between the amount of cash dividends distributed and size of the firm
(Baker et al., 2007; Jakob and Johannes, 2008). Jensen and Meckling (1976) argue that managers have greater control over
larger firms where ownership is more dispersed and shareholders have a low incentive and ability to monitor. Hence, the
level of agency problems and information asymmetry intensifies. As an alternative solution, a high dividend payout ratio
would help these firms send costly positive signals about the future prospects of the firm, the good faith of management, and
the low level of agency conflicts (Lloyd et al., 1985; Sawicki, 2005). The good faith of management is portrayed not only in
sharing firms’ profits with its shareholders, but also in the willingness to undertake a scrutiny exercised by capital markets
as the need for external financing increases with high dividend payments (Bhattacharya, 1979; Dempsey and Laber, 1992;
Mitton, 2004; Moh’d et al., 1995; Rozeff, 1982; Saxena, 1999). Both the monitoring problem and the risk-aversion problem
are lessened if the firm is repeatedly in the market for raising additional capital. Financing from financial markets provides
investors with a chance to closely examine the business. These managers are more likely to act in investors’ interests than
agents who are immune from this kind of monitoring (Easterbrook, 1984).
Other scholars link the low dividend payment of small firms to the high transaction costs they will bear if they need to
raise funds externally (Holder et al., 1998). Prior literature reports that smaller firms are less diversified on production and
distribution side, and hence, are riskier and would encounter more financing restrictions (Behr and Güttler, 2007). The high
interest rate charged can be justified by their lack of diversification as well as their inability to provide appropriate collateral
due to their low asset base (D’Auria et al., 1999; Lehmann and Neuberger, 2000). The inaccessibility of external financing
and its high cost if obtained, limit small firms’ ability to pay dividends and make them more inclined to retain these funds
to finance their future growth.
However, other studies confirm a negative relationship between dividend payments and firm’s size. They document that
the reaction of small firms’ stock prices to dividend announcements is higher than the reaction of larger firms (Jin, 2000;
Yoon and Starks, 1995). It is argued that the bigger the size of the firm the greater is the publicly available information on
the firm and the lower is the information asymmetry (Eddy and Seifert, 1988). The level of information asymmetry between
insiders and outsiders would determine the value of the information contents embedded in dividend payments. Therefore,
this strand of literature implies that the signaling power of dividends decreases with an increase in firm size, which would
dissuade large firms from paying dividends. This discussion allows us to formulate the first hypothesis as follows:
H1. There is a positive/negative relationship between dividend payout ratio and size of the firm.
4.2. Financial leverage
Surveys of Chief financial officers and managers indicate the influence of capital structure on dividend policy (Baker et al.,
2001). Various studies confirm these results by showing a negative relationship between the level of debt and dividend policy
(Al-Twaijry, 2007; Crutchley and Hansen, 1989; Papadopoulos and Charalambidis, 2007). Many interpretations are found in
the literature for this relationship. For instance, firms with a high level of debt prefer to cut dividends, voluntarily or under
creditors’ pressure, to maintain cash needed to fulfill their obligations toward corporate debt-holders (Afza and Hammad,
2011; Agrawal and Jayaraman, 1994; Faccio et al., 2001; Gugler and Yurtoglu, 2003). Alternatively, the increase in firms’
riskiness due to the use of more debt raises their external financing costs and makes them more dependent on retained
earnings (Hufft and Dufrene, 1996). Further, low dividend payments increase equity amount on the balance sheet and
improve leverage ratios, such as debt to equity ratio or debt to asset ratio, and hence, its credit worthiness. Improvement in
these ratios facilitates the renewal of debts and minimizes financing costs.
Other studies highlight the role of negative covenants that put restrictions on firms’ dividend payments (Day and Taylor,
1996; Kalay, 1982; Malitz, 1986; Mather and Peirson, 2006; Smith and Warner, 1979). These studies document that dividend
payments always favor shareholders at the expense of creditors. Therefore, management planning to access credit markets
frequently would cut dividends to restore creditors’ confidence and reflect a low level of agency cost of debt within the firm
(Black and Scholes, 1973; Brockman and Unlu, 2009; Jensen et al., 1992; John and Nachman, 1985; Nini et al., 2007).
Another strand of literature maintains that debt is another mechanism used to reduce agency costs of cash flow (Agrawal
and Knoeber, 1996; Fleming et al., 2005; Jensen and Meckling, 1986; Myers, 1977). These studies assert that debt enables cred-
itors to exercise more control and monitoring over management who are pressured to meet debt obligations by improving
organizational efficiency and eliminating value-destroying projects. Agency problems in these leveraged firms are reduced
thanks to the potential detriments, in terms of compensation and reputation, management would suffer in the event of
bankruptcy (Grossman and Hart, 1982; Jensen, 1986; Williams, 1987). In fact, debt can substitute for dividends in reducing
information asymmetry and agency problems. Therefore, if the signaling power of dividends is limited in firms with a high
level of debt, these firms will have less incentive to pay dividends compared to less leveraged firms.
All the arguments presented support the negative association between dividend policy and financial leverage. Therefore,
the following hypothesis is stated as follows:
H2. There is a negative relationship between dividend policy and leverage.
4.3. Growth opportunities
In a survey of Canadian managers on how they set dividend policy, Baker et al. (2008) reveal that investing, financing and
dividends decisions should be consistent and dependent on each other. Partington (1983) confirms this finding by showing
that a firm’s motivation to pay dividend and the size of this dividend depend on its investment and growth potential. Other
studies document that the available growth opportunities exhaust the cash resources of the firm that could be used to pay
dividends (Faccio et al., 2001; Gaver and Kenneth, 1993; Smith and Watts, 1992). Consistent with the firm life cycle theory,
slow or non-growth firms pay high dividends at their mature stage (Baker and Powell, 2012; Baker and Kapoor, 2015).
Whereas, high-growth firms tend to retain most of their earnings to reduce their dependence on costly external financing
(Alli et al., 1993; Kania and Bacon, 2005). A plausible explanation is the investment in working capital needed to support the
growth is higher than the incremental cash flow provided by growth in sales (Higgins, 1972, 1981). However, it is argued
that the negative relationship between dividend payments and growth opportunities is valid only in countries with strong
legal protection for shareholders (Mitton, 2004). In fact, if shareholders feel unsecure and doubt their ability to share the
firm’s future profits, they will prefer to receive current earnings by putting pressure on firms to pay dividends, regardless
of the growth opportunities available (La Porta et al., 2000a). The level of investor protection and adequacy of governance
mechanisms differ among the investigated countries, which complicates the nature of the relationship between dividend
payout and growth opportunities. The next hypothesis is presented as follows:
H3. There is a positive/negative relationship between dividend payout ratio and growth opportunities.
4.4. Profitability
Evidently, there is no disagreement on the significance of the firm’s profitability as a determinant of corporate dividend
policy (Amidu and Abor, 2006; Baker and Jabbouri, 2016; Fama and French, 2000, 2002; Jakob and Johannes, 2008). However,
the question that should be asked is: does dividend policy depend on current or future earnings of the firm? Several studies
document the positive association between dividend payments and the earnings of the same year especially in developing
economies (Adaoğlu, 2000; Ahmed and Javid, 2009; Oza, 2004; Wang et al., 2002). Companies tend to increase dividend
payments with an increase in profitability and avoid retaining earnings within the firm, which is coherent with Jensen’s
free cash flow hypothesis. For instance, research on the Indian market reveals the importance of current earnings on setting
dividend policy (Bhat and Pandey, 1994; Mishra and Narender, 1996). This finding is equally established in the US market
(Pruitt and Gitman, 1991).
The expected level of future earnings is, also, cited as a main factor influencing dividend policy (Baker and Powell, 1999,
2000a,b; Baker and Jabbouri, 2016; Bhat and Pandey, 1994; Nissim and Ziv, 2001). Firms are reluctant to increase dividends
unless they can maintain that level in the future, which depends on future earnings (Fama, 1974; Fama and Babiak, 1968).
These studies argue that a cut in dividends is, most of the time, interpreted as a warning about the firm’s future prospects
leading to a negative reaction by investors (Bajaj and Vijh, 1990; Denis et al., 1994). In a survey of chief financial officers
of New York Stock Exchange, Farrelly et al. (1986) document the importance of future earnings in deciding on a dividend
payout ratio. More recently, the same results were confirmed in the US (Baker and Powell, 2000b) and Canada (Baker et al.,
2007) through a survey of managers in both countries. Accordingly, hypotheses four and five are formulated as follows:
H4. There is a positive association between dividend payout ratio and current profits.
H5. There is a positive relationship between dividend payout ratio and expected future profits.
4.5. Past dividends
Since early research on dividend policy, studies have addressed the role of past dividends in setting the current dividend
payout ratio. Starting with Lintner (1956) who surveyed 28 managers in the United States and concluded that past dividends
is a key factor that influences dividend policy. He pointed that firms are reluctant to raise dividend rates to a level that could
be difficult to sustain and try to maintain a long record of stable payout. Various studies that tested Linter’s model in different
markets and over many periods endorse this finding and conclude that past payments affect current dividends (Allen, 1992;
McCluskey et al., 2007; Pourheydari, 2009; Tse, 2005). For instance, a survey of 562 firms listed in New York Stock Exchange
(Farrelly et al., 1986) and 318 firms listed in NASDAQ (Baker et al., 2002) confirms the importance of past dividend pattern
and report managers’ inclination to smooth dividend growth.
However, there is evidence that in developing markets current dividend payment is independent from its historical
pattern. Since current dividend is based, mainly on current profitability, dividend payment is unstable over the years (Glen
et al., 1995). In china, Wang et al. (2002) contend that firms do not follow a stable dividend policy. These firms focus on
the same year’s profitability to determine current dividends with no regard to its variability from past payments. In the
same line of research, Adaoğlu (2000) conducted a study to investigate dividend policy in Istanbul Stock Exchange (ISE) and
asserts that dividend policy is independent from its historical pattern and do not follow a stable dividend policy. Based on
this discussion, it is interesting to test whether firms in MENA region consider past dividends when setting the current one.
The next hypothesis is formulated as follows:
H6. There is a relationship between current and past dividend payouts.
4.6. Liquidity
One of the most important factors influencing dividend policy is the firm’s liquidity. With a shortage of cash, no dividend
will be paid even if the income statement, based on the accrual basis of accounting, reflects a decent profitability. Prior
studies report that corporate dividend policy is highly dependent on the firm’s cash position rather than earnings (Anil
and Kapoor, 2008; DeAngelo et al., 2004; Khang and King, 2006). Using a sample of industrial firms in New York Stock
Exchange (NYSE) and American Stock Exchange (AMEX), Deshmukh (2003) demonstrates the importance of liquidity in
setting dividend policy. The author establishes a positive relationship between dividend payout ratio and cash position.
Moreover, in their analysis of Japanese firms, Kato et al. (2002) conclude that changes in dividend policy are, mainly, due to
alterations in firms’ liquidity. Based on these arguments, it can be hypothesized that:
H7. Dividend payout ratio is positively related to the liquidity of the firm.
4.7. Free cash flow
In his seminal work on the free cash flow hypothesis, Jensen (1986) argues that agency problems between insiders and
minority shareholders increase as the level of free cash flow increases. In their attempt to serve their goals, the agents
spend the excess cash on projects with a negative present value, which decreases shareholders’ wealth (Allen and Rachim,
1996; Hu and Kumar, 2004; Zwiebel, 1996). Faccio et al. (2001) investigate East Asian and Western European firms and
show that dividend payouts are significantly impacted by the vulnerability of a firm’s minority shareholders to expropri-
ation by insiders. A number of studies demonstrate that paying high dividends can be used to lessen agency costs and
mitigate information asymmetry problems through the reduction of discretionary funds that could be expensed on value
destroying projects (Faccio et al., 2001; Fairchild, 2010; Gomes, 2000). For instance, Sawicki (2008) shows that, in emerging
countries, a high dividend payout ratio is an efficient tool to build or improve the firm’s reputation of decent corporate
governance. Therefore, firms paying high dividends are perceived to be less risky and experiencing low agency problems
and information asymmetry (Jensen, 1986; Hope, 2003). Based on the discussed arguments a hypothesis can be presented as
follow:
H8. There is a positive relationship between dividend payout ratio and free cash flow.
4.8. State of the economy
Dissimilarities in dividend policy across countries are mainly due to differences in macro-economic conditions, which
are reflected in the stock market performance (Glen et al., 1995). Macro-economic changes not only impact firm’s funda-
ments but also managerial decision-making (Mascarenhas and Aaker, 1989; Zarnowitz, 1985). Management may change
their investing, financing as well as dividends decisions in response to changes in the economic conditions. The litera-
ture illustrates how economic fluctuations drive management to alter their financing mix (Hatzinikolaou et al., 2002);
delay, cut or expand their investments (Carpenter et al., 1994; Huizinga, 1993), or to decide about strategic decisions
such as mergers and acquisitions (Melicher et al., 1983; Melicher and Rush, 1973; Nelson, 1959; Weston and Mansinghka,
1971). These economic fluctuations, also, induce management to modify their dividend policy either to convey signals
to investors or adjust the firm’s dividend policy to the prevailing economic conditions (Greer, 1984; Mascarenhas and
Aaker, 1989). The detrimental effects associated with macroeconomic variations in emerging financial markets (Pallage
and Robe, 2003) and the limited access of emerging markets firms to international capital markets, especially in a poor
economic climate (Kaminsky et al., 2004), make the change and adaptation of dividend policy to macroeconomic changes
a must.
Furthermore, previous studies show that the signaling power of dividend varies under different economic conditions
(Farooq et al., 2012; Salminen and Martikainen, 2008). They argue that investors’ reactions to dividends are higher during
economic downturns compared to booming or stable growth periods. It is documented that investors in Casablanca stock
exchange care less about dividend policy during high growth periods, which was reflected in the low reaction of investors to
changes in the firm’s dividend policy (Farooq et al., 2012). A plausible explanation of this finding could be the low concern
about corporate governance during good economic times. Rajan and Zingales (1998) assert that investors ignored corporate
governance problems in good economic times in East Asian Markets. The authors report that both regulators and investors
pay less attention to corporate governance mechanisms when markets are booming and investors’ appetite for risk is high.
One of the explanations proposed is that as long as investors earn what they were expecting, less attention will be given
to the corporate governance within the firm as well as to dividend payments (Mitton, 2002; Shleifer and Vishny, 1997).
However, investors are more concerned about corporate governance during economic downturns when yields shrink and
firms’ resources become more vulnerable to expropriation by insiders (Johnson et al., 2000). Under such circumstances,
shareholders require dividend payments to increase their return already affected by the market performance and to reduce
the likelihood of expropriation by insiders (Lemmon and Lins, 2003). Alternatively, management and insiders may increase
dividend payments in a period of mediocre market performance, as dividend is the most efficient tool to reassure investors
about the firm’s future and to reflect the proper governance and low agency problems. Based on the above discussion the
following hypothesis is formulated as follow:
H9. There is a relationship between dividend policy and the state of the economy.
It should be highlighted that there are other firm specific and market variables that would significantly affect the firm’s
dividend policy such as ownership structure and quality of corporate governance at the firm level. These variables are
excluded from this analysis because of the unavailability of this data for most of MENA markets.
5. Methodology
This section will discuss the methodological aspects of the research, mainly sampling, data and variable construction,
including the dependent and independent variables.
5.1. Sampling
The sample used in this study consists of firms listed in eleven stock markets of ten MENA countries (Bahrain, Egypt,
Jordan, Kuwait, Morocco, Oman, Qatar, Saudi Arabia, Tunisia, and United Arab Emirates). The period covers between 2004
and 2013, which is considered to grab the impact of recent changes surrounding the economy in the region in general
and corporate sector in particular. Datastream and Worlscope were used to extract the data needed. All data is yearly and
obtained in US Dollars. Classification of firms into industries was based on ICB (Industry Classification Benchmark) of 2013
data. Banks and financial institutions were excluded from the analysis due to their special financial structures, accounting
methods and corporate governance (Berger et al., 1997). The sample includes both dividend and non-dividend paying firms.
Exclusion of the non-dividend paying firms from the analysis may lead to a selection bias (Allen et al., 2000; Kai and Xinlei,
2008). The sample is exclusive of delisted firms. This yields a final sample of 2149 firm-year observations from 533 firms
across ten countries1 for the period of 2004 through 2013.
5.2. Data and variable construction
5.2.1. Dependent variable

The dependent variable is dividend policy measured as dividend payout ratio. It is defined as the ratio of total dividends
to operating profits – profits before interests and taxes – This ratio helps avoid issues related to the traditional measure of
dividend payout ratio, computed as total dividends divided by net income, in case the firm incurs losses and decides to pay
dividends. Dividend to sales ratio will be used in the robustness test and will be discussed later.
5.2.2. Independent variables

Firm size (SIZE) is measured as the natural logarithm of total assets, total book value of debt divided by total assets (Lever-
age) will proxy for financial leverage. For the growth opportunities, annual growth in assets is used as a proxy (Growth).
Return on equity is used in several studies as a proxy for a firm current profitability (CurrentProfit). Forecasted earnings
per share, is employed to estimate expected future profitability (FutureProfit). The average of the last three periods of div-
idend payout ratio is used to proxy for the past dividend (PastDiv). Quick or acid test ratio is employed as a measure of
liquidity (Liquidity). The measure used to proxy for free cash flow is the free cash flow to the book value of total asset
ratio (FCF). Finally, the yearly return on the main index of the market (MarketReturn) in which the firm is listed will
be used to control for the state of the economy. Appendix A contains variables’ definition and their various uses in the
literature.
5.3. Descriptive statistics
Table 1 illustrates the descriptive statistics of dividend policy year, country, and industry wise. From Panel A, dividend
policy of the studied firms remains stable over the whole period ranging between 29.33% and 32.95% except for 2011 where it
falls to its lowest level, 18.32%. The lowest median is 12.19% in 2011 and the highest is 18.1% in 2006. The standard deviation
varies between 17.31% and 29.08%. The results in Panel B show that for most of the countries included in the study, dividend
policy remains close to the average of the whole sample, 29.52%. The lowest and highest payout ratio was in Egypt, 24.76%
and Bahrain, 44.45%, respectively. Panel C indicates that most of the industries have a mean payout ratio that is close to that
of the whole sample, with the exception of Utilities with the highest payout ratio of 49.78% and Technology with the lowest
payout ratio of 19.36%.
Table 2 presents the correlation analysis. As expected, a high correlation, 0.81, exists between the two proxies of div-
idend policy, dividend payout ratio and dividend to sales ratio. Another point to note is the low pairwise correlation
1
The number of firms included in the study broken down by country is as follows: Bahrain (30), Egypt (71), Jordan (68), Kuwait (62), Morocco (42),
Oman (61), Qatar (26), Saudi Arabia (81), Tunisia (31), and United Arab Emirates (61).
Table 1
Descriptive statistics for dividend policy.
Panel A: Dividend policy for each year during the period 2004–2013
Year Mean Median Standard deviation
2004 29.47 17.28 23.08

2005 29.33 13.56 17.31
2006 32.16 18.10 18.97
2007 32.95 17.40 27.26
2008 32.55 17.98 17.49
2009 31.98 16.83 18.02
2010 30.46 16.31 27.18
2011 18.32 12.19 29.07
2012 31.42 16.64 29.08
2013 29.53 17.25 28.51
Panel B: Dividend policy for each country during the period 2004–2013
Country Mean Median Standard deviation
Bahrain 44.45 47.19 23.87

Egypt 24.76 23.5 25.58
Jordan 33.02 17.31 15.76
Kuwait 32.33 33.39 28.85
Morocco 27.53 25.92 23.67
Oman 38.41 33.82 20.46
Qatar 29.73 20.43 16.79
Saudi Arabia 29.28 17.83 18.46
Tunisia 28.03 30.01 22.45
United Arab Emirates 27.37 26.11 21.34
Panel C: Dividend policy within each industry during the period 2004–2013.
Industry Mean Median Standard Deviation
Oil and gas 29.08 18.33 19.49

Basic materials 28.24 17.55 20.34
Industrials 29.55 17.67 24.21
Consumer goods 29.86 16.24 17.87
Consumer services 37.04 16.53 23.26
Telecommunications 41.95 20.75 21.76
Technology 19.36 13.87 24.65
Utilities 49.78 22.68 29.52
Healthcare 25.54 17.48 21.96
Table 2
Correlation matrix.
Payout Div to Size Leverage Growth Current Future PastDividend Liquidity FCF MarketReturn
Ratio Sales Profit Profit
Payout Ratio 1.00

Div to Sales .81 1.00
Size −0.23 0.15 1.00
Leverage 0.02 −0.22 0.26 1.00
Growth −0.05 −0.06 0.08 0.07 1.00
Current Profit 0.60 −0.10 −0.12 0.05 0.09 1.00
Future Profit −0.06 0.02 0.01 0.02 0.05 −0.04 1.00
PastDividend −0.02 0.01 −0.03 0.01 −0.00 −0.03 0.01 1.00
Liquidity 0.64 −0.02 −0.22 −0.09 0.00 0.09 −0.07 −0.05 1.00
FCF −0.04 0.02 −0.01 −0.06 −0.09 −0.00 0.12 −0.00 0.00 1.00
MarketReturn −0.06 −0.03 −0.01 −0.05 −0.10 −0.02 0.11 −0.01 0.01 .14 1.00
among all the explanatory variables. The highest correlations are between Leverage and Size, 0.26, and Liquidity and
Size, −0.22.
To assess more directly whether the sample suffers from multicollinearity, the Variance Inflation Factors (VIF) for each
of the explanatory variables were calculated and presented in Table 3. All VIF values are relatively small and none of them
exceeds 1.4. Therefore, it can be concluded that there is no problem of multicollinearity, which is very consistent with the
precedent analysis.
Table 3
Variance inflation factors.
Variable VIF
Liquidity 1.32
CurrentProfit 1.30
Size 1.16
Growth 1.10
MarketReturn 1.07
Leverage 1.05
FCF 1.05
PastDividend 1.01
FutureProfit 0.99
Table 4
Fixed effects model of the panel regression 2004–2013. Dependent variable: Dividend payout ratio.
Payout ratio Coef. Std. Err. T P > |t| Level of significance
Size 6.59 2.09 3.14 0.00 ***

Leverage −31.26 8.35 −3.74 0.00 ***
Growth −11.18 4.69 −2.38 0.02 **
CurrentProfit .07 .02 2.74 0.00 ***
FutureProfit .35 .33 1.05 0.29
PastDividend -.05 .71 −0.08 0.93
Liquidity 1.79 .76 2.34 0.02 **
FCF −.31 .04 −6.73 0.00 ***
MarketReturn −3.35 2.06 −1.62 0.01 ***
Constant −34.23 24.61 1.39 0.16
Number of obs 2149
Prob > F 0.00
Adj R-squared .66
The results significant at 10% significance level are followed by *, at 5% significance level by **, and at 1% a significance level by***.
6. Empirical procedure
In order to examine the impacts of size, leverage, growth opportunities, profitability, past dividends, liquidity, free cash
flow and the state of the economy on dividend policy the study uses a panel analysis. It is important to mention here that
panel data regression with fixed effects was used for the analysis. Hausman test was used to decide between fixed effect
and random effects. The basic regression takes the following form:
PoRit = ˛i + ˇ1 Sizeit + ˇ2 Leverageit + ˇ3 Growthit + ˇ4 Currentprofitit + ˇ5 Futureprofitit + ˇ6 PastDividendit
+ ˇ7 Liquidityit + ˇ8 FCFit + ˇ9 MarketReturnit + it (1)
In this equation, the subscript i represents the cross-sectional dimension and t denotes the time-series dimension. The
results of the analysis are reported in Table 4.
7. Discussion of the results
The adjusted R squared is relatively high, around 66%. The results are interesting and intuitive. The analysis documents a
positive relationship between size and dividend policy, which is significant at the 1% level. The positive relationship between
size and dividend policy confirms the results reported by several prior studies in both emerging and developed economies
(DeAngelo et al., 2004; Fama and French, 2000; Manos, 2003; Redding, 1997). The payment of high dividends is an effective
tool used by large firms, with dispersed ownership and powerful management, to send costly and significant cash signals to
reveal management good faith and decent treatment of shareholders (Jensen and Meckling, 1976; Lloyd et al., 1985; Sawicki,
2005). A high payout ratio may, also, indicate a reliance on capital markets for financing and willingness to undertake the
scrutiny exercised by the suppliers of finance, which is a substantial indicator of the proper governance level within the firm.
Another reason that could explain this relationship is the easy access to capital markets enjoyed by larger firms compared
to smaller ones. Lastly, no support is found for the notion that the value of the information contents embedded in dividend
payments decreases with firm’s size.
Consistent with previous findings, the analysis reports a negative relationship between financial leverage and dividend
policy (Afza and Hammad, 2011; Kania and Bacon, 2005; Faccio et al., 2001). The negative relationship has three main
explanations. First, highly leveraged firms prefer to cut dividends voluntarily or under creditors’ pressure. Cash that could
be used to pay dividend may be employed to service debt obligations (Afza and Hammad, 2011; Gugler and Yurtoglu,
2003). Second, a high level of debt increases the firm’s riskiness and raises its external financing costs, which makes it more
dependent on retained earnings (Hufft and Dufrene, 1996). Third, debt has an important role in disciplining management
and reducing information asymmetry and agency problems (Agrawal and Knoeber, 1996; Grossman and Hart, 1982; Myers,
1977; Williams, 1987). Thus, a high level of debt may reduce the need for valuable cash signals embedded in dividend
payments.
As expected, the study reveals a negative relationship between growth and dividend policy since investment opportunities
would exhaust cash available for dividend payments. The model confirms that this relationship is significant at the 5% level
and supports the findings reported in previous research (Omran and Pointon, 2004; Grossman and Hart, 1980; Rozeff, 1982).
Cutting dividend is a means to sustain growth and reduce firms’ reliance on costly external financing (Dempsey and Laber,
1992; Joshua and Bokpin, 2010; Manos, 2003).
The analysis reports a significant positive relationship with current profits and an insignificant association with expected
future profits. These findings support Adaoğlu’s (2000) results, which highlight the role of current year’s earning in deter-
mining dividend policy in emerging markets, with no influence of expected future profits. The analysis shows no significant
relationship between dividend policy and the historical pattern of dividend payments. This finding contradicts prior results
reported in developed financial markets (Baker et al., 2007; Jakob and Johannes, 2008; Pourheydari, 2009). Yet, it is consis-
tent with results reported from a broad set of emerging financial markets including China (Wang et al., 2002), India (Som,
2006), Turkey (Adaoğlu, 2000) and Jordan (Al-Malkawi, 2007). Therefore, this result supports the conclusion that dividend
policy in emerging economies is not sticky and that firms in these markets do not consider dividend stability as important
as do their counterparts in developed markets. The model, also, validates the expected positive relationship between firm’s
liquidity and dividend policy. Consistent with prior literature, firms facing a lack of liquidity are unlikely to issue a cash
dividend (Anil and Kapoor, 2008; Baker and Powell, 1999; Baker et al., 2005).
Another interesting result of the analysis is the significant negative relationship established between free cash flow and
dividend policy. Contrary to several studies (Fairchild, 2010; Jensen and Meckling, 1976; Lang and Litzenberger, 1989; La
Porta et al., 2000b; Mollah and Mobarek, 2007; Rozeff, 1982; Sawicki, 2008), this research documents that as the amount of
free cash flow increases dividend payments decreases. Prior literature maintains that high dividend payouts alleviate agency
conflicts through the reduction of free cash flow available to managers (Grossman and Hart, 1980). Other related studies
conclude that high dividend payouts lessen agency problems by reducing free cash flows that could be spent on lossmaking
projects (DeAngelo et al., 2004). Jensen (1986) argues that conflicts of interest between shareholders and managers over
payout policies intensify when the firm generates substantial free cash flow. The author confirms that the challenge is how to
motivate managers to disgorge the cash rather than investing it at below the cost of capital or wasting it on organization inef-
ficiencies. In the context of developing countries, where markets are characterized by the absence of corporate governance
mechanisms, high information asymmetry, weak legal institutions, and managerial expropriation of shareholders (Claessens
and Fan, 2002; Denis and McConnell, 2003; Khwaja and Mian, 2006), dividend payments are expected to increase with an
increase in free cash flow in order to substitute for the weak governance at the country level. However, in this analysis,
the negative relationship between free cash flow and dividend policy shows that management reduces dividends with the
increase in free cash flow. This finding suggests high agency problems that may range from investing the available cash at
value destroying projects to diversion or expropriation. This is consistent with Jensen (1986) who documents that managers
are reluctant to disgorge free cash flow to investors and are prone to investing in empire building. The negative relationship,
also, indicates that as the amount of free cash flow increases managerial incentives to deviates from the purported objec-
tive, shareholders’ value maximization, increase. The result, also, confirms the conclusion of Faccio et al. (2001) who study
East Asian and Western European firms and find that dividend payouts are significantly impacted by the vulnerability of
a firm’s minority shareholders to expropriation by insiders. Therefore, it can be concluded that the added value of proper
governance at the firm level becomes undeniable and its prominence raises as the organization generates substantial free
cash flow.
Another important finding of the analysis is the significant negative relationship reported between dividend policy
and the state of the economy. This result indicates that management tends to decrease dividend payments in good eco-
nomic times and increase them in period of economic downturns. The finding supports previous studies and confirms that
macro-economic conditions influence dividend policy decision among other corporate financial decisions (Glen et al., 1995;
Mascarenhas and Aaker, 1989). It, also, indicates that managers act according to the belief that the signaling power of
dividend varies under different economic conditions, because investors care less about dividends during good economic
times compared to poor economic periods. Investors’ behavior could be driven by the fear of expropriation during poor
economic performance as yields drop and insiders attempt to expropriate to maintain a decent rate of return (Johnson et al.,
2000; Rajan and Zingales, 1998). Consequently, shareholders, in such circumstances, demand high dividend payments to
increase their return affected by the overall market performance and to make sure that no expropriation is taking place.
Managers seem to be aware of this, hence they tend to increase dividend payout when the market is performing poorly to
reinsure investors about the firm’s future and the governance environment within the firm. Alternatively, when the market
prospers, management inclines to lower dividend payments. This finding can be explained by the fact that the signaling
power of dividend in good economic times is lower, hence, they prefer to keep it until it is most efficient to disgorge. In
fact, management seems to maintain some reserve of earnings during good economic times to be able to pay high dividend
during economic slumps. Another explanation that is in line with the finding related to free cash flow, is that in growth
periods earnings are high and investors care less about corporate governance, therefore, any expropriation is likely to go
unnoticed.
Table 5
Fixed effects model of the panel regression. Civil law countries.
Size 6.18 2.53 2.44 0.00 ***

Leverage −33.49 9.98 −3.35 0.00 ***
Growth −.33 .69 −0.48 0.63
CurrentProfit .07 .03 1.93 0.05 **
FutureProfit .15 .66 0.23 0.82
PastDividend .34 .52 0.66 0.50
Liquidity .67 .27 −2.47 0.01 ***
FCF −1.86 1.12 −2.26 0.03 **
MarketReturn −1.52 .85 −1.78 0.07 *
Constant −22.60 33.71 −0.67 0.50
Number of obs 1599
Prob > F 0.00
Adj R-squared .68
Table 6
Fixed effects model of the panel regression. Common law countries.
Size 3.89 .85 4.56 0.00 ***

Leverage −10.65 3.73 −2.85 0.00 ***
Growth −4.05 1.22 −3.31 0.01 ***
CurrentProfit 1.24 .29 4.21 0.00 ***
FutureProfit −.04 .08 −0.51 0.61
Liquidity 2.30 .56 4.10 0.00 ***
FCF 1.62 .38 4.19 0.00 ***
MarketReturn 1.98 .59 3.34 0.00 ***
Constant −39.94 10.86 −3.68 0.00 ***
Number of obs 550
Prob > F 0.00
Adj R-squared .63
8. Robustness of results
The objective of this section is to test whether the previous results are robust to different specifications. The first robust-
ness test is to check whether the legal environment and the level of investor protection have any impact on the results. The
second test is related to a change in the proxy of the dependent variable.
8.1. Effect of legal traditions and level of investor protection on the determinants of dividend policy
The findings documented in the prior analysis, related to free cash flow and the state of the economy and which shed light
on agency costs of equity and the quality of corporate governance, are the main motivation behind this investigation. In this
analysis, the sample is split into two subsamples, one with firms headquartered in MENA civil law countries and the other
with firms headquartered in MENA common law countries2 . Prior literature reports significant differences between common
law and civil law countries in terms of transparency and investor protection. It is reported that investors enjoy a stronger
legal protection and less information asymmetry in common law countries compared to civil law countries (Brockman and
Unlu, 2009; La Porta et al., 1998, 2000a). The extra protection provided in common law countries assures investors against
expropriation by management and insiders and improves the quality of corporate governance. These differences influence
the signaling power of dividends and shape the interaction between dividend policy and its determinants. Eq. (1) is re-
estimated for both groups. The results are reported in Tables 5 and 6. Based on the Hausman test, the fixed effects model
was selected over the random effects model.
This analysis confirms the prior results related to size, current profits, liquidity, leverage, expected future profits, and past
dividend pattern. The main differences reported between the two groups are related to growth, free cash flow and the state
of the economy. First, the negative relationship between growth and dividend policy is confirmed only in MENA common
law countries. In MENA civil law counties, even if the coefficient of growth was negative, it was never significant. This finding
endorses the prior conclusion of La Porta et al. (2000a) and Mitton (2004) who argue that the negative relationship between
2
The study follows La Porta et al. (2008) who classify Morocco, Tunisia, Egypt, Jordan, Qatar, Kuwait, United Arab Emirates, and Oman as civil law
countries while Bahrain and Saudi Arabia as common law countries.
Table 7
Panel regressions 2004–2013. Dependent variable: dividend to sales ratio.
Div to Sales Coef. Std. Err. T P > |t| Level of significance
Size .09 .05 1.87 0.06 *

Leverage −.34 .18 −1.96 0.04 **
Growth −.11 .06 −1.83 0.07 *
CurrentProfit .01 .00 2.12 0.03 **
FutureProfit .00 .01 0.39 0.69
Liquidity .01 .00 −2.61 0.00 ***
FCF −.01 .01 −1.87 0.06 *
MarketReturn −.15 .08 −1.73 0.08 *
Constant −.94 .60 −1.56 0.11
Number of obs 2149
Prob > F 0.00
Adj R-squared .63
dividend payments and growth opportunities is valid only in countries with strong legal protection for shareholders. Mitton
(2004) reports that when investor protection is poor, shareholders fear expropriation and seek to extract whatever value
they can, regardless of the firm’s growth opportunities. More recently, Denis and Osobov (2008)3 support this finding. The
result suggests that shareholders may prefer and coerce management to disgorge dividends without any regard to the firm’s
growth prospects when they fear expropriation and doubt their ability to share firms’ future profits. However, when they
feel more protected and their interests are secured, they are willing to accept the deferral of dividends for firms with better
growth opportunities.
Second, the relationship between free cash flow and dividend policy is significant in both groups but with opposite
signs. The relationship is negative in MENA civil law countries and positive in MENA common law countries. The result
in civil law countries suggests that agency problems of cash flow indicated by the negative relationship between divi-
dend policy and free cash flow are relevant only when managers’ incentives are high, information asymmetry is severe,
and investor protection is low. However, in common law countries, where country level governance mechanisms are
stronger, high free cash flow dictates high dividend payments. This finding is consistent with La Porta et al. (2000a) who
find that insiders pay higher dividends in common law countries where minority shareholders are better protected com-
pared to civil law countries. They contend that firms in common law countries disburse higher dividends because the law
and regulations make the opportunities to steal rare and because minority shareholders have enough power to extract
dividends.
Third, the relationship between the state of the economy and dividend policy is reported negative in MENA civil law
countries and positive in MENA common law countries. On the one hand, the weak investor protection at the country and
firm level in civil law countries increases the fear of investors, especially in economic downturns, which depresses stock
prices. At these times, disbursing high amount of cash could be an efficient tool to reassure investors. Further, when the
market is performing well, dividend payments go down. As discussed earlier, this could be due to the decrease in the signaling
power of dividend in good economic times, the need to maintain some reserve of earnings to be able to pay dividend during
economic downturns, or expropriation by management while investors are delighted by the market performance. On the
other hand, in common law countries characterized by solid governance mechanisms and adequate information disclosure,
management do not need to reassure investors against expropriation; hence, the amount of dividend paid depends on the
existing economic conditions. This analysis shows the robustness of the prior results and reflects the importance of country
specific factors as well as macro-economic conditions in setting dividend policy.
8.2. Dividends to sales ratio as a proxy for dividend policy
Dividend to sales ratio (Div to Sales) is used as a proxy for dividend policy to test the robustness of the previous results.
It is defined as total cash dividend divided by total sales revenues of the period. Dividends to sales ratio can be more
robust than dividend payout ratio for several reasons. La Porta et al. (2000a) note that because sales are less dependent
on accounting conventions, they are less subject to manipulation or smoothing through accounting practices, compared
to earnings. Further, compared to dividend payout ratio, dividend to sales ratio is less affected by macroeconomic shocks.
Baker et al. (2011) argue that if corporate earnings drop dramatically in an emerging market because of an economic down-
turn and if firms do not cut their dividends significantly, then large swings should be expected in many firms’ payout
ratios. Dividends to sales ratio is more resistant to these shocks while maintaining a good description of dividend poli-
cies. Eq. (1) is re-estimated using the new proxy for dividend policy. Based on the Hausman test, the fixed effects model
was selected over the random effects. The results are reported in Table 7. They are consistent with the previous results
3
Denis and Osobov (2008) examined dividend policies of firms from the France, Japan, United States, Canada, United Kingdom, and Germany between
1989 and 2002.
in terms of significance and correlation with dividend policy, which implies that the prior results are robust for a change
in the proxy.
9. Summary and conclusion
This paper attempts to identify the main determinants of dividend policy in MENA emerging markets during the period
between 2004 and 2013. The analysis reveals that size, current profits, and liquidity show a significant positive association
with dividend payments. Leverage, growth, free cash flow, and the state of the economy are significantly negatively related
to dividend policy. Whereas, expected level of future profits and pattern of past dividend have no significant influence on a
firm’s dividend policy. The negative relationship with free cash flow raises “a red flag” about serious agency problems and
shareholders’ expropriation within these firms. The negative relationship between the state of the economy and dividend
policy could be explained by the weakness of governance mechanisms, at both country and firm level, and the severity of
information asymmetry in MENA markets. Management appears to increase dividend payout during economic slumps in
an attempt to reassure investors fearing insiders’ expropriation. The results of the robustness tests indicate that growth is
negatively related to dividend policy only in MENA common law countries, where investors are confident about their ability
to share firm’s future profits. In MENA civil law countries, investors tend to pressure the firm to pay dividends regardless of the
growth opportunities available. In the same line, the negative relationship between free cash flow and dividend policy holds
only in MENA civil law countries. The weak investor protection and low transparency appear to encourage management
expropriation of shareholders wealth. Such an environment increases the fear of investors and impels management to
distribute high dividends in poor economic times to calm investors and restore their confidence. The need to send such
signals is not relevant when country governance mechanisms and investor protection are strong. These results verify the
importance of country specific factors and macro-economic fluctuations in setting dividend policy. The results are, also,
robust to changes in the proxy of dividend policy.
The results of this study have practical implications for analysts, investors, and regulators. Identifying the main deter-
minants of dividend policy and perceiving their interaction in different investing environments and economic conditions
improve analysts and investors’ understanding of dividend policy. The results can help analysts and investors build up their
dividends forecasts and select the right valuation models. Better valuation of firms enhances investors’ confidence, improves
market activity, and advances economic growth (Baker and Jabbouri, 2016). The conviction that corporate governance is
fundamental to develop financial markets and achieve economic take-off makes the results of the study highly relevant
for policy makers. The study reports evidence of agency problems in MENA markets, which could persuade regulators
to instigate new and foster existing governance mechanisms to address this prominent issue. The results should encour-
age policy makers, board of directors, analysts, institutional investors as well as other investors to scrutinize corporate
governance issues through active monitoring to restore the integrity of the financial markets and attract local and interna-
tional investors.
The focus of this study are firm fundamentals, improvement can be realized in future research by including some firm
non fundamental characteristics or market characteristics that influence dividend policy such as the quality of corporate
governance, ownership structure, or incentive compensation plans. Several studies report the significant impact of ownership
structure (Farooq and Jabbouri, 2015; Short et al., 2002) and executive compensations plans (Alves et al., 2015) on firm
performance and dividend payments. Most of these variables were not included in this study because of its unavailability in
MENA emerging countries.
Appendix A. Variables’ definition
See Table A1.
Table A1
Variables’ definition and a representative sample of their use in the literature.
Variable Definition Representative Studies of its uses in Source

the literature
Dividend policy (Payout Ratio) The ratio of total dividends to Chen and Dhiensiri (2009), Chen and Worldscope
operating profits (profits before Steiner (1999)
interests and taxes)
Dividend policy (Div to Sales) Total dividends divided by total sales La Porta et al. (2000a), Mitton (2004) Datastream
Size of the firm (Size) The natural logarithm of the total Eddy and Seifert (1988), Redding Datastream
assets. (1997)
Financial Leverage (Leverage) The total book value of debt divided by Al-Malkawi (2007), Jensen et al. (1992) Worldscope
the total value of assets.
Asstes growth (Growth) The ratio of change in the firm’s assets Rozeff (1982), Lloyd et al. (1985), Worldscope
between two consecutive years Jensen et al. (1992), Alli et al. (1993),
Moh’d et al. (1995), Manos (2003),
Travlos et al. (2002)
Table A1 (Continued)
Variable Definition Representative Studies of its uses in Source

the literature
Liquidity (Liquidity) (Current Assets - Papadopoulos and Charalambidis Datastream

Inventories)/Short-term Liabilities (2007)
Free Cash Flow (FCF) (Net income + interests expenses Holder et al. (1998) Worldscope
+depreciation + amortization–capital
expenditure)/Book value of assets
Past dividens (PastDividend) The arithmetic average of the payout Daniel et al. (2008) and Norashikin Worldscope
ratio of the last three years et al. (2013)
Current Profit (Current Profit) Return on Equity (ROE) = Net profits Aivazian et al. (2003) Datastream
divided by shareholders equity
Expected Future Profits (EPS) A measure of Company profitability Aivazian et al. (2003) Datastream
that shows the result of potential
dilution on the computation of
earnings per share amounts.
State of the economy The yearly return on the main index of Farooq et al. (2012), Rajan and Zingales Datastream
(MarketReturn) the market in which the firm is listed. (1998), Salminen and Martikainen
(2008)
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Research in International Business and Finance 37 (2016) 283–298

Contents lists available at ScienceDirect

Research in International Business

Determinants of corporate dividend policy in emerging

E-mail address: I.jabbouri@aui.ma

2. Motivation and background

4.1. Firm size

4.2. Financial leverage

4.3. Growth opportunities

4.5. Past dividends

H6. There is a relationship between current and past dividend payouts.

4.7. Free cash ﬂow

4.8. State of the economy

5.2. Data and variable construction

5.2.1. Dependent variable

5.2.2. Independent variables

5.3. Descriptive statistics

Year Mean Median Standard deviation

2004 29.47 17.28 23.08

Country Mean Median Standard deviation

Bahrain 44.45 47.19 23.87

Industry Mean Median Standard Deviation

Oil and gas 29.08 18.33 19.49

Payout Ratio 1.00

Payout ratio Coef. Std. Err. T P > |t| Level of signiﬁcance

Size 6.59 2.09 3.14 0.00 ***

+ ˇ7 Liquidityit + ˇ8 FCFit + ˇ9 MarketReturnit + it (1)

7. Discussion of the results

Payout ratio Coef. Std. Err. T P > |t| Level of signiﬁcance

Size 6.18 2.53 2.44 0.00 ***

Payout ratio Coef. Std. Err. T P > |t| Level of signiﬁcance

Size 3.89 .85 4.56 0.00 ***

Div to Sales Coef. Std. Err. T P > |t| Level of signiﬁcance

Size .09 .05 1.87 0.06 *

8.2. Dividends to sales ratio as a proxy for dividend policy

9. Summary and conclusion

Appendix A. Variables’ deﬁnition

See Table A1.

Variable Deﬁnition Representative Studies of its uses in Source

Variable Deﬁnition Representative Studies of its uses in Source

Liquidity (Liquidity) (Current Assets - Papadopoulos and Charalambidis Datastream

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