The Gaps in Research of Dividend Till Now

There have been many national and international studies in the field of Dividend Policy to date. But, as the Nepalese capital market is in the early stage of development, the conclusion made by the international studies may not be relevant in the Nepalese context. So far the Nepalese studies concerned, there are some studies done which can be considered to be landmark in the field of dividend policy; but many more changes have taken place in Nepalese capital market in last few years and the validity of the past results are doubtful in the present context. Besides this, some researchers have taken only few.

Firms of the same sector as sample and so, the results drawn from those studies may not be accurate to represent the present practices and efforts made in the Nepalese capital markets. So, it is necessary to carry out a fresh study related to dividend pattern of Nepalese companies.

In this study, it is tried to carry out the distinct from other previous studies in items of sample size, nature of the sample firms, and methodology used. The study has covered 6 banks. Five years data have been analyzed with due consideration of EPS, DPS, DPR and MVPS. Analyses of financial indicators, standard deviation, regression analysis etc. are used as the main models in the study with a view to obtain the relevant and accurate results. So, it has been believed that this study will be different than earlier one.

More Studies on Dividend

Adhikari (2014) carried out a research on “Corporate dividend practices in Nepal” using primary as well as secondary data. The main objectives of his research were:

a.       To analyze the properties of portfolios formed on dividend.

b.      To examine the relationship between dividend and stock prices.

c.       To survey the opinions of financial executives on corporate dividend practices.

Major findings of this research are:

a.       Financial position of high dividend paying companies is comparatively better than that of low dividend companies.

b.      Market price of stock of both finance and non finance sectors are affected by dividends.

c.       There is a positive relationship between dividend and stock price.

d.      There is a negative relationship between dividend payout and earnings before tax to net worth.

e.       Stocks with larger ratio of DPS to book value per share have higher profitability. These profitability ratios of stocks paying larger dividends are also more variable as compared to stocks paying smaller dividends.

f.       Companies paying higher are reluctant to employ higher degree of leverage in their capital structures.

g.      The stocks with larger ratio of dividend per share to book value per share have also higher turnover ratio and higher interest coverage.

Budhathoki (2015) carried on a research on “The study of dividend policy of the commercial banks in Nepal on May 2014.” The main objectives of the study were;

a.       To highlight the dividend practices of commercial Banks.

b.      To compare the dividend policy followed by different commercial banks chosen.

c.       To provide the sample with some fruitful suggestion that can be implemented easily and possible guideline to overcome various issues and gaps based on the findings of the analysis.

Some of the major findings of this study are:

a.      The average earning per share (EPS) of the banks under study shows a positive result. But the coefficient of variation indicates that there is no consistency of EPS.

b.      The average dividend per share (DPS) shows that there is no regularity in dividend payment.

c.      The analysis of DPR shows that the Dividend Payout Ratio (DPR) of the banks is not stable.

d.     The average market price shows that there is quite high level of fluctuation.

Bhattarai (2016) conducted study on “Dividend Decision and its impact on stock valuation.” The objectives of this study were as follows:

a.      To test the relationship between dividend per share and stock prices.

b.      To identify whether it is possible to increase the market value of the stock changing dividend policy or pay out ratio.

c.      To determine the impact of dividend policy or payout ratio.

The study used simultaneous equation model are developed by friend and puckett (2015), to explain the prices behavior. The findings of the study were as follows:

a.       The relationship between dividend per share and stock prices is positive in the sample companies.

b.      Dividend per share affects the share prices variedly in different sectors.

c.       Changing the dividend policy or dividend per share might help to increase in  market price of shares.

d.      The relationship between prices and retained earnings per share is not prominent.

e.       The relationship between stock prices and lagged earnings price ratio is negative.

Pandey (2016) researched on “Pricing and yield behavior of Equity shares in Nepal:A case of commercial Banks”on March 2016. The main objectives of the study are:

a.       To establish relationship between market prices of commercial bank’s equity shares and their yield behavior in Nepal.

b.      To see how effective is yield in determining the market price of the securities?

c.       If yield is not the sole determining factor then what could be other factors, which could affect the market prices of the securities in Nepal.

d.      To identify problems of securities market in Nepal and suggest measure to correct the existing problems.

Main findings of this research are:

a.       Market prices of the equity shares ate overvalued when compared to the earnings per share, which is the primary indicator of the financial status of the concerned financial institution. This was mainly due to ignorance and Improper access to financial  health of the company.

b.      The result of simple regression analysis between the market price and yield indicator reflected that net worth per share explained the best of the market prices compared to other indicators. Dividend per share and earnings per share were equally explanatory, whereas dividend payout ratio was not a good indicator of stock pricing. The result showed that market price corresponds to the earnings per share at a greater extent and then to dividend per share and then to earnings per share.

Studies Related to Dividend

Shrestha (2016) in his article “Shareholders” Democracy and annual General meeting Feedback” has dealt with the policies and financial performance of some financial companies and has made the following outcomes

·         The cost-push inflation at exorbitant rate has made the shareholders to expect higher return from   their investment.

·         Multiple decreases in the purchasing power of the Nepalese currency to the extent that higher return by the way of dividend is just a natural economic consequence of it.

·         Erosion in the purchasing power of the income has made it clear that dividend payment must be directed to enhance shareholders’ purchasing power by raising dividend payout ratio on the basis of both earnings and cost theory.

·         Indo-Nepal trade and transit deadlock has become a sort of economic warfare putting rise in the cost of living index to a considerable extent. This is one of the reasons, which made shareholders to expect higher demand for satisfactory dividend.

·         The waiting of five years with peanut dividend in previous year is equally a strong enforceable reason of the bank’s shareholders to expect handsome dividend already assured and committed in various reports of the earlier annual general meeting.

·         One way to encourage risk-taking ability and preference is to have proper risk-return trade off by bank’s management board in a way that higher return must be the investment rule for higher risk-takers that comprise bank’s shareholder.

Pradhan  (2017) in his articles “Stock market behaviors in a small market: A case of Nepal"  has conducted a study on small market Behavior  in A Small Capital Market : A Case of Nepal in 2016. It is pertinent to put forth here because he has analyzed various ratios related to dividend and market price of shares. The study was based on the pooled-cross sectional data of 17 enterprises.

The objectives of this study were as follows:

·         To assess the stock market behavior in Nepal.

·         To examine the relationship of market equity, market value to book value, price-earning , and dividends with liquidity, profitability, leverage, assets turnover and interest coverage.

Some findings of his study, among others, were as follows:

i)              Stocks with larger ratio of dividend per share to market price per share have higher liquidity. Liquidity position of stocks paying lower dividends is also more variable as compared to stock paying higher dividends.

ii)            Stocks with larger ratio of dividend per share to market price per share have lower leverage ratios. So, leverage ratios of stocks paying smaller dividends are also more variable as compared to stocks paying higher dividends.

iii)          Stocks with larger ratio of dividend per share to market price per share also have higher earnings. But these earning ratios of stocks paying larger dividends are also more variable as compared to stocks paying smaller dividends.

iv)          Positive relationship is observed between the ratio of dividend per share to market price per share and turnover ratios. Stocks with larger ratio  of dividend per share to market price per share also have higher turnover ratios. Turnover ratios of stocks paying larger dividends are also more variable than that of stocks paying larger dividends are also more variable than that of stocks paying smaller dividends.

v)            There is also positive relationship between the ratio of dividend per share to market price per share and interest coverage. Stocks with higher ratio of dividend per share to market price per share also have higher interest coverage. Interest coverage stocks paying larger dividends is also more variable as compared to stocks paying smaller dividends.

vi)          So, in conclusion, it indicates positive relationship of dividend per share to market price per share with liquidity, profitability, assets turnover and interest coverage; and negative relationship with leverage.

Sharma (Rajopadhaya) (2012) conducted a research on “Dividend policy with respect to insurance companies in Nepal”. The objectives of this research were;

·         To identify the existing practice of dividend policy in insurance companies.

·         To find out the impact of dividend per share of the market price of the stock.

·         To examine whether there is significant different or not among DPS,EPS and DPR on the selected companies.

·         To know if there is any relationship between market value per share (MVPS) ON dividend policy and other financial indicator such as DPS, EPS, DPE, PE Ratio, liquidity ratio.

Some major Findings of the study are pointed out as:

a.       The average DPS and EPS of NLGICO and NICO is satisfactory compared to ICO and UICO.

b.      The insurance companies are new in dividend distribution.

c.       The analysis of coefficient of variation indicates largest fluctuation in PICO and UICO.

d.      The dividend is fluctuation in all sample in all sample insurance companies.

Dividend Policies Practices

In this section, an attempt has been made to review of the major studies concerning dividends and stock prices and management views on dividend policy.

Lintner (1956) conducted a study on corporate dividend policy in the American context. He investigated a partial adjustment model as he tested the dividend patterns of 28 companies. According to John Lintner’s  study, dividends are ‘sticky’ in the sense that they are slow to change and lay behind shifts in earnings by one, or more periods. According to J lintner, dividend is a function of earnings of that year, existing dividend rate, target payout ratio and speed of adjustment . The followings were the basic objectives of the study:-

a)      To identify occasions when a change in dividends might well have been under active consideration even though no change was made.

b)       To determine the factors existing most actively into dividends.

He concluded that a major portion of a firms dividend could be expressed in the following manner.

DIV_t*=PEPS_t                                                  (1)

andDIV_t-DIV_t-1=a+b(DIV_t* - DIV_t-1)+e_t       (2)

Adding DIV_t-1 on both sides of equation (2)

DIV_t= a+bDIV_t*+(1-b)DIV_t-1+et                   (3)

Where,

DIV_t*=Firm’s desired payment

EPS_t= earnings

P= Targeted payout ratio

a= constant relating to dividend growth

b=adjustment factor relating to the previous period’s dividend and new desired level of dividends where, b<1

The major findings of this study were as follows:-

1.      Firms generally think in terms of proportion of earnings to be paid out.

2.      In order to modify the pattern of dividend, investment opportunities, liquidity position, funds flow are not considered.

Firms generally have target payout ratios in view while determining change dividend rate or dividend per share.

Modigliani and Miller (1961) conducted a study on the irrelevance of dividend. This is popularly, known as mm approach. It is sometimes termed as Dividend Irrelevance model.

According to mm, dividend policy of a firm is irrelevant as it does not affect the wealth of the stockholders. They argue that the value of the firm depends on the earning power of the firm’s assets or its investment policy. Thus, when the investment policy is given, the dividend decision-splitting the earnings into packages of retentions and dividends does not influence the value of equity shares. In other words, the division of earnings between dividend and retained earnings is irrelevant from shareholders viewpoint.

In general, the argument supporting the irrelevance of dividend valuation is that dividend policy of the firm is a part of its financing decisions. As a part of the financing decisions of the firm, the dividend policy of the firm is a residual decision and dividends are passive residual.

Rules Regarding Dividend Practices in Nepal

Some legal provisions for dividend payment in the Nepal. Nepal company’s Act 1997 makes these provisions may be seen as- under. Section 2(m) states that bonus share (stock dividend) mean share issued in the form of additional shares to shareholders by capitalizing the surplus from the reserve fund or profit of the company. The term also indicates an increase in the paid up values of the shares after capitalizing the surplus from the reserve fund or the profit of the company. The term also indicates an increase in the paid up values of the shares after capitalizing surplus from the reserve find or the profit of the company. The term also indicates an increase in the paid up values of the shares after capitalizing surplus from the reserve fund or the profit of the company. The term also indicates an increase in the paid up values of the shares after capitalizing surplus or reserve funds.

Section 47 has prohibited company from purchasing, its own share. This section states that no company shall purchase its own shares or supply loans against the security of its own shares.

Section 137 bonus share and subsection (1) states that the company must inform the office before issuing bonus shares. Under subsection (1) this may be done only according to a special resolution passed by the general meeting.

Section 140 dividends and subsequent of this section as follows.

Sub section (1) states that except in the following circumstances, dividends shall be     distributed among the shareholders within 45 days from the date of decision to distributed them.

·         In case of any law forbids the distribution of dividends.

·         In case of the right to dividend is disputed.

·         In case of dividend cannot be distributed within the time limit mentioned above owing, the circumstances beyond any one’s control and without any fault on the part of the company.

Sub section (2)in case dividends are not distributed with the time limit, mentioned in sub section (1) this will be done by adding interest at the prescribed rate sub section (3) states only the person who has registered in the register of existing  shareholders at the time of declaring the dividend shall be entitled to it.

Factors affecting dividend policy

Dividend decision is the critical decision for the management various factors should be considered while taking dividend decision. Following factors influenced dividend decision directly or indirectly.

a. Legal rules

The legal rules are important in establishing the legal boundaries with in which a firms finalized dividend policy can operate. These rules have to do with capital impairment, insolvency and undue retention of earning

i. Capital impairment rule

Some states define capital as the total par value of the common stock. If a firm’s shareholder’s equity consists of $4million in common stock (at par),$3 million in additional paid-in-capital and $2million in Retained earnings, total capital would be $4million. This company could not pay a cash dividend to tell more than $5million without impairing capital (i.e., reducing shareholders equity before $4 million).

Other states define capital to include not only the total per value of the common a stock But also the additional paid in capital. Under such state states dividends can be paid only to the extent of retained earnings. Notice, we did not say that dividend can be paid “out of retained earnings.” A company pay dividends “out of cash “while incurring a corresponding reduction in the retained earnings account.

ii. Insolvency rule

Some states prohibit the payment of cash dividend if the company is solvent. Insolvency is defined either in a legal sense, as total liabilities of a company exceeding its assets  “at a fair valuation” or,in a” equitable”(technical)sense, as the firm’s inability to pay its creditors as obligation come due. As the firm’s ability to pay its obligations is dependent on its liquidity rather than on its capital, the equitable (technical) solvency restriction gives creditors a good deal of protection. When cash is limited, a company is restricted from favoring  shareholders to the determent of creditors.

iii. Undue retention of earnings rule

The internal revenue code prohibits the undue retention of earnings. Although undue retention is vaguely defined, it is usually though to mean retention significantly in excess of the present and future investment needs of the company. The purpose of the law is to present companies from retained earnings for the sake of avoiding takes.

a. Liquidity position

Profits held as the retained earnings (which show up on the right hand side of the balance sheet) are generally invested in plant and equipment, inventories, and other assets, they are not held as cash. Thus even if a firm has record of earnings, it may not be able to pay cash dividends because of its liquidity position. Indeed, a growing firm, even a very profitable one, typically has a processing need for funds, in such a situation a firm may elect not to pay cash dividends.

b. Need to repay debt

When a firm has issued debt to finance expansion or to substitute for other forms of financing, it is faced with two alternatives. It can refund the debt at maturity by replacing it with another form of security, or it can make provisions for paying off the debt at maturity by replacing it with another form of security, or it can make provisions for paying off the debt. If the decision is to retire the debt, this will generally require the retention of earnings.

c. Restriction in debt contains

Debt contracts particularly when long-term debt is involved, frequently restrict a firm’s ability to pay cash dividends such restrictions, which are designed to protect the designed to protect the position of lender, usually state that(1) future dividends can be paid only out of earnings generated after the signing of the loan agreement (that is, they cannot be paid out of past retained earnings ) and (2) that dividends cannot be paid when net workings capital (current assets minus current liabilities) is below a specified amount. Similarly, preferred stock agreements generally, state that no cash dividends can be paid on the common stock until all accrued preferred dividends have been paid.

d. Stability of earnings

A firm that has relatively stable earnings is often able to predict approximately when its future earnings will such a firm be therefore more likely to pay out a higher percentage of its earnings than is a firm fluctuating earnings. The unstable firm is not certain that subsequent years the hoped for earnings will be realized, so it is likely to retain a high proportion of current earnings. A lower dividend will be easier to maintain if earnings fall off in the future.

e. Profit rate

The expected rate of return on assets determines the relative attractiveness of paying out earnings in the form of dividends to stockholders (who will use then elsewhere) or using  them in the present enterprise.

f. Rate of asset expansion

The more rapidly a firm is growing, the greater its needs for financing asset expansion. The greater the future need for funds, the more likely the firm is to retain  earnings rather than pay then out. If a firm is to raise fund externally, natural sources or the present shareholders, who already know the company . But if earnings are paid as dividends and are subjected to high personal income tax rates, only a portion of them will be available for investment.

g. Access to the capital markets

A large, well established firm with a record of profitability and stability of earnings has access to capital markets and other forms of external financing. A small, new or venturesome firm, however, is riskier for potential investors. Its  ability to raise equity or debt funds  from capital markets is restricted, and it must return more earnings to finance its operations. A well-established firm is thus likely to have a higher dividend payout rate than is a new or small firm.

h. Control

Another important variable is the effect of alternative sources of financing on the control situation of the firm. As a matter of policy, corporations expand only to the extent of their internal earnings. This policy is defended on the ground that raising funds by selling additional common stock dicules the control of the dormant group in that company. At the same time, selling debt increases the risks of fluctuating earnings to the present owners of the company. Reliance on internal financing in order to maintain control reduces the dividend payout.

Constant payout ratio and Low regular plus extra

Constant payout ratio

Another form of stable dividend policy is constant target payout ratio. The term payout refers, as already mentioned, to the ratio of dividend to earnings of the percentage share of earnings used to pay dividend. A stable dividend payout ratio implies that the percentage of earnings paid out each year is fixed Accordingly, dividend would fluctuate proportionately with earnings and are likely to be highly volatile in the wake of wide fluctuations in the earnings of a firm decline substantially or there is loss in a given period, the dividends accordingly to the target payout ratios, would be low or nil. To illustrate, if a firm has a policy of 50%target payout ratios, would be low or nil.

Low regular plus extra

Under this policy both dividend policy (constant dividend per share and constant dividend payout ratio) are included. Under this policy, a firm usually pays a constant dividend to the shareholders and when the firm swells, additional or extra dividend is paid over and above the regular dividend per share. Generally this type of policy is mostly followed by those companies whose stockholders prefer at least a certain account of regular dividends.