Dividend Payout Behaviour Of Firms In Pakistan

Published Date: 02 Nov 2017

The research aims to reveal the insight dynamics for determination of Dividend Payout with reference to Non Financial Firms listed in KSE. In light of prior studies, key explanatory variables were identified including macro economics variables to disclose their relationship and effect on determination of Dividend Payout. These variables are Profitability, Volatility, Permanent Earnings, Size, Liquidity, Efficiency, Investment Opportunities, Leverage, Real GDP Growth Rate and Real Interest Rate. Through observation, 319 such companies were identified for the above mentioned variables for 12 years (1999-2010). Hence, two complete business cycles have been encompassed in the study under reader’s view.

Binary Probit model is used for regression analysis, where a firm pays dividend=1 and firm that do not pay dividend=0. Results revealed that all the each explanatory variable have a significant relationship with dividend payout policy except for Financial Leverage (GR).

Table of Contents

Introduction

The most important part of a work is its beginning (PLATO). Dividend policy has been an issue of interest in financial literature since Joint Stock Companies came into existence. Brealey and Myers (2005) described dividend policy as one of the top ten most difficult unsolved problems in financial economics. This description is consistent with Black (1976) who stated that "The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that don’t fit together".

Good governance is vital for the development of a healthy and competitive corporate sector. A strong corporate sector boosts "sustained" and "shared" economic growth, i.e. growth that can withstand economic shocks and benefit all stake holders. Countries can, therefore, benefit immensely from corporate governance framework as a tool to address factors leading to sagging economic activity. The most important decision, at corporate level, which emanates from corporate governance mechanism, is the dividend policy. Dividend policy involves decision to pay out earnings or to retain them for reinvestment. The major aspect of the dividend policy of a firm is its dividend payout ratio, that is, the percentage share of the net earnings distributed to the shareholders as dividends.

The payment of dividends results in the reduction of cash and therefore, depletion in total assets. In order to maintain the asset level, as well as to finance investment opportunities the firm must obtain funds from the issue of additional equity or debt. If the firm is unable to raise external funds its growth would be affected. Thus dividends imply outflow of cash and lower future growth. In other words the dividend policy of the firm affects both the shareholders wealth and the overall growth of the firm.

The optimum dividend policy should strike the balance between current dividends and future prospects of the firm which maximizes the price of the share price. The d/p ratio of a firm should be determined with reference to two basic objectives – maximizing the wealth of the firm’s owners and providing sufficient funds to finance growth. These objectives are not mutually exclusive, but interrelated.

Shareholders wealth is represented in the market price of the company’s common stock, which, in turn, is the function of the company’s investment, financing and dividend decisions. Among the most crucial decisions to be taken for efficient performance and attainment of objectives in any organization are the decisions relating to dividend. Dividend decisions are recognized as centrally important because of increasingly significant role of the finances in the firm’s overall growth strategy. In developed countries the decisions between paying dividend and retaining earnings has been taken seriously by both investors and management- Dividend policy provides a signaling mechanism of the future prospects of the corporate and therefore affects its market value.

The investors have different relative risk perceptions of dividend income and capital gains and are not indifferent between receiving dividend income and capital gains. Management should be responsive to the shareholders preferences regarding dividend and the share buyback programme should not replace the dividend payments of the corporate. The firm should seek a stable dividend policy which avoids occasional reductions in dividends.

The factors determining the dividend policy of a firm can be classified into following considerations:

(a) D/p ratio

(b) Stability of dividends

(c) Contractual and internal constraints and restrictions

(d) Owner’s considerations

(e) Capital market considerations and inflation.

The integral part of dividend policy of a firm is the use of bonus shares and stock splits both involve issuing new shares on a pro rata basis to the current shareholders. Corporate dividend decision is among the important financial decisions for the management. Dividend payout is not only the source cash flow to shareholder but it also provides information regarding firm’s current and future performance. There are no obligations to payout dividends on common stock. How much to pay is still an open issue.

Dividend policy contributes not only at the micro level but also to the analysis of several macroeconomic issues, as cash dividends constitute a part of national income and any variation in corporate dividend payouts may affect the corporate propensity to save and reinvest. Therefore, corporate payout policy is of great importance not only for the corporation itself but also for the economy as a whole.

As Identified by IFC in 1991, the equity Market of Pakistan is one of the twenty promising markets of Pakistan. During the period of 2002-2004 it has been regarded as the best performing emerging market (The International Magazine Business Week). There is an increasing interest in analyzing the dividend behavior of the firms after the introduction of Code of Corporate Governance by SECP in 2002 in Pakistan but many issues in this area are uncovered. In particular, the factors involve for determination of dividend policies in Pakistan, which is central issue of this area needs in depth research. It is in this perspective this study aims to make contribution in the literature on dividend policy.

Literature Review

Dividend policy has been the subject of considerable debate since Miller and Modigliani (1961) illustrated that under certain assumptions, dividends were irrelevant and had no influence on a firm’s share price. Miller and Modigliani (1961) suggest that in perfect markets, dividend do not affect firms’ value. Shareholders are not concerned to receiving their cash flows as dividend or in shape of capital gain, as far as firms don’t change the investment policies. In this type of situation firm’s dividend payout ratio affect their residual free cash flows and the result is when the free cash flow is positive firms decide to pay dividend and if negative firm’s decide to issue shares. They also conclude that change in dividend may be conveying the information to the market about firm’s future earnings. Since then, financial researchers and practitioners have disagreed with Miller and Modigliani’s proposition and have argued that they based their proposition on perfect capital market assumptions, assumptions that do not exist in the real world. Those in conflict with Miller and Modigliani’s ideas introduced competing theories and hypotheses to provide empirical evidence to illustrate that when the capital market is imperfect, dividends do matter. For instance, the bird in the hand theory (predating Miller and Modigliani’s paper) explains that investors prefer dividends (certain) to retained earnings (less certain): therefore, firms should set a large dividend payout ratio to maximize firm share price (Gordon, 1956; Lintner, 1956; Fisher, 1961; Walter, 1963; Brigham and Gordon, 1968). Gordon and Walter (1963) present the bird in the hand theory which says that investors always prefer cash in hand rather than a future promise of capital gain due to minimizing risk

In the early 1970s and 1980s, several studies introduced tax preference theory (Brennan, 1970; Elton and Gruber, 1970; Litzenberger and Ramaswamy, 1979; Litzenberger and Ramaswamy, ; Kalay, 1982; John and Williams, 1985; Poterba and Summers, 1984; Miller and Rock, 1985; Ambarish et al., 1987). This theory suggests that dividends are subject to a higher tax cut than capital gains. This theory further argues that dividends are taxed directly, while capital gains tax is not realized until a stock is sold. Therefore, for tax-related reasons, investors prefer the retention of a firm’s profit over the distribution of cash dividends. The advantage of capital gains treatment, however, may lead investors to favour a low dividend payout, as opposed to a high payout. The agency theory of Jensen and Meckling (1976) is based on the conflict between managers and shareholder and the percentage of equity controlled by insider ownership should influence the dividend policy. Miller and Scholes (1978) find that the effect of tax preferences on clientele and conclude different tax rates on dividends and capital gain lead to different clientele. In the early 1980s, signalling theory was analyzed. It revealed that information asymmetry between managers and outside shareholders allows managers to use dividends as a tool to signal private information about a firm’s performance to outsiders (Aharony and Swary, 1980; Asquith and Mullins, 1986; Kalay and Loewenstein, 1985; Healy and Palepu, 1988). The explanation regarding the signalling theory given by Bhattacharya (1980) and John Williams (1985) dividends allay information asymmetric between managers and shareholders by delivering inside information of firm future prospects. Easterbrook (1984) gives further explanation regarding agency cost problem and says that there are two forms of agency costs; one is the cost monitoring and other is cost of risk aversion on the part of directors or managers.

Another explanation for dividend policy is based on the transaction cost and residual theory. This theory indicates that firms incurring large transaction costs will be required to reduce dividend payouts to avoid the costs of external financing (Mueller, 1967; Higgins, 1972; Crutchley and Hansen, 1989; Alli et al., 1993; Holder et al., 1998). A different explanation, which received little consideration prior to the 1980s, relates dividend policy to the effect of agency costs (La Porta et al., 2000). Agency costs, in this case, are costs incurred in monitoring company management to prevent inappropriate behaviour. Large dividend payouts reduce internal cash flows, forcing managers to seek external financing, and thereby, making them liable to capital suppliers, thus, reducing agency costs (Rozeff, 1982; Easterbrook, 1984; Lloyd, 1985; Crutchley and Hansen, 1989; Dempsey and Laber, 1992; Alli et al., 1993; Moh’d et al., 1995; Glen et al., 1995; Holder et al., 1998; Saxena, 1999).

Life Cycle Theory explanation given by the Lease et al. (2000) and Fama and French (2001) is that the firms should follow a life cycle and reflect management’s assessment of the importance of market imperfection and factors including taxes to equity holders, agency cost asymmetric information, floating cost and transaction costs Catering theory given by Baker and Wurgler (2004) suggest that the managers in order to give incentives to the investor according to their needs and wants and in this way cater the investors by paying smooth dividends when the investors put stock price premium on payers and by not paying when investors prefer non payers.

Review Of Articles

THE DETERMINANTS OF CORPORATE DIVIDEND POLICIES IN PAKISTAN: AN EMPIRICAL ANALYSIS by ANEEL KANWER ( 2002)

The paper attempts to identify factors which KSE listed firms face while considering dividend payout decisions. Data used 1992-98 for some 300 companies

The research was encountered with selection bias problem. There are two kinds of selection bias;(1) in the standard case selection bias, information on the dependent variable for part of the respondents is missing (2) in the other version of the selection bias problem, information on the dependent variable is available for all respondents, but the distribution of respondents over the categories of the independent variable we are interested in has taken place in a selective way. Here we observe standard case selection bias. The Sample contained over 70% of observations where firms do not pay dividends and to overcome this Heckman Two Step procedure has been used.

DPS = F (SIZE, SURPLUS, M/BRATIO, EBIT_INC_DEC, )

Larger companies might be expected to have higher dividend yields as compared to smaller companies. The surplus variable is expected to influence the dividend declaration negatively. We expect company’s dividend choices to be determined in large part by the extent of their investment opportunities. The greater those opportunities (relative to the size of the firm), the lower should company’s dividend yield. According to the signaling theory, high quality companies will make higher dividend payments than low quality firms. One major challenge in testing this signaling argument is coming up with a reliable proxy for quality that can be readily observed.

The determinants of dividend policy in Pakistan by Hafeez ahmed and Attiya javid(2009)

The aim of the study is to examine the determinants of dividend payout policy e.g firm specific factors and agency cost explanations of dividend smoothing of 320 non-financial listed firms in KSE during period of 2001-2006.

The authors attempts to find the answer of the following questions:

Do the firms listed in Karachi Stock Exchange follow the stable dividend payout policies?

Does the dividend yield differ?

What are the main factors that determine the dividend payout policies in listed firms of Karachi stock exchange?

For the analysis they used dividend model of LINTNER (1956) and its extended versions. Where: Dividend Yield = Æ’ (NE, MBV, MSH, MV, TURN, SLACK, SIZE, SG, LEVERAGE,)

Financial Characteristics

Explanatory Variables

Profitability

Net Earnings and earnings per share after tax

Signals

MBV and Growth in terms of sales

Ownership

MSH no of majority shareholding more than 5% of stocks

Leverage

LEV=Total debt/current year value of equity

Size

MC market capitalization Size in term

Market Liquidity

TURN= annual value of Stock traded/stock market capitalization

Investment Opportunities

SLACK= accumulated retained earnings/total assets

They have used the dividend yield as dependent variable instead of payout ratio because the full sample contains the firms with negative earnings. The dividend yield has been calculated as dividend per share divided by price per share.

The results of the research paper supports that the non financial firms rely on both past and current EPS to set their dividend payments. And most importantly the paper explains why the listed firms are not able to smooth their dividend and what are the main factors affecting or influencing the dividend policy decisions.

The answer to the first question is the target payout ratio is very low 25% to 38.50% with the sample of 224 dividend paying firms. Therefore low target payout ratio and high speed of adjustment clearly shows the trends towards the low smoothing and instability of dividend payout policies in Pakistan.

Why the dividend yield differs, is due to the firms having high profitability with stable earnings can afford larger free cash flows thus pay out larger dividends. The firms with larger investment opportunities can easily influence and play important role to determinant of dividend payout policies in Pakistan.

The ownership structure has the major impact to determine the dividend payout policy in Pakistan. The firms with the major inside share holdings pay more dividends to its shareholders in Pakistan which means the firms with high inside ownership or major inside shareholding pay dividend to reduce the cost associated with agency conflict.

The ownership identity also matters in this policy and inside ownership is positively associated with the growth of dividends.

Impact of financial leverage on dividend policy: Empirical evidence from Karachi Stock Exchange-listed companies By: Aasia Asif, Waqas Rasool and Yasir Kamal (2010)

This paper examines the relationship between dividend policy and financial leverage of 403 companies, listed with Karachi Stock Exchange during the period 2002 to 2008.

Importance of leverage: The leverage of the firm is an important determinant of its equity risk since preferred stocks have priority over common stock in the financial residual, in case of capital bankruptcy. The larger the debt in the firm's capital structure, the higher is the risk of default and the lower is the valuation of its equity.

Using a KSE panel data set, this paper examines the impact of the debt ratio on the dividend per share of the major KSE listed firms during the period 2002 to 2008 to provide an empirical support to the hypothesized relationship between dividend policy and financial leverage with a distinction between the positive or negative changes in the earnings of the firm between time t and time t-1.

Research hypotheses

H1 = DR (Leverage) has no impact on DPS (dividend per share)

H2 = DY has no impact on DPS (dividend per share)

H3 = ∆E has no impact on DPS (dividend per share)

The regression results suggest through random effects model that there is a significant impact of leverage and Dividend yield on DPS but the leverage association is negative with DPS while Change in earnings may impact dividend policy under certain circumstances.

Debt Ratio (leverage) and dividend yield are found to be the most influential variables affecting the dividend payout policy of the corporate sector of Pakistan but the coefficient and relationship of DR with Dividend policy is negative which means that firms are facing the over debt management problem. There should be strategies to improve the company’s debt management system to minimize the risk. It is also found that firms are not setting target capital structure which they have to follow to avoid risk of default. Dividends are treated as the rewards to the stockholders for the assumption of the risks, distribution of surplus earning or, sometimes, capital stock, paid out to the stock holders. It is not liked, rather illegal in some laws, to pay the dividends out of the invested capital stock or excess received over stock par value.

Institutional shareholdings and corporate dividend policy in Pakistan By: Talat Afza and Hammad Hassan Mirza (2011)

The paper investigates the impact of institutional ownership and growth opportunities on dividend policy based on the sample of 120 Listed Companies of Karachi Stock Exchange (KSE), Pakistan, during 2002 to 2007. The estimated results, using OLS and Tobit regression models, suggest that dividend payouts are positively affected by growth opportunities, proportion of shares held by insurance companies and profitability and negatively affected by leverage.

Variable Explaination:

Dependent Variable

DPO

Dividend Payout

Dividend per share/Earning per share

DININT

Dividend Intensity

Total cash dividend/total assets

Independent Variable

INSUR

Insurance companies ownership

Proportion of shares held by insurance companies

MOD

Modarbah Ownership

Proportion of shares held by modarbah companies

NIT

National investment trust ownership

Proportion of ownership held by NIT

INST*

Misc. Institutional Ownership

Proportion of ownership held by Misc Institutions

GROW

Growth opportunities

Market value per share/Book value per share

SZ

Size

Log of Assets

LVRG

Leverage

Total liabilities/Total Assets

PRFT

Profitability

Net Profit after tax/no of shares outstanding

Model 1 estimates the impact of ownership by Insurance companies, growth opportunities and three control variables i.e. size, leverage and profitability on dividend payout.

Model 2 estimates the impact of Modarbah ownership on dividend leverage and profitability payouts while controlling for corporate size.

Similarly, in equations 3 and 4 the ownership by NIT and miscellaneous institutions respectively, are used as independent variables. Finally in model 5 the joint impact of all institutional ownerships has been estimated. To check the robustness of results models 1 to 5 are re-estimated using alternative proxy of dividend policy i.e. Dividend intensity.

The purpose of the study is to investigate the reasons behind decreasing corporate dividends in Pakistan. It is evident from the results that insurance companies prefer cash dividend, therefore, the companies in which insurance companies hold large number of shares are more likely to pay higher dividends. Most of the companies in Pakistan are small in size and they don’t have easy access to credit market, therefore, rely heavily on equity capital for financing their investment and growth opportunities and reducing dividend during growth phase can negatively affect the share value of the companies. Profitability, however, affects the payout positively in Pakistan which is in line with the existing literature on dividend policy. It shows that more profitable companies are more likely to pay high dividends. The study also emphasized the use of Tobit model instead of OLS regression in case where

dependent variable is restricted either to an upper or lower limit.

IMPACT OF OWNERSHIP STURCTURE ON DIVIDEND POLICY OF FIRM By: Dr. Syed Zulfiqar Ali Shah, Wasim Ullah, Baqir Hasnain.(2011)

This study has been conducted to find out the impact of ownership structure on dividend payout behavior of firms. Data has been analyzed for the period of 2002 to 2006. We have used panel data of Pakistani firms listed at Karachi stock exchange to explain the relationship. Common Effect Model has been applied as a research tool and the results have shown a positive relationship between ownership structures and dividend policy.

Following represents the model:

DPO=

F (O.S + Size + Leverage)

OS

Ownership Structure

Size

Size

ROE

Return On Equity

It shows that ownership structure has significant positive effect on dividend policy of the firm. Which means the companies where more owners are present on the board pays more dividends as far as Pakistani corporate culture is concerned. Or we may infer that the companies where more owners are sitting in the Board, they tend to take care for the dividends. This relationship is significant at 95% confidence level as t value is more than 1.96. So we may conclude that ownership structure has positive effect on the firm’s dividend policy. The size of firm, chosen as a control variable, has shown positive effect on dividend payout but is not statistically significant. Another control variable, ROE has been found negatively related with dividend payout but this also being statistically insignificant. Leverage has also been found having negative relationship with dividend payout but is insignificant.

The results show that there is a positive and significant relationship of ownership structure with dividend payout. This means that the companies where shareholders are sitting in the board they try to influence their power in the decision making regarding dividend policy. This reduces the agency conflict and develops the trust of the outsiders and shareholder on the company. The results are supported by (Shleifer and Vishny, 1986) and Gugler and Yurtoglu (2003). The size of the firm is found statistically insignificant but has positive relationship.

Dataset, Variables and Methodology

Data Sample:

For the empirical analysis the sample of 319 non financial listed firms in the Karachi Stock Exchange (KSE) are selected. The data is collected from Securities Exchange Commission of Pakistan, State Bank of Pakistan and the Karachi Stock Exchange (Balance Sheet Analysis of Joint Stock Companies Listed on the Karachi Stock Exchange).

The variables of the study are calculated from the Audited Annual Accounts of 319 firms for the period of 1999 to 2010 which is about 3828 observations for each variable and it is a long period enough to smooth out variable fluctuations (Rozeff, 1982).The data is totally transparent in context of authenticity. Softwares of Eviews and Microsoft Excel 2007 were used for data analysis.

Variables Explaination:

Probit Model for Regression analysis is used and the dependent variable is Dividend Payout policy for which the following codes were used:

1 = the company has a policy to pay dividend;

0 = the company has a policy not to pay dividends

Whereas in light of literature review the explanatory variables identified are Profitability, Variation in Profitability, Permanent Earnings, Size, Liquidity, Efficiency, Investment Opportunities and Financial Leverage while the macro-economic variables like Real GDP Growth rate and Real Interest Rate are also added to the model in order to check whether they affect the decision making of company’s Dividend payout policies. The table next shows the independent variables and the expected signs.

Sr.no

Financial Characteristics

Symbol

Variable Explanation

Expected Sign

1

Profitability

ROA

Net Income as % of Total Assets

+

2

Volatility

RROA

Variation in Profitability

-

3

Permanent Earnings

PROA

ROA-RROA

+

4

Size

LOG(TA)

Natural logarithm of Total Assets

+

5

Liquidity

CR

Current Assets as % of Current Liabilities

+

6

Efficiency

ATR

Gross Sales as % of Total Assets

+

7

Investment Opportunities

INV

Retention In Business as % of Total Assets

-

8

Leverage

GR

Total Fixed Liabilities as % of Total Capital Employed

-

9

GDP Growth Rate

GDP

Gross Domestic Product Growth Rate

-

10

Real Interest Rate

RIR

Weighted Average Rates of Return on Advances -Inflation Rate

+

Hypothesis 1

Dividend Payout is positively associated with Profitability (ROA).

The return on assets has been added in the study as independent variable and defines as net income divided by total assets. The characteristics of return on assets are as profitability of the firm. According to the Belanes et al (2007) return on asset is positively related to the dividend yield of the Tunisian firms. The financial literature documents that a firm’s profitability is a significant and explanatory variable of dividend policy (Jensen et al., 1992; Han et al., 1999; Fama and French, 2000). However, there is a significant difference between dividend policies in developed and developing countries. This difference has been reported by Glen et al. (1995), showing that dividend payout rates in developing countries are approximately two-thirds of those in developed countries. Moreover, emerging market corporations do not follow a stable dividend policy; dividend payment for a given year is based on firm profitability for the same year.

ROE has been used in several studies as a proxy for firm profitability (Aivazian et al., 2003, ap Gwilym et al., 2004.) Profits have long been regarded as the primary indicator of a firm’s capacity to pay dividends. Pruitt and Gitman (1991), in their study report that, current and past years’ profits are important factors in influencing dividend payments. Al Kuwari (2009) too found a significantly positive relationship between the two.

Hypothesis 2

Dividend Payout is negatively associated with Volatility (RROA).

Variation in the profitability has a negative impact on dividend payout policy. As there is uncertainty about profit making thus firms do not declare dividends.

Hypothesis 3

Dividend Payout is positively associated with Permanent Earnings (PROA).

The value of this variable is calculated by subtracting Profitability from Volatility or (ROA-RROA). When we exclude the risk factor from actual thing it shows us the true side of the picture. Likewise in the variable volatility is excluded from actual values of profitability. Thus PROA is positively related to dependent variable.

Hypothesis 4

Dividend Payout is positively associated with firm SIZE LOG(TA).

Size variable is defined as natural logarithm of Total assets of a firm. Eriotis (2005) reports that the Greek firms distribute dividend each year according to their target payout ratio, which is determined by distributed earnings and size of these firms. Research by Lloyd, Jahera, and Page (1985), and Vogt (1994) indicates that firm size plays a role in explaining the dividend-payout ratio of firms. They find that larger firms tend to be more mature and thus have easier access to the capital markets, which reduces their dependence on internally generated funding and allows for higher dividend-payout ratios. The hypothesized relationship between firm size and dividend-payout ratios is positive. Firm size (SIZE) is measured as a natural logarithm of total assets. This is due to the fact that large firms will pay large dividends to reduce agency costs (Ghosh and Woolridge, 1988; Eddy and Seifert, 1988; Redding, 1997).

Eddy and Seifert (1988), Jensen et al. (1992), Redding (1997), and Fama and French (2000) indicated that large firms distribute a higher amount of their net profits as cash dividends, than do small firms. Several studies have tested the impact of firm size on the dividend-agency relationship. Lloyd et al. (1985) were among the first to modify Rozeff's model by adding "firm size" as an additional variable. They considered it an important explanatory variable, as large companies are more likely to increase their dividend payouts to decrease agency costs. Their findings support Jensen and Meckling’s (1976) argument, that agency costs are associated with firm size. Holder et al. (1998) revealed that larger firms have better access to capital markets and find it easier to raise funds at lower costs, allowing them to pay higher dividends to shareholders. This demonstrates a positive association between dividend payouts and firm size.The positive relationship between dividend payout policy and firm size is also supported by a growing number of other studies (, Eddy and Seifert, 1988; Jensen et al., 1992; Redding, 1997; Holder et al., 1998; Fama and French, 2000; Manos, 2002; Mollah 2002; Travlos et al., 2002; Al-Malkawi, 2007).

Hypothesis 5

Dividend Payout is positively associated with firm Liquidity CR.

The formula for Current ratio is as follows: (Current Assets/Current Liabilities)*100. If a firm is highly liquid this means firm’s currents assets can easily meet its current liability and in conclusion those firms with higher ratios can announce dividends because current assets can easily cover short term liabilities, thus no profits are not used for short term debt payment and vice versa. Thus, the relationship between the firm’s liquidity and dividend payout is positive. The evidence supported by the findings of Reddy (2006), Amidu and Abor (2006) and deviate from the Belans et al (2007).

Hypothesis 6

Dividend Payout is positively associated with firm Efficiency ATR.

To calculate ATR Asset turnover ratio following formula is used: (Gross Sales/Total Assets)*100. The term highly efficient firm implies that Gross Sales as a % of total assets of a firm are very high. Thus in this framework if firm have good figure of gross sales given the total assets then it leaves a good impression that firm is performing well and is relatively efficient and vice verse. In theoretical context efficient firm are more likely to payout dividends therefore the ATR is positively related to payment of dividends.

Hypothesis 7

Dividend Payout is negatively associated with firm Investment Opportunities INV.

The firms with larger investment opportunities can easily influence and play important role to determinant of dividend payout policies in Pakistan. Greater the investment opportunities of the firm the greater will be probability that firm will not distribute their profits amongst shareholders; they will retain their earning for growth purposes. The slack (INV) is the very important factor for the making of decision regarding dividend policy and it captures the investment opportunities available to firms.

It is calculated as the accumulated retained earnings divided by total assets of the firm. According to the theory the presences of slack reduce the external financing requirements and become the important factor to solve the problem of the under investment. According to the Myers and Majluf (1984) and John and William (1985), it reduced the signaling need of the firms and incentives to smooth the dividend behavior. Thus INV is negatively related to dividend policy. Higgins (1972) shows that payout ratio is negatively related to a firm’s need for funds to finance growth opportunities. Higgins (1981) indicates a direct link between growth and financing needs: rapidly growing firms have external financing needs because working capital needs normally exceed the incremental cash flows from new sales. Overall literature portrays a negative as well as a positive relationship between the dependent variable and Investment opportunities.

Hypothesis 8

Dividend Payout is negatively associated with Leverage GR.

The formula for Gearing ratio is as follows: (Total Fixed Liabilities/Total Capital Employed)*100. A growing number of studies have found that the level of financial leverage negatively affects dividend policy (Jensen et al., 1992; Agrawal and Jayaraman, 1994; Crutchley and Hansen, 1989; Faccio et al., 2001; Gugler and Yurtoglu, 2003; Al-Malkawi, 2005). Their studies inferred that highly levered firms look forward to maintaining their internal cash flow to fulfil duties, instead of distributing available cash to shareholders and protect their creditors.

However, Mollah et al. (2001) examined an emerging market and found a direct relationship between financial leverage and debt-burden level that increases transaction costs. Thus, firms with high leverage ratios have high transaction costs, and are in a weak position to pay higher dividends to avoid the cost of external financing. To analyze the extent to which debt can affect dividend payouts, this study employed the financial leverage ratio, or ratio of liabilities (total short-term and longterm debt) to total shareholders’ equity. Al Kuwari (2009) too found a significantly negative relationship between the two. The proxy used for financial leverage is Debt to Equity Ratio as used in all these studies.

Hypothesis 9

Dividend Payout is negatively associated with Real GDP Growth Rate GDP.

The real economic growth rate builds onto the economic growth rate by taking into account the effect that inflation has on the economy. According to a recent study by Dr. Amjad Waheed, CFA "Impact of Economic Growth and Corporate Earnings on the Stock Market" in July 2011 concludes that 11 percent of the variation in corporate earnings is explained by the real economic growth rate. This means that 89% of the variation in corporate earnings is related to factors other than economic growth. In the research paper he also states that "Earnings have grown at around 19% over the last three years despite downturns in real GDP growth rate."

Some other studies suggest that firm activities (such as financing, investing, operations, and dividend policy) adjust with economic fluctuation (Dhalla 1980, Greer 1984, Zarnowitz 1985,Mascarenhas and Aaker 1989). If economy is in good shape then its effect will be reflected in the stock market and companies progress as well and for the companies to grow and expand during growth phases it is necessary to retain profits for further investments and growth purpose. During economic downturns firms try to follow stable dividend policy considering the fact if they don’t pay dividend in bad economic years then as a result the investor or shareholder will lose confidence, thus withdraw their invested amount which will further slow down the growth and activity of the firm and the economy overall.

Hypothesis 10

Dividend Payout is positively associated with Real Interest Rate RIR.

RIR= Weighted Average Rates of Return on Advances (%) - Inflation Rate (%)

Interest rate is one of the important macroeconomic variables, which is directly related to economic growth. Generally, interest rate is considered as the cost of capital, means the price paid for the use of money for a period of time. From the point of view of a borrower, interest rate is the cost of borrowing money (borrowing rate). From a lender’s point of view, interest rate is the fee charged for lending money (lending rate).

Good investors always look for investing in an efficient market. In an inefficient market few people are able to generate extra ordinary profit causes of confidence losses of general people about the market. In such cases, if the rate of interest paid by banks to depositors increases, people switch their capital from share market to bank. This will lead to decrease the demand of share and to decrease the price of share and vice versa. On the other side of the picture, when rate of interest paid by banks to depositors increases, the lending interest rate also increases lead to decrease the investments in the economy which is also another reason of decreasing share price and vice versa. Therefore, in this context there is a direct relationship of real interest rate and dividend payout policy. In order to maintain their equity and share prices level they should declare dividend when interest rate rises otherwise investor will withdraw their share of investment leading to decrease in share price and fall in equity section and vice versa.

Model Specification

Y (Dividend Policy) = (ROA, RROA, PROA, LOG(TA), CR, ATR, INV, GR, GDP, RIR)

Since dependent variable is in binary form, takes on values of zero and one. A simple linear regression of on is not appropriate, since among other things, the implied model of the conditional mean places inappropriate restrictions on the residuals of the model. Furthermore, the fitted value of from a simple linear regression is not restricted to lie between zero and one. Therefore Probit Model is used.

Functional form of model is following:

Where is a continuous, strictly increasing function that takes a real value and returns a value ranging from zero to one. This function assumes that the index specification is linear in the parameters so that it takes the form.

The choice of the function determines the type of binary model. It follows that:

Given such a specification, we can estimate the parameters of this model using the method of maximum likelihood. The likelihood function is given by:

The first order conditions for this likelihood are nonlinear so that obtaining parameter estimates requires an iterative solution.

Results

Dependent Variable: DIV

Method: ML - Binary Probit (Quadratic hill climbing)

Sample (adjusted): 2001 2010

Included observations: 3119 after adjustments

Convergence achieved after 5 iterations

Covariance matrix computed using second derivatives

Variable

Coefficient

Std. Error

z-Statistic

C

-3.364601

0.178992

-18.79746

ROA

0.034150

0.002680

12.74150

RROA(-1)

-0.028107

0.003783

-7.428740

PROA

0.090335

0.007948

11.36559

LOG(TA)

0.278637

0.019163

14.54003

CR

0.000903

0.000145

6.247724

ATR

0.375058

0.039284

9.547429

INV

-1.445872

0.229479

-6.300684

GR

-3.48E-06

0.000232

-0.015011

GDP

-0.032951

0.011552

-2.852276

RIR

0.045868

0.006218

7.376403

McFadden R-squared

0.285759

    Mean dependent var

S.D. dependent var

0.497959

    S.E. of regression

Akaike info criterion

0.991146

    Sum squared resid

Schwarz criterion

1.012466

    Log likelihood

Hannan-Quinn criter.

0.998800

    Restr. log likelihood

LR statistic

1228.022

    Avg. log likelihood

Prob(LR statistic)

0.000000

Obs with Dep=0

1703

     Total obs

Obs with Dep=1

1416

Discussion of Results

As per hypothesis the estimated signs of the coefficients are in accordance with the expected signs as discussed earlier in the section of variable explanation. The value of the R² is 28.5% which is good considering that the analysis is based on the panel data and the time period is short. The value of LR Statistics 1228.022 shows that overall the model is a good fit to the data.

All the independent variables have correct stipulated coefficient signs according to the literature Review. A 1% increase in ROA increases DIV by 0.034 percent, one percent increase in lagged RROA decrease DIV by 0.028 percent. One percent increase in PROA increases DIV by 0.090 percent. One percent increase in LOG (TA) raises DIV by 0.278 percent. While one percent increase in CR and ATR raises DIV by 0.0009 and 0.375 percent. The 7th coefficient states that 1% change in INV brings negative change of 1.44% whereas one percent change in GR decreases DIV by 3.48E-06. The second last coefficient of the model GDP also negatively affects the Div as expected by 0.0329 %. Lastly, a 1% change in RIR brings a positive change of 0.045% as the relation derived in literature is direct with dependant variable. All the variables are significant except for one variable of GR which is highly insignificant whereas the expected sign of the coefficient is as per expectations.

Conclusion

The ink of this thesis work draws the result that all the variables considered in it are plotted in the same line of expected signs, i-e either negative or positive. In total the 10 independent variables drive their dependent variable which is dividend policy of a company in the same way as depicted in the previous studies. The ROA had a positive expected sign with an absolute zero probability which means that the ROA is directly proportional to the dividend policy of a company and holds a major significance in its draft. Same is the case with other variables, but except one. The level of Leverage of a company, denoted by GR, is in paradox when it comes to its significance of impact on dividend policy of a company. It rests with the results of expected sign in the model which shows an inverse relation of GR with the dividend policy of a company, but when it comes to the significance it leaves a dark shadow of probability which is 0.9880. This shows that the relation of GR with the dividend policy if inversely proportional but its significance is really low. There may be companies who announces dividend besides having a high GR and vice versa. Over all the results of this thesis work is consistent with the results of those done before. The prior works done on the Dividend Policy of a Company and the variables that drive it stand align to this work. However, it is important to add that the prior works considered one business cycle with almost few companies, but this piece of work contains the data from 319 non-financial listed firms listed in Karachi Stock Exchange and expands over two business cycles (12 years). The independent variables considered in the work are all relevant especially in the case of Pakistan, where the high economic growth is a luxury to taste and companies respond to it in negative fashion when it comes to the dividend policy of a company. The reason behind this is the opportunity to expand the business rather than declaring the dividends and shareholders too are interested in the capital gains. Similarly high profitability of a company in Pakistan leaves a room for the declaration of dividend to her shareholders, this in a way to attract more shareholders and declare that the company is doing well even in normal circumstances.

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