09-08-2012, 12:50 PM
TREND ANALYSIS OF DIVIDEND POLICY IN THE INDIAN IT SECTOR
A Study on Trend analysis of dividend policy in the Indian IT Sector - Gipin Paul (90014).pdf (Size: 841.34 KB / Downloads: 61)
INTRODUCTION
Dividend policy is a critical decision area in the field of finance. The subject of corporate dividend policy has captivated finance scholars for a long time, resulting in intensive theoretical modelling and empirical investigation. But several questions related to dividend decisions remain perplexing because of diverse and conflicting theories and also due to diverse empirical results. This paper attempts to give a focused overview of the important dividend theories and identify the leading factors that determine the dividend behaviour in the corporate financial management. Dividend behaviour of Indian Software Industry has been analyzed using various econometric techniques.
There are a number of decisions that have to be taken for efficient performance and attainment of objectives in the software sector and among the most important is decisions relating to dividend. The area of corporate dividend policy has been studied by financial scholars and economists for a long time, resulting in intensive theoretical modelling and empirical examination. Dividend Policy is one of the most complex aspects in finance. Three decades ago, Black (1976: 5) wrote, “The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don’t fit together”. Brealey and Myers (2002) have enlisted dividend policy as one of the top ten puzzles in finance.
A number of conflicting theoretical models, all lacking strong empirical support, define recent attempts by research in finance to explain the dividend phenomenon. But to come out with concrete conclusions an intensive study of all theoretical models together with empirical proof is needed. In the Indian context, a few studies have analyzed the dividend behavior of corporate firms. Krishnamurty and Sastry (1971), Mahapatra and Sahu (1993), Bhat and Pandey (1994), Narasimhan and Asha (1997) and Narasimhan and Vijayalakshmi (2002) are the good examples of empirical research carried out in India in the field of dividend decisions. However, it is still not clear what the dividend payment pattern of firms in India is and why they initiate and omit dividend payments or reduce or increase dividend payments. This
paper analyzes the dividend payout of the software industry in India and presents the dividend initiations and omissions and determinants of dividends. The efficiency and performance of software industry is improving in all conducts.
The present paper is an attempt to understand the software dividend decisions in a competitive global economy. Dividend decisions may enhance the market value of the firm but on the other hand it may mean less availability of internal funds and more dependence on external sources and expansion purposes. Furthermore, while determining dividend payment, a prudent management strikes a balance between shareholder’s expectation and firm’s long term interest. Such analysis is of great relevance from the policy standpoint, because as the dividend literature suggests, if these decisions are handled efficiently, this is expected to be reflected in value of firms. More importantly, such analysis is useful in enabling policymakers to identify the success or failure of policy initiatives or, alternatively, highlight different strategies undertaken by software firms, which contribute to their successes.
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Miller and Modigliani (1961) viewed dividends as irrelevant, and believed that in a world without market imperfections like taxes, transaction costs or asymmetric information; dividend policy should have no effect on its market value. However, since the capital market is neither perfect nor complete the dividend irrelevance proposition needs to be re-visited, especially focusing the effects of information content of dividends, agency cost and institutional constraints. The market imperfection of asymmetric information is the basis for three distinct efforts to explain corporate dividend policy. The mitigation of the information asymmetries between managers and owners via unexpected changes in dividend policy is the cornerstone of dividend signalling models. Agency cost theory uses dividend policy to better align the interests of shareholders and corporate managers. The free cash flow hypothesis is an ad hoc combination of the signalling and agency costs paradigms; the payment of dividends can decrease the level of funds available for perquisite consumption by corporate managers. The signalling theories depict dividend policy as a vehicle used by corporate managers to transmit private information to the market (Bhattacharyya, 1979; Miller and Rock, 1985; Williams, 1988; John and Williams, 1985). Agency cost models begins with the agency problems emphasized by Jensen (1986). Agency problems result from information asymmetries, potential wealth transfers from bondholders to stockholders through the acceptance of high-risk and high-return projects by managers, and failure to accept positive net present value projects and perquisite consumption in excess of the level consumed by prudent corporate managers. Large dividend payments reduce funds available for perquisite consumption and investment opportunities and require managers to seek financing in capital markets. The efficient monitoring of capital markets reduces less than optimal investment activity and excess perquisite consumption and hence reduces the costs associated with ownership and control separation (Easterbrook, 1984). Moreover, Lintner (1956) made an empirical attempt to explain corporate dividend behaviour by means of conducting interviews of personnel of large firms of United States of America. It was established that the primary determinants of changes in dividends
paid out were the most recent earnings and past dividends paid. It was found that management is concerned with change in dividends rather than the amount and it tries to maintain a level of dividends. Also, there was propensity to move towards some target payout ratio but speed of adjustment varies among companies. There exist many empirical studies in India and abroad that identifies the pattern and factors affecting dividend policy.
Bauer and Bhattacharyya (2006) established that empirical modelling of dividends has been dominated by Lintner (1956). The study established that Lintner’s model is also poorly specified when earnings are serially correlated. In time series testing, model fits the empirical reality at least 75% of the time. Moreover, for firms with longer data series of 35 years or more, it described the empirical data succinctly in 96% of the cases. Li, Feng, Song and Shu (2006) analyzed the decision-making of dividend policy and the reasons for dividends policy selection in non-state-owned listed companies in China by using structural equation modelling. The main research findings are as follows:
(1) The dividend policy of non-state-owned listed companies in China can be interpreted by the western agency theory for dividend, and they found that if compared with manager, owner is a more important variable that influence the dividend policy,
(2) Four motives such as investment opportunities, refinancing ability, stock price and potential repayment capacity are all important factors for decision maker to determine the dividend policy.
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Frankfurter and Wood (2002) established that a number of conflicting theoretical models lacking strong empirical support define current attempts to explain the puzzling reality of corporate dividend behaviour. The outcome is consistent with the contention that no dividend model, either separately or jointly with other models, is supported invariably. DeAngelo, DeAngelo and Skinner (2000) analyzed the information content of special dividends. The research concluded that special dividends were not displaced by stock repurchases, indicating that most specials failed to survive on their own accord and not because managers discovered the tax
advantages of repurchases. Slovin, Sushka and Poloncheck (1994) assessed the information conveyed by commercial bank announcements of dividend reductions. It has been established that valuation effects on announcing banks are negative and significantly greater than for industrial firms. Cross-sectional regressions used in the study indicate that the size of dividend reductions is crucial but there is no evidence of clientele effects. Dhameja (1978) in his study tested the dividend behaviour of Indian companies by classifying them into size group, industry group, growth group and control group. The study found that there was no statistically significant relationship between dividend payout, on the one hand and industry and size on the other. Growth was inversely related to dividend payout and was found to be significant. The main conclusions re that dividend decisions are better explained by Lintner’s model with current profit and lagged dividend as explanatory variables.
Fama and Babiak (1968) studied the determinants of dividend payments by individual firms during 1946-64. For this purpose, the statistical techniques of regression analysis, simulations and prediction tests were used. The study concluded that net income seems to provide a better measure of dividend than either cash flow or net income and depreciation included as separate variable in the model. Smith (1963) studied factors influencing corporate saving decision of firm. The factors have been classified into two broad categories, first being factors involved in investment decisions and second arising from stability of dividends. It was concluded that income, previous levels of dividend played a very important role in corporate saving in short run but demand for investment funds had somewhat smaller role in deciding behaviour of corporate savings. But in long run, demand for investment funds played crucial role in estimating corporate savings. In the Indian context, a few studies have analyzed the dividend behaviour of corporate firms.
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Krishnamurty and Sastry (1971) analyzed dividend behaviour of Indian chemical industry for the period 1962-1967 and took cross sectional data of 40 public limited companies. The results revealed that Lintner model provides good explanation of dividend behaviour. Mahapatra and Sahu (1993) find cash flow as a major determinant of dividend followed by net earnings. Bhat and Pandey (1994) undertake
a survey of managers’ perceptions of dividend decision and find that managers perceive current earnings as the most significant factor. Narasimhan and Asha (1997) observe that the uniform tax rate of 10 percent on dividend as proposed by the Indian union budget 1997-98, alters the demand of investors in favour of high payouts. Mohanty (1999) finds that firms, which issued bonus shares, have either maintained the pre-bonus level or only decreased it marginally there by increasing the payout to shareholders. Narasimhan and Vijayalakshmi (2002) analyze the influence of ownership structure on dividend payout and find no influence of insider ownership on dividend behaviour of firms.
Leading determination of dividend policy
Dividend decision in the corporate sector is governed by a large number of determinants. The review of literature reveals that profit after tax, lagged dividend, depreciation, capital expenditure, current ratio, debt equity ratio, interest payments, change in sales, share price behaviour, and cash flow are expected to have a direct bearing on the dividend policy decision of the firms. These determinants are briefly discussed here under:
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Profit after Tax: The crucial determinant of dividend payments is the current earnings (profit after tax) representing the capacity to pay dividends, which have a positive relationship with dividends. Further, the level of profit is almost invariably the starting point in the management’s consideration of whether dividend in any given year. This variable as a key determinant of dividend policy is found in the work of Lintner (1956), Fama and Babiak (1968) and others. 8
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Cash Flow: Brittain (1966) suggests that cash flow is a more appropriate measure of the company’s capacity to pay dividend. Cash flow is derived from profit after tax plus depreciation expense of the concerned financial year. He argues that dividend payment is considered a charge prior to depreciation and hence should be related to earning gross of depreciation. This variable has
been proved to be significant determinant of dividend policy in the empirical works of Mahapatra (1992), Mahapatra and Sahu (1993).
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Lagged Dividend: Lagged dividend variable is the cash dividends paid by the company one year prior to the year under consideration. In order to follow a stable dividend policy management has to allow the past dividend trend to influence the current dividend payments. Moreover, it exhibits the speed of adjustment mechanism which states that companies try to achieve a certain desired payout ratio in the long run. Most of the theoretical and empirical studies have included this variable as an important determinant of dividend policy.
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Depreciation Allowance: Depreciation charge is a non-cash expense; it is added as an independent variable in the dividend behaviour model, since regulation and accounting practices regarding depreciation might affect dividend policy inversely through its impact on current net profits. This variable has been used as explanatory variable by Brittain (1966), it was found statistically significant.
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Capital Expenditure: Another important factor that determines the dividend decisions is the firm’s capital expenditure. The extent to which the company decides to finance these expenditure from internal resources, both dividend and capital expenditure decision would compete with each other, therefore, capital expenditure in a company is negatively related to its dividend payments. The impact of this determinant has been studied by Dhrymes and Kurz (1964), Mahapatra and Sahu (1993).
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Current Ratio: Payment of dividend means cash outflows. Though, a firm may have adequate earnings to declare dividends, but it may not have sufficient cash to pay the same. Thus, current ratio of the firm is an important consideration in paying dividends. The greater the current ratio, the greater is ability to pay dividend. 9
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Debt Equity Ratio: Another feature, which has strong impact on dividend behaviour, is the debt equity ratio (capital structure). The demand for external
finance usually arises in a company on account of constraints imposed by its internal resources. The higher the internal flows, given the investment requirements, lesser will be the demand for borrowings and vice-versa. Internal flows are generated by net profits after tax and dividend. That is, higher the dividend, higher the demand for borrowings. On the other hand, lower dividends would mean less demand for borrowings and low debt equity ratio. This variable has received emphasis in the work of Dhrymes & Kurz (1964), Mahapatra & Sahu (1993), Mahapatra& Panda (1995).
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Interest Payment: Another variable which may have a direct bearing on the dividend policy of the firms is the amount of interest. A rise in interest payment by a company would depress its dividend payment. Brittain (1966) found dividends to be negatively related to interest payment.
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Sales: Another important factor that determines the dividend decisions is the sales. As suggested by Brittain (1966), rapid gains in earnings as indicated by sales change might make firms more cautious. Firms feel that the rapid growth cannot be maintained and they might adopt more conservative dividend policy.
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Share Price Behaviour: There have been many attempts in the past to test whether or not the share price of a company affects its dividend policy (Friend and Puckett, 1964; Khurana, 1985; Mahapatra and Sahu, 1993). This variable is expected to have negative relationship with the dividend policy of a company.
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RESEARCH METHODOLOGY
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RESEARCH METHODOLOGY
A well comprehensible modus operandi empowers the innovative researcher to revisit the study setting. Good methodology follows the standards of the established conventions. For the present paper, a number of indispensable inimitabilities of the research methodology are defined here:
Objectives of the Study
The main objective of the paper is to know the functional relationship between dividend decision of Indian Software Industry and their determinants. Results of this replication will be helpful for designing dividend policies at the firm level.
Hypothesis
The hypothesis of the present study is: dividend decisions are not affected by any determinant.