Financial Managements And Investments

Published Date: 02 Nov 2017

Chapter 1

INTRODUCTION

Since joint stock companies came into existence, dividend policy is a topic that is frequently used by researchers in the field of Financial Managements and Investments in Corporate Finance. However, the issue dividend policy affects stock prices still remains controversial among managers, policy makers and researchers. Dividend policy is important for investors, managers, lenders and for other stakeholders. This is because investors consider dividends not only the source of income but also a way to assess company from investment point of view. Besides, it is also the way of assessing whether the company is cash generative or not. This study is focused on the effects of dividend policy measures on the stock prices volatility. The objective of this chapter is to provide the background and motivation for this study. The problem statement is defined; the objective of the study and the research design are discussed.

1.2 Background

Booth and Cleary (2010) has defined dividend Policy as an exclusive decision by the management to decide percentage of profit is distributed among the shareholders or percentage of it retains to fulfil its internal needs. The price volatility is derived from Parkinson (1980) extreme value estimation of the variability of return.

According to Wilcox (1984) and Rappoport (1986), many factors affect the share prices and are associated with the valuation of shares, for example, dividend yield, profitability of the firm, growth and assets of the firm. Analyzed linkage between accounting variablesand stock price risk and stated that dividend policy remains in a state of controversy (Allen & Rachim, 1996). In 1963, Gordon had analyzed the paying large dividends reduces risk and influence stock price. From the studies above, they show that significant relationship exists between stock price and accounting variables. A number of theoretical mechanisms have been recommended that cause dividend yield ratios to vary inversely with common stock volatility. Common stock prices are the most reliable and important tool available to investor to decide whether to invest or not. Thus, need to investigate these variables impact and relationship on stock prices volatility in a developing economy.

During crisis, managers adopt different strategies to cope with the current business environment and economic conditions in the country, so this study was aimed for the financial institutions, investors for further research to understand the stock market price volatility with reference to continuous economic failure in the country after a good economic period (in terms of stock prices and accounting variables relationship). When the stock exchange is a high risk and high return market and foreign investors have a good opportunity to attain good profit.

According to Ling, Mutalip, Shahrin and Othman (2008), the characteristics of dividend paying companies are more profitable, less risky and more mature in their activities as compared to non-dividend paying companies. Dividend paying companies are generally larger in size, in terms of liquidity ratio and developments as compared to non-dividend paying companies. Moreover, if the policy of the dividend is in the same pattern then the stocks with high dividend yield will have shorter life as compared to the stocks with low dividend yield and payout (Donaldson, 1961; Gordon, 1963). Thus expanding firms although may have dividend yield, show price stability. This may be because dividend yields serves as proxies for the amount of projected growth opportunities. If forecasts of profits from growth opportunities are less reliable than forecasts of returns on assets in place, firms with low dividend yield may have greater price volatility. Some studies found positive relationship between the dividend yield, dividend payout ratio and stock price volatility (Nishat, 2001) and other found the negative relationship (Easton & Sinclair, 1989; Nishat, 2001).

The analysis of stock markets has come to the forefront since this is the most sensitive segment of the economy. Through this segment, the country's exposure to the outer world is readily felt. Due to the investor’s preferences, the dividend policy is important for them and that is the main task for the management of the companies to manage the interests of all the stakeholders.

1.3 Problem Statement

Many researchers worked on accounting variables (dividend policy and other variables) and stock prices. Nevertheless they found mixed results. Earlier researches stated the share price changes are associated with changes in fundamental variables which are relevant for share valuation like operating earnings, dividend yield, growth rate and the size of the business. There is also an increasing interest in the stock markets of developing countries. According to Gordon (1959), Ariff and Finn (1986), Lee (1995), Irfan and Nishat (2001),found that stock price has a significant positive relationship with the dividend payment. However, Easton and Sinclair (1989) had found a negative relationship. Thus, the findings regarding the effects of dividend policy measures on stock market by different researchers needed to further research.

There are so many researches on dividend policy in other developing countries, such as Bangladesh, Pakistan, and Indonesia. In Malaysia, it is very little research on the relationship dividend policy and stock price. Thus, this study will examine the effect of dividend policy measures after controlling other accounting variables on stock price of the stock exchange. This study will use four representative accounting variables to explain the effects of dividend policy measures on stock prices volatility in stock market. Moreover, this study will be based on listed companies in Malaysia. In this study, the research questions will be focus on the effect of dividend yield on stock price, the effect of dividend to total asset ratio on stock price, the effect of profitability on stock price, and the effect of business growth on stock price.

The previous studies have used few representative accounting variables to explain the effects of dividend policy measures on stock prices volatility in Karachi stock market, Pakistan. On the other hand, this study used four representative variables which is dividend yield, dividend to total asset, profitability and growth to study the effects of dividend policy measures on stock prices volatility in Malaysia.

Moreover, most of the previous studies have focused on few sectors and some studies conducted event analysis in Pakistan. Hence, this study will be based on the economic sectors of Malaysia. Thus, this study needed to further research.

1.4 Research Objective

1.4.1 General Objective:

This study is conducted to find out the effect of dividend yield, dividend to total assets, profitability and growth on the stock exchange prices. The results of this study will help the shareholders, management of the firms, investors and financial institutions to provide basis for rationale decision making and also provide basis for future research.

1.4.2 Specific Objective:

To research about the effect of dividend yield to stock price

To research about the effect of dividend to total assets ratio on stock price

To research about the effect of dividend to profitability on stock price

To research about the effect of dividend to growth on stock price.

1.5 Significant Of Research

During the past ten years, business trends have been moving toward globalization and the number of multinational corporations continues to grow. Newly developed information technology allows investors around the world to trade stocks in other countries without physically crossing borders. Cross-national investors become cross-national shareholders via internet. Their decisions to trade depend merely upon information announced to the public. Dividends are one of the key factors that influence the prices of shares. The relevance of dividend policy on stock price is a matter of considerable importance to the management who sets the policy to the investors who invest in shares, and to the financial economists who endeavour to understand and appraise the functions of the capital markets. Over the half last century, the clash of ideas whether dividend policy is relevant or irrelevant has been the focus of a great deal of attention and continues to be a controversial topic among financial scholars around the world. Therefore, it is important to have an understanding of whether dividend policy is important or not in Malaysia. The topic of this study is to discern the effect of dividend policy on stock prices of the listed companies in Malaysia. The purpose of this study was to unfold the relationship between dividend policy and share prices with the aim of helping management to re-sketch their dividend policies and to either validate or disprove the academic explanation of the practice of paying dividends.

1.6 Scope Of Research

The scope of this research is listed companies in Malaysia. This study limits the discussions of four variables, which are dividend yield, total asset ratio, profitability and growth of the companies. Other than that, the result of this study is not applicable in other countries. The result is only applicable in Malaysia since this study used the companies in Malaysia. The time frame of this study is limited. This study uses 5 years of data from 2007 to 2011.

1.7 Theoretical Framework

Wilcox (1984), Rappoport (1986) and Downs (1991) had projected that the share price changes are associated with changes in fundamental variables which are relevant for share valuation. Share price are important in helping investors to make their decisions on investing. This implies that dividend yield with other major accounting factors may affect the investor’s decision in investment and encourages many researchers to investigate the stock exchange prices affected by those accounting variables. This study will investigate the effects of dividend policy on stock market prices. To identify this effect, this study uses major dividend policy measure, that dividend yield, dividend to total assets ratio, profitability and growth. The annual stock exchange prices are used for this purpose.

1.8Research Design

The theoretical framework of the study has quantitative research approach and hypothesis is stated and variables are measurable by the use of statistical data. This study is conducted with a view to test the hypothesis as "The effect of dividend policy measure (after controlling factors) on stock prices volatility". Christensen (1997); Nishat (2001) had indicates that the primary characteristics of the descriptive research approach are that it represents an attempt to provide an accurate description of a particular phenomenon. It attempts to identify variables that exist in a given situation and describes the relationship that exists between those variables, this research meets these requirements as both variables are clearly defined and analyzed using quantitative techniques, and the aim of the research is to determine the effects of relationship between the two variables. The independent variables are the dividend policy measures along with the other accounting factors (control variables) and the dependent variable is stock prices volatility. The purpose is to find out whether dividend policy of the firms affects the stock prices volatility.

Chapter 2

LITERATURE REVIEW

2.1 Introduction

This chapter will discuss about the literature regarding the effects of dividend policy measures on stock market prices. The stock market prices are affected by many factors. As for this study, the factors discussed are dividend yield, dividend to total assets ratio, profitability and growth.

2.2 Meaning of Dividend Policy

Dividend policy is a firm’s policy with regard to paying out earnings as dividends versus retaining them for reinvestment in the firm. It is the division of profit between payments to shareholders and reinvestment in the firm. Dividend policy is an essential part of the firm’s long-run financing strategies. In other words, dividend is the capital that a corporation pays out to its shareholders from the profits that the company’s had made (Droughty, 2000). It can be made in cash or by issuing of additional shares as in script dividend. According to Davies and Pain (2002), dividend policy is defined as the amount payable to shareholders from profit or distributable reserves. Firms that are listed in the stock exchange market are generally compelled to pay out dividends on a quarterly or semiannual basis. The semiannual or quarterly payment is referred to as the interim dividend. The payment which typically paid at the end of the financial year of the firms is known as final dividend. Dividends are normally paid after the corporate tax has been deducted.

2.2.1Dividend relevance theory

A research about dividend policy was done by Lintner in 1950s. The research was completed by interviewing the corporate managers. The research was examine in four parts, for example: Part A- Companies or corporationsaim long term dividend payment ratios. Part B- Managers lean to be more critical about the changes of dividend. Part C- Managers always focus on smooth dividend that cause the shifts in long term earnings propose changes in dividends. Part D- Managers disinclined to make changes in dividends that might have to be reversed, they are particularly concerned about having to rescind a dividend increase.

The dividend relevance theory is track and explored by many researchers presently. As stated by Siddiqi (1998), tax penalty on investors and paying dividends reduces firm value in the presence of taxes were cause by the payments of dividends. Lintner dividend model declare that the earnings per share would equivalent to a constant proportion to dividend payment in ensuring year if target payment ration of a corporation or company is persisted (Wolmarans, 2003).

Various researchers analysis that the stockholders trade away their dividend paying stocks while the stock price is high unless the stock prices goes down to provide more returns to meet the consequences of the tax on dividend payout.

According to Nishat (2001), as investors assess dividend paying stocks less risky as compared to non dividend stocks, the research done at least since 1963 is much based on Gordon and Lintner work. A bird in the hand is worth two in the bush, Literature shows that dividend relevance theory is of growing interest and has also some opposite views.

2.2.2 Dividend Irrelevance Theory

Many researchers supported the dividend relevance theory but a new theory, dividend irrelevance theory is presented. Miller and Modigliani (1958) stated that value of a firm is unaffected by dividends. The dividend irrelevance theory involves the a few criteria, that are :(1) Dividend policy has no effect on either the value of a firm’s stock or its cost of capital. (2) M&M argue that the value of the firm depend on the income it produces from its assets, and not by how this income is divided between dividends and retained earnings. (3) Their assumptions were: (a) No personal or corporate taxes. (b) No floatation or transaction cost. (c) Investors are indifferent between dividends and capital gains. (d) The investment decision is dependent of dividend policy. (e) There exists symmetric information. M&M are of the view that dividend itself did not effect, value is effected by the information comes up from the changes in dividend. Their view is based on different assumptions, like perfect capital market and some investors binding assumptions.

2.3 Effect of dividend policy on stock price

Dividend policy is a widely researched topic in the field of investments and finance. However, in the field of investments and finance, it still remains an unknown that whether Dividend Policy affects the Stock Prices or not. Dividend policy remains a source of controversy despite years of theoretical and empirical research, including one aspect of dividend policy: the linkage between dividend policy and stock price risk (Allen et al., 1996). Paying large dividends reduces risk and hence influence stock price. It is a proxy for the future earnings (Baskin, 1989). The results of researches conducted in various stock markets are different. There are many internal and external factors, which simultaneously affect stock prices and it is almost impossible to segregate the effect of each so the variations remain. There are some previous researches on dividend policy and stock price volatility.

Duration may cause imply that high dividend yields provide nearer term cash flow. If the dividend policy is stable, high dividend stocks will have a shorter period. Gordon Growth Model can be used to predict that high dividend will be less sensitive to fluctuations in the discount rate. Hence, supposed to display the price volatility is lower.

Nishat and Irfan (2003) determined the impact of dividend policy on stock price risk in Pakistan. A sample of 160 listed companies in Karachi Stock Exchange is examined for a period from 1981 to 2000. The empirical estimation is based on a cross-sectional regression analysis of the relationship between stock price volatility and dividend policy after controlling for firm size, earning volatility, leverage and asset growth. Both dividend policy measures (dividend yield and payout ratio) have significant impact on the share price volatility. The relationship is not reduced much even after controlling for the above mentioned factors. This suggests that dividend policy affects stock price volatility and it provides evidence supporting the arbitrage realization effect, duration effect and information effect in Pakistan. The responsiveness of the dividend yield to stock price volatility increased during reform period (1991-2000). Whereas payout ratio measure is having significant impact only at lower level of significance. In overall period the size and leverage have positive and significant impact on stock price volatility. The size effect is negative during pre reform period (1981-1990) but positive during reform period. The earnings volatility impact is negative and significant only during reform period. Although the results are not robust enough as in the case of developed markets but are consistent with the behaviour of emerging markets.

The leading proponents of the bird-in-the-hand theory found that stockholder value a dollar received in dividend were more highly than dollar earnings retained (Gordon & Lintner, 1962). Thus, dividend policy is related to the value of shares. Miller and Scholes (1981) also dispute that the observed relationship between common stock returns and dividend yields as attributed to the favourable information contained in the knowledge that a company will actually state any dividend. Dhillon and Jhonson (1994) study the stock and bond price effect to dividend changes. Dividend increases that react from the positive stock market due to several potential explanations such as two of the more commonly discussed being information content and wealth redistribution between stockholders and bondholders. The proof obtain able by Dhillon and Jhonson (1994) support the wealth redistribution hypothesis but does not rule out the information content hypothesis. Typically, Dhillon and Jhonson (1994) found out that the bond price response to announcement of large dividend changes is contrary to the stock price reaction. Their result different from the analysis of (Handjinicolaou & Kalay, 1984) who analyse bond returns around dividend changes, and report that the dividend increases will not affect the bond price however the bond prices react negatively to divided reductions. Dhillon and Jhonson (1994) dispute that their data supports the information content hypothesis. On the contrary, Jayaraman and Shastri (1988) discover insignificantly negative bond price reaction to dividend announcement.

Arahony and Swary (1980), Kwan (1981), Eades (1982), and Woolridge (1982), have found a significant positive association between announcement of dividend changes and the stock return, using the dividend announcement made in isolation of other firm news report. Gordon (1962 & 1963) and Walter (1963) support the dividend relevance doctrine. They suggest that dividend policy and investment policy are inter-linked. Investment policy cannot be separated from dividend policy and the choice of an appropriate dividend policy affects the value of the firm.

Carper (2008) examined the price volatility of dividend-paying stocks in the United States because of the 2003 statutory tax decrease on capital gains. The goal of the study is to investigate how the linkage between corporate dividend policy and corresponding stock price volatility may have changed over time because of the capital-gain tax relief. Baskin (1989) examined 2344 U.S. common stocks from 1967 through 1986, and he found a significant, dominating, negative relationship between dividend yield and stock price volatility. Contrarily, Allen and Rachim (1996) studied 173 Australian listed stocks, and they found no evidence that dividend yield is correlated with stock price volatility. The current study re-examines Baskin’s cross-sectional data of the U.S. common stocks from 2003 through 2006, with specific emphasis on the effect of the 2003 statutory tax decrease on capital gains. The study employs a model symmetric to the ones in Baskin (1989) and Allen and Rachim (1996). The research employs a cross-sectional regression analysis of the relationship between stock price volatility and dividend policy, after controlling for firm size, earnings volatility, leverage, and growth. The implications of the estimation result provide insight into different trading strategies and investment methods for general investors.

Pani (2008) explored the possible links between dividend policy and stock price behaviour in Indian corporate sector. 500 listed companies from BSE are examined for the years 1996-2006. The present paper features a panel data approach to analyse the relationship between dividend-retention ratio and stock-price behaviour while controlling the variables like size and long-term debt-equity ratio of the firm. The sample is taken across six different industries namely electricity, food and beverage, mining, non-metallic, textile and service sector. The results are based on the fixed-effect model, as these perform statistically better than random effects and pooled OLS model. Results of the fixed-effect models indicate that dividend-retention ratio along with size and debt-equity ratio plays a significant role in explaining variations in stock returns. The fixed effect models show the presence of firm level effect in explaining the possible links between dividend policy and stock price behaviour of the firm. In another words it exhibits the possibility of "clientele effect" effect in case of some industries. Therefore the model helps to understand the intricacies of dividend policy and stock-return behaviour in Indian corporate sector for the same period. Although the results are not robust enough as in the case of developed markets but shades some more interesting facets to the existing corporate finance literature on dividend policy in India.

Asamoah (2010) examined the relationship between dividend policy and stock price volatility. A sample of 10 Ghanaian listed companies is examined for a period from 1993 to 2005. The study also identifies the major determinants of stock price volatility on GSE. It further establishes the proportions of firms on Ghana Stock Exchange that have policies to pay dividend. In support of Baskin's (1989) US results, evidence is found that dividend yield influence stock price volatility. The relationship is not reduced even after controlling for the above mentioned factors. This suggests that dividend policy affects stock price volatility and it provides evidence supporting the arbitrage realization effect, duration effect and information effect in Ghana. On the other hand, contrary to expectations, there is significant positive relationship between size and stock price volatility, plus insignificant negative relationship with debt. It is also discovered that a negative relationship exit between growth and stock price volatility as expected. The results support Baskin's suggestion that dividend policy per-se can influence stock price volatility.

Corporate dividend policy has been remained a deeply investigated issue in corporate finance. Nazir, Nawaz, Anwar and Ahmed (2010) investigated the role of corporate dividend policy in determining the volatility in the stock prices in Pakistan. A sample of 73 firms has been selected from Karachi Stock Exchange (KSE) indexed (KSE-100) firms for the period of 2003-2008 and fixed effect and random effect models have been applied on the panel data. The results found that dividend policy has a strong significant relationship with the stock price volatility in KSE. The findings are consistent with the earlier researchers of developing economies that price volatility may be reduced by employing an effect corporate dividend policy (Rashid and Rahman, 2008).

Ullah (2010) examined the dividend policy measures effect on the stock prices. A sample of 171 listed companies from Karachi Stock Exchange, Pakistan is examined for a period from 1998 to 2006. The dependent variable stock price volatility is regressed against the dividend policy measures (independent variables) e.g., dividend yield, dividend payout ratio, actual cash dividends and dividend to total assets of the firm, after controlling for firm’s profitability, liquidity, gearing, size and growth. This study finds that, dividend policy measures have strong effect on the stock market prices but results are contradictory to earlier research in Pakistan. Dividend payout and actual cash dividends have negative, significant relationship with stock prices and dividend yield have significant positive relationship with stock market prices.

Asghar et al. (2011) studied the impact of dividend policy on stock price risk in Pakistan. The data of the study is taken from the published resources of State Bank of Pakistan and Karachi Stock Exchange regarding to five important sectors for the period 2005 to 2009. Descriptive statistics, correlation and regression models are used to perform the data analysis. The results of the study reveals that the correlation of price volatility and dividend yield is quite significant as compare to other variables. Moreover price volatility has negative correlation to the growth in assets. It is also inferred from the study that all the variables are linked to the price volatility; however, second model justifies the relational impact of some variables on the price volatility.

Corporate dividend policy is mysterious and one of the puzzles in corporate finance. Rashid and Anisur Rahman (n.d.) examined the relationship between dividend policy and stock price volatility. By using the cross-sectional regression analysis after controlling for earning volatility, payout ratio, debt, firm size and growth in assets, this paper identifies that there is an evidence of positive, but non-significant relationship between stock price volatility and dividend yield. An important implication of this study is that, the share price reaction to the earnings announcement is not similar to that of other developed countries. Therefore, the managers may not employ the dividend policy to influence their stock’s risk. The influence of stock price risk through dividend may be also ambiguous due to the inefficient capital market in Bangladesh. This paper contributes to the reducing the dearth of studies on dividend and stock price volatility in emerging economies.

Institutions and long term investors give due consideration to dividends and dividend polices of companies, which is a large and significant portion of the total investment in the stock markets. Khan, A.A. and Khan, K.I. (n.d.) explained the effect of Dividend Policy on the Stock Prices by taking a sample of 131 companies listed at Karachi Stock Exchange for a period of 10 years from 2001to 2010. Panel data approach is used to explain the relationship between dividends and stock prices after controlling the variables like Profit after Tax, Earnings per Share and Return on Equity. Results indicate that Stock Dividend, Dividend Policy and Stock Prices Profit after Tax, Earnings per Share and Return on Equity have positive relation with Stock Prices and significantly explain the variations in the market prices of shares, while Retention Ratio has negative, insignificant relation with stock prices. Overall model is significant. Results of Fixed and Random Effect Models further validate these results. Overall results of this study indicate that Dividend Policy has significant positive effect on Stock Prices.

In Pakistan corporate sector is adversely facing competition due to economic downturn in the world and making efforts to survive in a competitive and uncertain economic environment. Khan’s (n.d.) study will help to improve dividend decisions of corporate sector through proper implementation of their dividend policies. This paper is an attempt to explain the effect of dividend announcements on stock prices of chemical and pharmaceutical industry of Pakistan. A sample of twenty five companies listed at KSE-100 Index is taken from the period of 2001to 2010. Results of this study is based on Fixed and Random Effect Model which is applied on Panel data to explain the relationship between dividends and stock prices after controlling the variables like Earnings per Share, Retention Ratio and Return on Equity. Results indicate that Cash Dividend, Retention Ratio and Return on Equity has significant positive relation with stock market prices and significantly explains the variations in the stock prices of chemical and pharmaceutical sector of Pakistan while Earnings per Share and Stock Dividends have negative insignificant relation with stock prices. This paper further shows that Dividend Irrelevance Theory is not applicable in case chemical and pharmaceutical industry of Pakistan.

2.4 Effect of dividend yield on stock price

There are many methods to calculate dividend yield. Diverse ways was used to calculate the dividend yield but the most common method is dividend per share divided by the market price of the share. Other than that, many researches also use different approaches to determine the stock market prices. Fama and French (1988), has used the method by totalling all the monthly dividends over the period and dividing the total amount with the beginning and finale share price. According to Irfan and Nishat (2001), average stock market price is used to calculate dividend yield. They sum all the annual dividends paid to the shareholders and divided them by average stock market value in the year.

Black and scholes (1974) has examine the dividend yield and they stated that there is no consistent impact of dividend yield on the expected returns. Litzenberger and Ramaswamy (1979) has explore drastically positive relationship between the dividend yield and expected returns. On average observations Blume(1980) found that it will have higher returns if the stocks have high dividend yields. Christie (1990) had found out that the stocks of non paying dividend firm’s had negative returns. As for Hodrick (1992), he had studiedwhether dividend yield had some influence of prediction about the expected returns. Thus, he states that dividend yield have the predictive power to describe the returns. Levis (1989) investigated the effect of dividend yield on stock returns for London stock exchange and he has observe that stock returns are strongly influenced by the dividend yield and price to earnings ratio.

According to Donaldson (1961), companies or corporations which have low payout and low dividend yield might have tendency to be valued more in terms of future investment opportunities. Subsequently, the sensitivity of the stock price possibly will be more sensitive to changing estimate of rates of return over distant time period. As a result expanding firms may have lower payout ratio and dividend yield, exhibit price stability. This could be because of dividend yields and payout ratio serve as proxy for the amount of projected growth opportunity. Companies or corporations with low payout and low dividend yield might have greater price volatility, if forecasts of profits from growth opportunities are less reliable than forecasts of returns on assets in place. According to duration effect and arbitrage effect, the dividend yield is the relevant measure. The rate of return effect implies that both dividend yield and payout ratio. Dividend policy possibly will serve as a proxy for growth and investment opportunities. Both the duration effect and the rate of return effect assume differentials in the timing of the underlying cash flow of the business. If the relationship between risk and dividend policy remains after controlling for growth, this would suggest evidence of either the arbitrage effect.

As stated by Gombola and Liu (1993), dividend yield has a positive impact on the return in bear market and negative impact on returns in bull market. They also experimental the systematic risk and dividend yield has a negative relationship. Moreover, company’s paying stable and high returns have a positive alpha. Some other researchers like Gwilym, Morgan and Thomas (2000); Nishat (2001) had found out those results which were almost similar to each other and state that dividend stability reduce the systematic risk and vice versa.

In contrast, there were also negative relationship between dividend yields income. Dividend yield and stock market priceshas a direct relationship and as earlier discussed by Black and Scholes (1974), they states that dividend yield and returns may have negative relationship if dividend income is taxed at higher rate. Irfan and Nishat (2001) found that there is a negative relationship between the dividend yield and stock price volatility in their empirical investigation with reference to Karachi stock exchange Pakistan. Irfan and Nishat (2001) also observed that there is less volatility in the stock market prices of the firms having large size and high dividend yield.

2.5 Effect of dividend to profitability on stock price

Profitability means excess of revenue over expenditure during the accounting period. Besides, profitability can also explain as the total income from operating and investing.

In previous research, various authors used earnings before interest and taxes and earnings after interest and taxes are used. Kumar and Sopariwala (1992), Ahmed and Khababa (1999), have done study about return on shareholders’ equity (calculated as earnings after interest and taxes divided by shareholders equity) is apply for the term of profitability of the firms. Earnings of the firm convey information to the investors about the position, which will affect investor choice. If the earnings are higher than the expectations of the shareholders, it will have a positive effect on stock prices and vice versa.

The decision to pay dividends is affected by profits. Hence, profitability can be consider as an entry factor. The level of profitability is one of the important factors that might influence firms dividend decisions. The theory suggests that dividends are usually paid out of the annual profits, which represents the ability of the firm to pay dividends. Thus, firms incurring losses are unlikely to pay dividends. Lintner (1956), found that a firm’s net earnings are the critical determinant of dividend changes. Furthermore, Jensen et al, (1992), Fama and French (2001), have done some studies and documented a positive relationship between profitability and dividend payouts.

Evidence from emerging markets also supports the proposition that profitability is one of the most important factors that determines dividend policy. Aivazian et al. (2003) in their study of the dividend policy of emerging market firms and US firms demonstrated that profitability has a significant impact on dividend payouts for both samples.

2.6 Effect of dividend to total asset ratio on stock price

Dividend to total asset ratio is being used in this study as an accounting variables to determine the stock price volatility. Stockholders received dividend income from total investment (total assets).

Dividend to total assets ratio show how much business is returning to the shareholders for their total investment.

This is calculated as:-

Dividend to total assets ratio =

In 1963, Gordon find out the effect on stock prices by used dividend to total assets ratio. Gordon examine momentous impact of dividend to total assets ratio on stock market prices volatility.

2.7 Effect of growth on stock market prices

Growth can refers to a business that generates significant positive cash flows or earnings, which increase at significantly faster rates than the overall economy. A growth company tends to have very profitable reinvestment opportunities for its own retained earnings. Businesses that grow are often seen in the technology industries.

Stock market prices and its dividend policy are connected to the firm’s growth. To determine the growth of the firm, different proxy were being used. The first proxy for growth and investment opportunity is the sales of firms. This proxy have been generally used for previous studies, for example, De Bondt and Thaler(1985); Abarbanell and Bernard(1992); Kasznik and McNichols (2002). The second proxy is the firm’s market-to-book ratio (MBR), for instance, Perfect and Wiles(1994);Barclay (1995); Cleary(1999); Travlos et al. (2001);Deshmukh(2003). According to Rozeff(1982), the other proxy for growth is the firm’s price-earnings ratio (PER). Growth also determined in terms of the age/life cycle of the firms (Farinas & Moreno, 2000; Grullon, Michaely & Swaminathan, 2002; Rodriguez et al., 2003; Huergo, Elena & Jaumandreu, 2004). But, the changes of percentage in sales is consider as growth.

Once the firm invest the funds inside the business for functioning activities or investing activities in respect of acquisition of new assets or outside the business for making investments in securities for returns, there will be off course decline in the firm resources, in short run might undergo its liquidity position. However, will result in inflow of funds while profits are generated in long run and finally result in growth of business Managerial practices and academic research link firm growth to dissimilar benefits. If companies are to remain vital and competitive, firm’s growth is a need(Drucker, 1973; Robins & Wiersema, 1995). Meanwhile, firm development relate to rising complexity and various managerial problems.Research had proved that excessive growth might mischief shareholders’ value and unfavourably effects profitability (Baumol, 1962; Hedberg, Nystrom & Starbuck, 1976; Richardson, 1964; Whetten, 1987). The study proved that mixed results regarding the relationship between growth and stock price. Some studies find support for a curvilinear relationship (Irfan and Nishat, 2001). Miedich and Melicher (1985) found out that others revealed a positive and linear Markman and Gartner (2002) found out no significant relationship at all.

Markman and Gartner (2002) stated that related explanation for earlier inconclusive research might be traced back to the practice of classify growth rates across corporations and industries into normal, high and hyper growth. Nevertheless, many researchers have disagreed that firms, companies or corporation’s capability to growth is dependent on their inimitable resource base as well as market conditions (Penrose, 1959; Porter, 1980). Hence, rather than being applicable to firms, the relative degree of growth is dependent upon firm-specific characteristics,

According to Mishina et al. (2004), various studies in finance field prove that a firm's resource endowment is the most important determinants of its ability to grow. Financial resources and human resources are the two major kinds of resource types that had been examine. As of a financial market perception, firms’ growth are determined by the shareholders long-term earnings growth potential, which are intrinsic in the firm’s current market value (Rashid & Rehman, 2008). According to Skinner and Sloan (2002), empirical studies examine that there is a reward for meeting expectations and a penalty for failing to do so. Firms that constantly reach the expectations fore number of years will have higher returns(Kasznik & McNichols, 2002). The rate of expected sales growth (ESG) may determine the firm's minimum growth requirement and the annual percentage increase in sales required to meet the market prospect. The firm’s return will be affected by the expected sales growth. The firms’ return will be affected negatively if the growth constantly below the expected sales growth. In addition, based on the maturity hypothesis study, as firms become mature, their growth and investment opportunity reduce,then causes a turn down in the capital expenditures (Grullon, Michaely & Swaminathan, 2002; Deshmukh, 2003; Nishat, 2001). Therefore, there will have more free cash flows to be paid as dividends. Companies which are relatively older and do not have the inducement to build-up reserves cause low growth and few capital expenditures, which enable them to follow a tolerant dividend policy In contrast, new companies should build-up reserves to face the rapid growth as well as financing requirements. Thus, they pay low dividends or no need to pay dividends and they also retain most of their earnings. Increase in dividends is a indication of changes in a firm’s life cycle (firm moving from higher growth phase to a lower growth phase). Researchers that done a study through choosing a sample of US firms announce the changes in dividends from the year 1967 to year 1993, had conclude that firms, companies or corporations which increase dividends, is a sign of shrinking growth and investment, experience decline in their systematic risk, return on assets and profitability.

Rozeff (1982) and Jensen (1992), found out a significant negative relationship between dividends and firm’s growth and investment opportunities. Corporate dividend policy is determined by the growth and investment opportunities. Recently, Fama and French (2001) stated that the dividend decisions are affected by the investment opportunity. Thus, firms, companies or corporations with enhanced growth and investments opportunities have lower payouts.

Chapter 3

METHODOLOGY

3.1 Introduction

This study purposed to investigate the impact of dividend policy and major accounting factors on stock price volatility. In this study, we collected panel data to study the relationship between dividend policy and stock price volatility. Panel data analysis is a method of studying a particular subject within multiple sites, periodically observed over a defined time frame. In economics, panel data analysis is used to study the stock market behaviour of firm’s performance measures and stock prices over time. Panel data collection helps to retain the originality of the data which can be neglected due to other methods of data collections. In addition, we used Ordinary Least Square Regression to determine the relationship of dividend policy and stock price volatility.

The independent variables in this study are the dividend yield, dividend to total assets ratio, size and growth on the stock exchange prices. These factors are the control variables and are included because of the fact that these factors can influence dividend policy as well as stock market prices of the firms. Similar sets of the variables have been used by Hamada (1972), Irfan and Nishat (2001).The dependent variable of this study is stock prices volatility (SPV) of each of the companies. The objective is to analyze the effects of dividend policy on stock market prices after controlling the above mentioned control variables.

The research hypotheses are developed on the basis of previous discussions regarding the effects of dividend policy and stock market prices. Studies established direct relation between share price changes and dividend changes (Ball and Brown 1968; Baskin 1989). Atiase (1985) showed that as the size of the firm increases, their share price volatility declines. Both dividend policy measures (dividend yield and payout ratio) have significant impact on the share price volatility. The relationship is not reduced much even after controlling for total assets ratio, profitability and growth. The growth in assets was included because it is quite possible that any other relation between dividend policy and stock price volatility could be occurring.

3.2 Data

This study considers the data for the period for the year 2007 to 2011. The sample consisted of all listed in Bursa Malaysia for three years, which the data will obtain from the data stream. The dividend yield was taken from data stream. Total assets ratio, profitability and growth, were collected.

3.3 Variables Measurement

3.3.1 Framework

3.3.2 Hypothesis

H1: There is a positive relationship between stock price volatility and dividend yield. Levis (1989) found out that the effect of dividend yield on stock returns for London stock exchange and he has observe that stock returns are strongly influenced by the dividend yield and price to earnings ratio.

H2:There is a positive relationship between stock price volatility and total asset ratio. Gordon (1963), used dividend to total assets ratio to find out the impact on stock price, Gordon observed momentous impact of dividend to total assets ratio on stock prices volatility.

H3: There is a positive relationship between stock price volatility and profitability. Jensen et al, (1992), Fama and French (2001), have done some studies and documented a positive relationship between profitability and dividend payouts.

H4: There is a significant association between stock price volatility and growth. Fama and French (2001) affirm that investment opportunities influence dividend decisions, firms with better growth and investments opportunities have lower dividend payouts.

3.3.3 Dependent And Independent Variables

Dependent variable

The dependent variable in the regression is stock price volatility, which was derived by following the Parikson's (1980) extreme value estimate or estimating variance of the rate of return. In this case, it is calculated by dividing the differences between stock price of today and previous day with stock price of previous day. Then variance for that year is averaged and is transformed into standard deviation. This method is considered better than the traditional methods in, which researchers use either opening price or closing price or average of opening and closing prices. Parkinson (1980), Allen and Rachim (1996), Nishat and Irfan (2003), Pani (2008), Rashid and Rahman (2008), Nazir et al.,(2010), and Asghar, Shah, Hamid, and Suleman (2011) also used price volatility as a dependent variable in their studies.

Independent variables

Dividend Yield

A financial ratio that shows how much a company pays out in dividends each year relative to its share price. In the absence of any capital gains, the dividend yield is the return on investment for a stock. Normally, only profitable companies pay out dividends. Therefore, investors often view companies that have paid out significant dividends for an extended period of time as "safer" investments. Thus, should events occur which are detrimental to the share price, the allure of the dividend combined with the stability of the company can support the price somewhat. Dividend yield is computed by taking the sum of annual cash dividends paid to stock holder’s and then divided by the sum of average market value of stock in that year. The average of five years is taken into account for this study.

Profitability

Profitability ratios measure a company’s financial performance and its ability to increase its shareholders value and generate profits.  Profitability ratios provide insight into the profits made by the company in relation to its size, assets, and sales and also measure the company’s performance in relation to itself. The Return on Assets ratio (ROA) is an important profitability ratio because it measures the efficiency with which the company is managing its investment in assets and using them to generate profit. It is obtained through net income divided by total assets.

Growth

It is calculated through increase in asset value this year over last year divided by last year value.

Total assets ratio

It is taken from the annual report of the companies. To calculate the dividend to total assets ratio, divide the amount of dividend by the total assets and multiply by 100.

3.4 Data Analysis

3.4.1 Descriptive Statistics

To study the background of the data collected. In order to test the mean, maximum, minimum, average, frequency of the panel data for the considerable variables of stock prices volatility, dividend yield ratio, size, growth and total assets of the firm, this study analyzed the standard deviation, mean, minimum, and maximum. The required analysis will indicate whether our decision about the macroeconomic variables is based on the reliable and valid data available.

3.4.2 Ordinary Least Square Regression

The results of this study are based on Ordinary Least Square (OLS) regression model as it is a suitable tool to get useful findings. Fama and French (1988) and Afza and Mirza (2010) also used the Ordinary Least Square (OLS) regression in their studies to explain the relationship between dividend policy and stock prices. 5% level of significance is used to accept or reject the null hypothesis. Following regression line is used for this purpose:

SPVi = β0 + β1DYi + β2TAi + β3Pi+ β4GRWi + Ԑi (1)

Where

SPV = Stock price volatility

DY= Dividend yield

TA= Total asset ratio

P= Profitability

GRW= Growth

Î’= Regression coefficient

Ԑ= Error term

The expectations are that dividend yield (DY) would be negatively related to stock price volatility (SPV) due to signalling effects that shareholders feel more satisfaction and show more confidence on the firms paying larger and consistent dividends which reduce stock price volatility. Total assets (TA), profitability (P) and growth (GRW) factors are also expected to have a negative effect on stock price volatility because of the fact that firms in larger size and growing rapidly will have greater returns in future and would meet the expectations of the investors, therefore, the stocks of these firms will show less volatility. The investors feel confidence in the stocks of those firms having upwards movement in profits and off course jump in earnings or sudden decrease in profits would increase in volatility. The stock price volatility is also directly affected by level of gearing due to the fact that higher level of debt financing in the capital structure expresses higher degree of risk, which would certainly increase stock price volatility. Test for correlation also had been test to determine the relationship between stock price volatility and the independent variables.