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CHAPTER 9

CONCLUSIONS AND FUTURE RESEARCH AND

THINKING

9.1 CONCLUSIONS

Academic researchers cannot specify a theoretical optimal dividend policy that

simultaneously fits all firms (a macro-level policy). Because of the complexities

involved, it is skeptical that a one-size-fits-all theory of dividend policy will ever gain

acceptance. Over the years researchers have proposed numerous theories on how

imperfections—various market frictions—might influence dividend policy. Each firm

faces a combination of potentially different market frictions with varying levels of

relevance; the optimal dividend policy for each firm may be unique. If each firm has a

uniquely optimal dividend policy, one should not be surprised that significant

statistical generalizations still elude researchers. Existing models studying the impact

of dividend policy on firms' value cannot fully reflect the complexities of the market

environment. The goal of this research is to provide a comprehensive framework to

assist managers in making dividend policy decisions.

Corporate Financial Managers view dividend decision as important and relevant

decision. However any advice offered to managers on how to set their dividend

policies must be made at the firm-specific level. These Corporate Financial managers

must examine how the various market frictions affect their firms, as well as their

current claimholders, to arrive at "Optimal" dividend policies for their firms.

Usually management of a firm believes that three market frictions are relevant to a

firm: They are taxes, asymmetric information, and agency costs. The firm's managers

should evaluate the impact on a dividend decision of each market friction in isolation

and then consider the potentially complex interaction of the three imperfections

before formulating a reasonable dividend policy. The figure 9.1 shows the competing

frictions framework, or schematic model. If a balance of scale is considered on which

the merits of the dividend policy are weighted on t he right-hand side against dividend

policy irrelevance on the left-hand side as illustrated in 9.2. Panel (a) reflects the view

of dividend policy relevance in a world of perfect capital markets, in which the scale

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strongly tips toward the irrelevance of dividend policy. In Panel (b) portrays the scale

in a world beset with market imperfections. It is believed that the forces of market

frictions tip the scale toward the relevance of dividend policy. For certain firms,

specific frictions will have a large influence; for other firms these same market

imperfections may be insignificant. In other words, the weights on the market

frictions will differ from firm to firm.

Figure 9.1: The "Balance Scale" of Dividend Relevance

Source: Lease, C,.Ronald, John Kose, Kalay Avner,Loewenstein Uri,Sariq H.Oded,

“Dividend Policy: Its Impact on Firm Value”

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Figure 9.2: The Competing Friction Model

Source: Lease, C,.Ronald, John Kose, Kalay Avner,Loewenstein Uri,Sariq H.Oded,

“Dividend Policy: Its Impact on Firm Value”

In the forthcoming sections the big three imperfections have been discussed and their

interaction with the little frictions has been discussed. An attempt has also been to

throw light on how financial managers should incorporate these imperfections into

their decision-making.

9.1.1 THE BIG THREE MARKET IMPERFECTIONS AND THEIR

INTERACTION WITH LITTLE FRICTIONS

9.1.1.1 Taxes

Firms should have a reasonable idea of the identity of their main categories of

shareholders. The attributes of the shareholders generally can be classified as:

Investors who prefer capital gains,

Investors who prefer dividend income, and

Low Payout

High Payout

Asymmetric information

High Payout

High payout

Low Payout

Taxes Agency costs

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Investors who are tax-neutral.

Evidence supporting the existence of tax-induced dividend clienteles of shareholders

is limited. It may be stated such tax- induced clienteles may not exist in India as

dividend income is tax exempt for shareholders. However, literature believes that

investors have a tendency to self-select into investing in firms that have dividend

payouts that best match their tax circumstances.

However, in the long-run, one tax-induced dividend clientele should be as good as

another. Because of the potential importance of tax considerations in making the

dividend policy decision, financial managers should keep a close eye on changes in

the tax code. Substantial changes may dictate a shift in dividend policy. The dual

moral of this discussion is, Know Both The Investors and Tax Code!

9.1.1.2 Agency Costs

Firms should adopt a dividend policy that allows implementation of an investment

policy that maximizes market value. In general, firms should not underpay dividends.

Retained funds should be invested in projects that pass the NPV Rule. Having too

much cash lying around is an ill-advised investment. Consistent with this observation

is research that illustrates that the market responds positively to the announcement of

increases in capital expenditures.

In short, excessive cash balances increase managers' degree of investment flexibility,

which may be to the detriment of shareholders. After all, managers experience a

normal set of human temptations. If management compensation and/or prestige is

based on firm size or sales, managers may be tempted to over invest in projects or to

acquire other firms that may not be strategically advisable nor value enhancing.

Several researchers have identified dividend payments as a source to mitigate agency

conflicts.

In general, high-growth firms can afford to write strict or tight dividend constraints

that severely limit their ability to pay future dividends. Moreover, dividends are less

important to investors in high-growth firms who seek out these firms in the

expectation of receiving little, if any, dividend income. Dividend slack decreases the

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protection of debt holders and results in an interest rate that is too high relative to the

risk of the debt.

For the opposite reasons, low-growth firms should negotiate looser dividend

constraints. With a scarcity of future positive NPV investments, these firms are likely

to generate large free cash flows that should be paid to shareholders. Without the

dividend payout commitment, overinvestment may be a temptation. Dividend slack

under the constraints is desirable in case of future economic setbacks and the desire to

maintain a high dividend payout level.

Highly leveraged firms can write strict dividend policy constraints. Heavy debt

service obligations limit these firms' ability to overinvest, and frequent refinancing

provides capital market discipline. Indeed, empirical research indicates that growth

firms and firms with higher leverage, all else being equal, choose tighter dividend

constraints and pay fewer dividends (Kalay 1979). Thus, the evidence suggests that

many financial practitioners share these views.

9.1.1.3 Information Asymmetry

Research consistently has shown that dividend changes convey significant

information to the market. One of the most compelling pieces of empirical evidence

regarding dividends is the announcement effect of dividend changes on share prices.

Several empirical studies have documented significant increases in share prices when

firms initiate payment of dividends for the first time or after a hiatus of at least five

years. Several studies also have documented share-price increases on announcement

of dividend increases versus dramatic share-price decreases when firms reduce

dividends. Hence managers must be aware of documented market reactions before

they make dividend policy decisions.

The empirical evidence also documents that the market infers different messages with

respect to different dividend types. For instance, the market reacts more strongly to

regular dividend increases relative to specially designated dividends, or dividends

labeled extra or special.

Decreases in free cash flows should not be accompanied by dividend cuts, unless the

reduced levels of free cash flow are expected to continue into the future. Investors

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interpret dividend cuts as especially bad news, and share prices decline dramatically

when dividend cuts are announced.

Similarly, managers should be cautious about large increases in dividends, again to

avoid the possibility of subsequent dividend decreases. If increases in free cash flows

occur and are expected to persist, the dividend increases should be made gradually

over time. Alternatively, or simultaneously with the increase in dividends, a firm

should declare some of the distribution as a specially designated dividend or engage

in some share repurchases, along with smaller dividend increases. This approach

avoids making implicit (optimistic) statements that later may have to be reversed.

Again, while the market's interpretation of the underlying cause of dividend changes

is not well understood, it is not known that such changes are met with significant

market reactions. This observation supports an effort to smooth dividends in relation

to expected free cash flows over time as suggested by the John Lintner (1956)

Similarly little market imperfections can also have an impact on firms’ dividend

policy decisions. Considered in isolation, the existence of transaction costs favors a

managed dividend policy. If firms have a consistent and stable dividend policy—

whether the policy is high, low, or no distribution—investors can select the policy that

best matches their consumption and tax profiles.

Similarly, flotation costs favor a residual policy when considered in isolation.

Flotation costs can be substantial, especially for small firms and small equity issues.

Accordingly, small firms should pay out cash only if operating cash flows exceed

expected capital expenditure levels. Managing dividends will, almost without doubt,

result in a higher level of flotation costs.

In the real world, imperfections affect firms interactively, and managers should

consider these interactions when making dividend policy decisions.

The number of permutations of the six market imperfections discussed is large. For

instance, we could consider a market setting that includes (1) taxes and agency costs,

(2) taxes and asymmetric information, (3) taxes plus transaction and floatation costs,

(4) agency costs plus floatation costs, or (5) asymmetric information, taxes,

transactions costs, and flotation costs.

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9.1.2 STRATEGIES IN DEALING WITH MARKET IMPERFECTIONS

Dealing strategically with market imperfections can be diagrammed on

multidimensional axes in a competing frictions model, as illustrated in Figure 9.2

wherein the frictions (imperfections) are weighted by management's assessment of

importance. Managers should qualitatively mark each market imperfection having an

impact on their firm on a continuum reflecting their assessed level of importance. The

managers can sequentially analyze the dividend policy implications of the relevant

imperfections. Decisions on the trade-offs among imperfections must be made in the

context of their relative importance.

For example, if the management believes that three market imperfections—taxes,

asymmetric information, and agency costs—are relevant to the dividend decision for

their firm. Further, they believe that these imperfections affect their dividend decision

in this same order of importance. Within this framework, the managers consider each

imperfection in isolation and then in combination to arrive at their choice of dividend

policy. (Refer again to Figure 9.2)

The present study is a fact finding research and complicated in nature like the other

functional areas of finance. In course of the study the importance and nature of

dividend decision in Indian corporate sector has been examined. The various

dimensions of dividend decisions have been dealt in the light of the existing theories

on dividend policy. The detailed review of empirical studies and the research work

has provided a direction and insight into various determinants having a direct bearing

on the dividend policy decision of the firm. This may help the financial managers in

handling the crucial and the complicated dividend policy decision-making. The

analysis of trend of dividend payout ratio tries to bring a close shot on payout policy

of the companies belonging to select sample industries.

The analysis of the determinants of dividend policy in select sectors in India based on

sophisticated statistical models highlighted the determinants that best explains

dividend policy in Indian IT, FMCG and Service sectors in India. Thus, this analysis

provides adequate information to the investors, managers and researchers to know the

relative significance of the various determinants influencing the dividend payment

decision of companies.

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As discussed in the section on literature review dividend relies on two sets of

explanation. Dividend signaling or information asymmetry models and secondly

agency costs. Both explanations to the dividend theories have been studied in the

present research work.

This study has tested empirically the agency cost theory, Lintner model, dividend

signaling and smoothing effects using a framework of various econometric models.An

attempt has also been made to identify linkage of dividend decision with shareholders’

wealth.

Assuming that dividend has information content and managers try to make efforts to

smooth dividend payments, the validity of the Lintner model in the select sectors under

study was tested. This also highlighted to what extent dividend smoothing efforts are

done by managers in the three sectors chosen for study.

Out of the chosen sectors Lintner model fits well in the FMCG sector signifying that

the dividend signaling and smoothing effects are present. Thus these firms follow

stable dividend policy year on year basis, even though earnings might change

dramatically. The findings in the FMCG sector are in alignment with Brave et.al that

managers are very reluctant to cut dividends once they are initiated. This reluctance

leads to dividends that are sticky, smoothed from year to year and tied to long run

profitability of the firm.

The regularity of dividend payment and constancy of its rate is an important objective

of the dividend policy followed by the Chief Finance officers of the FMCG sector. The

findings reflect the companies ensure that the current dividend signals their

performance and the desire of management to maintain a stable dividend.

The target payout ratio in FMCG sector hovers with in the range of 69% to 128%. The

partial adjustment factor is found to be 0.115 to0.52, which lies between one sixth and

one half as highlighted by Lintner in his findings. Due to strong bias against dividend

cuts, increase in earnings is translated into increase in dividends only gradually to

avoid future downward revision. It may be stated that the principal determinant of

dividend policy in FMCG sector is profitability. Thus, FMCG firms use dividends to

signal their surge in profit margins over the years. These findings are in conformity

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with Mookerjee Rajen(1992)who found that Lintner model is successful in explaining

dividend payout behavior of private corporate sector.

The amount of dividend distributed during the previous year was also found to be a

significant factor governing the dividend distribution of the current year. The results

in FMCG sector is in conformity with the pattern seen in developed economies like

USA and Germany and is in agreement with the studies by Fama and Babiak (1968)

and Behm and Zimmermann (1993).

However, IT sector and service sector demonstrated a pattern, which is seen in

emerging economies like Tunisia, Zimbabwe and Turkey. These sectors are

characterized by high target payouts coupled with high speed of adjustment

coefficient. The target payout ratio in service sector derived from β1 lies between the

broad ranges of 31 to 35%. This is relatively a low target payout ratio as compared to

what was suggested by Lintner. The partial adjustment factor is found to be with in

the range of 0.369 to 0.5278, which lies between one sixth and one half as

highlighted, by Lintner in his study. The choice of a particular speed of adjustment

factor depends upon possible variations in net earnings after tax and stability of

dividends required. Stable net earnings after tax would induce a management to

choose a higher adjustment coefficient. But if net earnings were subject to wide

fluctuations, a desire to have stable dividend would lead to choosing lower adjustment

coefficient.

It may be stated that the principal determinant of dividend policy in Service sector is

profitability. The results signify that Service sector companies score high on dividend

stability. Firms in Service sector use cash dividends to signal their prosperity to the

shareholders. The results are in agreement with the previous studies on banking

industry, which state that banks use their dividend history to set their dividend. These

results were established by Dickens N.Ross and Newman.A.Joseph in their study

“Bank Dividend policy: explanatory factors” and Pal Karam and Goyal Puja “Leading

determinants of Dividend policy: A case study of the Indian Banking Industry”. Bodla

B.S.,Pal Karam ,Sura S Jasvir “Examining Application of Lintner’s Dividend Model

in Indian Banking Industry”

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The firms in IT sector are not averse to cut dividends. Profits seem to be a noteworthy

determinant of dividend payments during entire time period under study. PAT is

significant at 5% level depicting for all the IT firms profitability is an indispensable

factor to be considered while determining dividend policy. But it should always be

kept in mind there are other factors also apart from profitability that may affect

dividend payments. However the regression coefficient of Div(t-1) is insignificant

showing that dividend paid during current year is not governed by dividend paid

during previous year. This also proves the fact that only one of the variables given by

Lintner has an impact on dividend declared by the firms in IT sector.

The target payout ratio in IT sector revolves around 30%. This payout ratio is lower

than target payout ratio of 50 % suggested by Lintner. As regards the speed of

adjustment coefficient the value lies between 1.16 to 1.51, which is much higher

compared to what was suggested by Lintner.This high speed of adjustment coefficient

denotes that actual changes in the dividend may be much higher than desired changes.

This low target payout ratio coupled with high speed of adjustment factor shows the

absence of dividend smoothing and dividend signaling. The IT firms’ dividend payout

fluctuates with changes in the earnings. This suggests that higher dividend payout is

witnessed in IT industry only in the case of increased profitability of the companies.

Any variation in the earnings is quickly reflected in dividend payment.

Firms in the IT sector use dividends to signal their surge in profit margins over the

years. The regularity of dividend payment and constancy of its rate is not an important

objective of the dividend policy followed by IT industry in India. These findings are

validated by the fact that IT sector is characterized by low target payout ratio and high

speed of adjustment factor.

Thus, the analysis of the first objective has unearthed the applicability of smoothing

and signaling approaches and relevance of information asymmetry models in IT,

FMCG and Service sectors in India.

Through the analysis of second objective it was found that there are sectoral

differences in corporate dividend policy determinants. The results are consistent with

the conclusion of Baker, Farrelly, and Edelman (1985) and Ho Horace (2002) that

firm’s industry type influence dividend policy. A factor which may be relevant for one

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industry becomes irrelevant for another depending upon the industry characteristics

like growth phase, ownership pattern, size, systematic risk and earnings variability.

The period undertaken for study i.e. 2000-2008 covered both recessionary and

booming phases of Indian IT sector and FMCG sector. A shift in the dividend

payment pattern was observed in the IT sector as there was hike in the dividend

payout ratios of the major companies belonging to this sector. The firms in IT sector

do not use dividends as a medium to signal their prosperity to the shareholders. The

findings reflect that there is lesser information asymmetry in this sector. The

information is becoming more and more symmetrical due to better Corporate

Governance practices adopted by IT companies.

IT sector is a human intensive sector and do not require huge capital asset base like manufacturing

companies for their operations. The major asset of this sector is manpower. The funds required for

recruitment and retention of manpower is comparatively less than funds required for purchasing

capital assets. So these firms can easily release funds for payment of dividends. Also a negative

relationship between liquidity can be attributed to the fact that agency problems are not very

relevant so that monitoring mechanism i.e. dividend payout may be less needed. A negative

regression coefficient of liquidity and Dividend Payout ratio can be attributed to the fact that in IT

sector capital gains are preferred to cash dividends.

Retained earnings are a vital variable governing the Dividend Payout ratio of IT firms.

The results show that Factor of retained earnings and Leverage is positively related to

DP ratio. Generally, higher debt equity ratio may negatively influence the dividend

payout of company. But in case of IT firms the proportion of debt in the total capital

structure of the company is relatively low as they are very low debt or zero debt

companies eg. Infosys (a zero debt company). Therefore, Bondholders do not consider

dividend payment as a way to expropriate their value. The positive relation depicts

that debt holders do not reduce the cash available for the dividend by imposing debt

covenants and related restrictions. This positive relationship between Dividend payout

ratio and Debt equity ratio is in alignment with the findings of Easterbrook(1984)

.According to him firms with high leverage are those whose value shifting is

potentially costly. Such firms are expected to pay large dividends.

The Factor of profitability and pecking order, long-term solvency, Shareholders

wealth and earnings variability, have not emerged as an imperative factors

affecting the dividend payout ratios of IT firms

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FMCG sector recovered from its prolonged slump in 2005. FMCG companies have

been known to be generous dividend distributors to its shareholders. These stocks

were known as ‘dividend yield’ stocks till 2004.The companies maintained consistent

dividend payouts to some extent even when the profits were not on surge. After 2004,

FMCG stocks were purely viewed as ‘dividend growth stocks’ since the companies

deployed their resources for sustaining larger product baskets . The FMCG companies

adopted a CAPEX mode and started ploughing profits for future expansion plans. But

the high profitability enabled the firms to continue pay encouraging dividends even

after retaining a part of the profits. HLL, Godrej, ITC are among the top dividend

payers.

FMCG companies are known to be generous payers of dividend due to their strong

cash flow and minimal Capex requirement. Indian FMCG companies like their global

peers have developed some strong brands, sustained stable growth, high dividend

payout and high return on net worth (RONW)

The analysis of the second objective showed that Profitability is a primary

determinant factor for dividend distribution. FMCG companies score high on

dividend stability and consistency, as Lagged dividend and PAT are important factors

governing dividend distribution. These findings are in alignment with the findings of

Aharony and Wary(1980),Asquith and Mullins(1983), Petit(1972) ,John and

Williams(1980), Bhattacharya(1979), Miller and Rock(1985).

The quality of cash flows, which is a measure of liquidity of the firm and firm size are

found to be a note worthy determinant of the dividend payout. According to previous

research studies larger firms face lower issuing cost and external debt financing

making it easier to raise funds. Thus, they can go for generous dividend payouts.

These findings are consistent with the findings of Smith and Watts (1992).

The opportunities for future growth and expansion are found to be negatively related

to dividend payout ratio. Larger is the growth and investment opportunities available

to the firm, lesser is the incentive to pay dividends as the firms prefer to retain larger

proportion of profits. According to Pecking order hypothesis, firms should prefer to

finance investment by retentions rather than debt. The regression results also disclose

negative and significant relationship with Retained earnings and Capital Expenditure

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during the current year. This result is in alignment with the existing literature, which

suggests that results are logically, and theoretically correct. In other words, dividend

decisions are not independent of uses of corporate funds and changes in fixed assets

i.e. capital expenditure is an important determinant of dividend payments in FMCG

sector.

The systematic risk, earnings variability and financial risk obstruct the stable dividend

payout but the results report that in case of FMCG sector in India the Dividend Payout

ratio is increasing even if the firm faces higher risk.

Dividend Payout ratio is found to be positively related to long term solvency of the

firm. But this relationship is significant at 10% level. The firms in FMCG sector

operate with very low level of debt .At the same time these firms are highly liquid

firms, therefore increase in debt proportion in capital structure do not put pressure on

firms capacity to pay dividend and consequently a positive relation can exist between

Debt Equity ratio and Dividend Payout ratio through the results Dividend are less

important to investors in high growth firms who seek out these firms in the

expectation of receiving little dividend income as these firms need outside financing

regularly and therefore are subject to the discipline of frequent capital market

scrutiny. This also indicates lesser degree of conflicts between bondholders and

shareholders. The bondholders do not reduce the cash available for dividend

distribution by imposing indenture restrictions.

Indian service sector comprises of trade hotels, transport, communication, IT and

software, banking and insurance etc. Till 2002 service sector was ignored in India and

the main emphasis was on manufacturing and agricultural sector. It was only after

2002 that service sector started growing at a healthy rate of 8-10%. Today it is the

highest contributor to the GDP of our economy.

The dividend payout of service sector in India has increased leaps and bounds in last

few years. These hefty dividend payments can be attributed to surged profitability of

firms in this sector.

The results portray that higher the earnings variability higher will be dividend paid by

the companies in Service sector. A positive relationship has also been reported

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between Dividend payout ratio and long-term solvency. Higher ICR indicates that the

firm is financially sound to meet its precommited cash outlays in form of interest

A finding of the study that refutes the existing literature is that through the analysis a

negative relationship has been found between firm’s size and the dividend payout

ratio.This finding is not consistent with Pecking order hypothesis and stands in sharp

contrast with results in Smith and Watts (1992). Larger companies despite having the

opportunity to tap easily the financial markets by issuing stocks or bonds prefer to

retain dividends so as to avoid the costly external financing. Moreover, small firms,

which are more risky, need to have a high payout ratio, in order to attract investors to

buy their stocks.

The analysis of third objective demonstrates that the influence of ownership pattern on

the dividend payout is heterogeneous. It has been observed that there are sectoral

differences in impact and influence of ownership groups on dividend payout. India is a

common Law country characterized by strong investor protection and dispersed

ownership (the role of the insider is played by the manager), hence the agency conflicts

are not so severe and cash dividends may not be essential to mitigate the agency

conflicts.

The results in terms of ownership variables in IT sector give an interesting picture.

The debt equity regression coefficient is positive which is strikingly different from the

negative linear relationship proposed by studies in the past. The positive relationship

can be interpreted in the sense that agency conflicts are not so grave in the Indian IT

sector. This relationship highlights lesser conflicts between two groups of

stakeholders i.e. shareholders and bondholders in the Indian IT sector. Stockholders

may expropriate wealth from bondholders by paying themselves dividends.

Bondholders try to contain this problem through restrictions on dividend payments in

bond indenture. Thus, the positive relation depicts that debt holders do not reduce the

cash available for the dividend by imposing debt covenants and related restrictions.

This positive relationship between Dividend payout ratio and Debt equity ratio is in

alignment with the findings of Easterbrook(1984). According his research firms with

high leverage are those whose value shifting is potentially costly. Such firms are

expected to pay large dividends. The positive relation may also exist because the debt

proportion in capital structure of IT companies is very less eg.Infosys. Low-leveraged

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firms also should negotiate looser dividend constraints relative to firms with high debt

levels to provide future flexibility. Low debt service obligations mean less debt

refinancing and discipline imposed by capital markets. Accordingly, dividends and

dividend slack are relatively more important. Moreover, since debt levels are low

anyway, wealth transfers to bondholders by maintaining slack is not a significant

concern.

The further analysis in the IT sector results are consistent with Manager Entrenchment

hypothesis depicting that institutional holding regression coefficient is positive in

level and negative in square. This implies that upto a certain threshold43, dividends act

as substitute for corporate governance. After the threshold the direct monitoring

efforts of institutional holders are insufficient or become too costly. Therefore,

dividend payments are increased so that managers are forced to raise finance from

external capital markets and acts as an external monitoring device. These results are in

agreement with the findings of Short, Zhang and Keasey 2002, and Farinha, 2003). A

non-monotonic and parabolic relationship has been established by the research in IT

sector for the period under study. This in conformity with the findings of Demsetz and

Lehn(1985) and Schleifer and Vishny(1986)

A negative sign of Institutional holding can be justified on the grounds that they act as

a monitoring device reducing the need of high dividend payments.). However, it also

suggests that institutions may influence higher dividend payouts by a company to

enhance managerial monitoring by external capital market, as their own monitoring

efforts may be insufficient or too costly. Higher dividends would thus push the firms

frequently towards capital market for raising funds. The positive relationship occurs

beyond a certain thresh hold44

Institutional investors, most of whom are banks and Financial Institutions (either as

shareholders or debt holders) are also the creditors to the firm and to protect their

credit they may hold low level of holding.They prefer paying themselves interest

rather paying dividends. However at low level of holding, their benefit from the

dividends payout may be less than that at high level of holding. Thus, institutional

43 Jayesh Kumar in his study on association between corporate Governance and dividend payout identified this threshold level to be 25 % 44 Jayesh Kumar(2006) identified this threshold level to be 25%

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shareholders have negative impact on payout at low level of shareholding and positive

impact after certain threshold level of holding.

An analysis of pooled data regression results in IT sector showed that FII holding also

has an effect on the dividend payout ratio at higher levels of holding because it is

significant negatively related to dividend payout ratio in square. However promoter

holding is significantly negatively related to dividend payout ratio in level and

positively in square. Most of the IT companies in India have high promoter holding.

In the recent scenario companies like Wipro Ltd. have been generous in rewarding

their owners with cash dividends than some of the largest business groups in the

country. In FY07, the dividend earnings of promoters grew around 20% over the

previous year more than twice the rate of earnings growth of non- promoters. Since

the dividends are tax-free for promoters in India, they prefer rewards in form cash

dividends as their controlling stake in the company increases. Thus, promoter holding

and Institutional holding have emerged as the two major ownership groups that have

an impact on dividend payout ratios of companies in IT sector.

As regards Service sector, linear relationship between ownership groups and Dividend

payout ratio is found to be a better fit. FII holding has a major influence on dividend

payout ratios. This sector became active post liberalization i.e. after opening up of the

Indian economy. The foreign institutional investors negatively influence the dividend

payout of Service sector companies. During last 8 years there has been a significant

increase in FII holding in Service sector companies chosen as sample for this research

work. But still the percentage of shares owned by this group is relatively lower as

compared to other ownership groups. According to previous research studies a

positive and significant relationship between FII and dividend payout can be expected

only at higher levels of holding. According to Jayesh Kumar (2006) beyond a

threshold of 10%, FIIs may be interested in investing only in specific firms that are

well managed and profitable or vice versa and may target such firms only for their

investments. They may be going systematically after quality or systematically seeking

out under performing assets. Thus, FII holding may be higher for firms, which are

profitable and consequently pay higher dividends.

An explanation for the negative relationship could be that according to dividend

signalling hypothesis, dividends and institutional ownership can be viewed as two

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alternative means of signalling. Since the presence of the specific investors can, by

itself, act as a signal of satisfactory profitability, mitigating the need for maintenance

of a high dividend yield for informational reasons. This leads to the conclusion that

FII holding in a firm may signal the prosperity of the firm to the shareholders.

Therefore, such a firm may not pay huge dividends. Higher is the holding lower will

be the dividend payout.

However in the FMCG sector none of the ownership groups were found to have

considerable influence on dividend payout.It has been found out that shareholding

pattern is not an important variable that influence the dividend policy of the FMCG

companies. The relationship varies for different types of shareholders and at different

levels. In other words, it can be said there is no uniform influence of the shareholding

pattern on dividend policy of the company. The results Random effect model show

that corporate holding is a major ownership variable that influences dividend payout.

A close look at the shareholding pattern of companies in FMCG sector indicates that

the level of corporate holding in total holding is comparatively less. Therefore,

Corporate bodies view dividend payment as a source to mitigate the agency conflicts.

Results indicate no significant relationship of corporate holding with Dividend Payout

ratio at higher levels of holding.The results also show that there is not much impact of

liberalization and foreign institutional investors for determination of dividend payout

ratios of the FMCG companies as this variable is found to be insignificant in all the

Models under study. The results Random effect (Model IV) also denotes a significant

negative relationship between Debt equity ratio and dividend payout at 10% level

which in agreement with existing literature. This relationship can be attributed to the

fact that high-growth firms with low leverage and broad ownership, dividends are

relatively more important in controlling potential agency conflicts between managers

and shareholders. All else being equal, dividend payments force a firm—especially a

high-growth firm—to the capital markets more regularly. The scrutiny provided by

the capital markets limits the extent of managements' self-serving behavior.

The regression results indicate that none of Models developed to study the impact

ownership groups has fitted well in FMCG sector. Thus, it can be stated that

ownership groups is not a significant factor determining the dividend payment

patterns and decisions in the FMCG sector.

272

Through the analysis of the fourth objective it has been found that cash dividends may

not always create abnormal returns for the shareholders. In the modern scenario a

gradual drift to other modes of payment of dividends has been observed. Small

abnormal returns on dividend announcement can also be attributed to the fact that the

dividend announced is below the investors’ expectations. More so, dividend income,

being a marginal constituent in investment return, may not inspire much to the over

enthused investors in rising capital markets. The findings of the research highlight that

in Service sector investors respond positively to cash dividends announcements

whether increasing or decreasing. Thus, the investors in this sector welcome cash

dividends. Considering the statistical significance of CAARs and AARs it can be said

that signaling hypothesis partially holds. However abnormal returns are created in

FMCG sector but they are not sustained over the event window and gradually CAARs

become negative. However, in the IT sector no significant abnormal returns are

generated on dividend announcement.

The results in IT sector do not strongly refute the informational efficiency of the

markets. To some extent semi-strong form of market efficiency is highlighted through

the analysis. Though positive abnormal returns of 0.83% and 1.18 % are generated on

cash dividend announcements but they are not statistically significant. The stock

prices do react positively on dividend announcement but abnormal returns generated

are not found to be statistically significant. The shareholder value could not be

sustained in the post announcement period. This can be attributed to the fact that the

corporates usually face constraints to declare lesser dividends due to the possibility of

large cash outflows on account of taxes. Therefore, dividend announced may be much

below investors’ expectations.

In FMCG sector the results showed that the investors lost more value in ex dividend

period than the value gained in the pre dividend announcement period. Thus, it can be

stated that dividend announcements do not carry information about future earnings

and cash flows of the companies. Dividend payout may not add to shareholders

wealth if the companies have positive net present value projects in hand. The findings

of the Market model strongly refute the signalling hypothesis and information content

of dividends. These results are in alignment with findings of many authors who have

dismissed the information role of dividend as unimportant. They suggest that equally

273

efficacious, cheaper alternatives exist through which managers can disseminate

information (e.g., Miller and Modigiliani; Petit 1972,Black 1976 ; Stern 1979).

In Service sector, the results cannot be taken in support and endorsement of

information efficiency because of positive incidence of AARs and CAARs and their

corresponding statistical significance. The results indicate semi- strong form of

market efficiency because any information content associated with dividend

announcements is not absorbed in the price movement on the announcement day only

but it leads to abnormal returns during post dividend announcement period also. This

is alignment with the findings of Ball and Brown (1968), Fama et.al(1969),Gupta

(2001) and Chaturvedi(2001).Thus, the results partially support the dividend-

signalling hypothesis in the Service sector. The reason for the partial support can be

attributed to the fact that not all the positive incidences of AARs and CAARs in the

event window are statistically significant .This information content of dividends

hypothesis has been formalized by Bhattacharya (1979, 1980), John and Williams

(1985), Miller and Rock (1985), Ambarish et al. (1987) and Offer and Thakor (1987).

This research work has made an attempt to evaluate the three crucial sectors of Indian

economy (IT, FMCG and Service) on the basis of four commonalities. These

commonalties are Lintner dividend Model, 21 variables affecting the dividend payout

ratios (based on literature survey) ownership patterns and agency conflicts and finally

dividend linkages with shareholders’ wealth maximization. On the whole the findings

of this research indicate that inspite of the fact that managers view dividend decisions

as important it cannot be concluded that market rewards a carefully managed dividend

policy with higher share price. In India finance managers typically view dividend

decisions as an important part of their job. The typical firm does not follow a residual

policy nor leave its dividend payout to chance. Rather, firms manage their dividends as

proposed by Lintner’s model and partially follow stable dividend policy. The results

are in support of semi-strong form of market efficiency. The study also by and large

supports the signaling and information content of dividend. A sectoral difference in

determinants of dividend payout ratios has been observed. The results also indicate

that in Indian context the impact of ownership groups on dividend payment is

heterogeneous.

274

9.2 FUTURE RESEARCH AND THINKING

The trouble of people is not that they don’t know, but that they know so much that

ain’t so- Henry Whealer Shaw; Josh Billing’s Encyclopedia of Wisdom.

No research work is complete without suggesting the directions for future research.

The research work offers numerous links that can be picked up by future researchers

in Corporate Finance more specifically in the area of ‘Dividend Policy’.

The research has primarily focused on empirically testing the validity of Lintner

Dividend model in IT, FMCG and Services sector respectively. How the various

determinants of dividend payout ratios vary across the sectors? Most importantly,

dividend announcements and its linkages with shareholders’ wealth has been

analyzed.

As revealed through the research, ownership groups influence the dividend payout of

a company. There is a significant scope for investigating further the relationship

between dividends and ownership over a longer period of time and to compare the

behavior of Indian firms with other countries’ corporations. A second possibility for

future extension of the present study is to examine the interactions between dividend

policy and other financial decisions and ownership structure. Examining the influence

of board structures on dividend payout policy can also be a future area of research.

More studies especially, in emerging economies are needed which can increase the

understanding of the relationship between block holders’ identity (ownership

concentration) on dividend policy. A well-known fact is controlling the corporation

also makes it possible to control dividend decisions. There may be controlling groups

in the organization, which may influence dividend payout ratio of a company.

However the influence on dividend decisions may depend on controlling groups’

perspective and their preferences. The three groups that are affected the most by the

firm’s dividend policy are stockholders, bondholders and managers. How the

controlling groups’ perspective and preferences change in different situations and its

corresponding impact on dividend payout policy requires more attention.

The research covers three sectors of Indian economy. Accordingly, further research is

needed to explore the issues surrounding payout policy more fully by extending the

275

research to other sectors of Indian economy. Every possible effort has been made to

make the study more intensive and practicable but the time and resources have been

the limiting factors due to which there may exist some gaps in the present study.

Hence future research may be directed to bridge the gap so as to enhance the scope of

analysis. Most of the previous empirical studies on dividend determinants done in

Indian context have focused on manufacturing sector. These studies predominantly

include Kumar Jayesh (2001); Mishra and Narender (1996). One of the sectors on

which the present research has focused is Services sector. Therefore, in future a

comparative study between Dividend policy determinants of Service and

Manufacturing sector can be conducted. This would reveal the sectoral differences in

the dividend policy determinants.

This research has examined the impact of a set of 21 variables on dividend payout

ratios of three respective sectors. Through the work done an attempt has been made to

suggest a comprehensive framework that can be useful to the companies, investors

and regulators in three chosen sectors for analysing dividend policy. The future

research on dividend payout determinants in Indian context can investigate two

possible issues. First of all, one may examine the suitability of the statistical methods

applied in studying dividend payout policy. There is no prior guarantee that the

relationship between dividend payout and its determinants is of linear form (an

assumption made in majority of the empirical studies). Furthermore, better proxies of

the existing determinants may be identified to obtain better results.

In Indian context, several studies have empirical analysed Lintner dividend Model

(1956). The present research work has tested the validity of Lintner Dividend Model

using pooled data and static panel data analysis. However, a step ahead could be to

empirically test the Lintner model using a framework of Dynamic panel data models.

The Lintner dividend model, which is a finance classic, is based on survey of CFOs of

top 28 American Corporations. Subsequently many other survey researches have been

reported which also gained popularity but till date Lintner model remains a “finance

classic”. Other survey researches include Baker et al. (1985); Farrelly et al. (1986);

Baker and Farrelly (1988); Pruitt and Gitman (1991); Lazo (1999);Mohanty (1999);

Baker and Powell (2000); and Baker et al. (2001). So far in Indian context Anand

Manoj (2002) has done a survey research on dividend policy determinants. He did

276

survey of 81 CFOs of Business Today 500 companies to find out the determinants of

the dividend policy decisions of the corporate India.

Therefore, one of the future research directions can be to do a survey of CFOs to

identify determinants having a significant bearing on dividend payout ratios of the

three sectors under study. Such research can be undertaken using a survey method

approach and a sample of corporate financial managers can be asked about the factors

they consider most important at the time of formulating the dividend policy. This will

assist assessment of management’s perception about factors governing dividend

policy decisions. Further this will also facilitate researchers to know whether

managers in different industries (categorized by age, size, investment and industry

group) in India share similar views about determinants of dividend policy or not.

It is a well-established fact the characteristics of capital markets vary according to the

difference in cultural, financial, legal and political environment of a country. These

environmental factors cause differences in the level of disclosure requirements of

stock markets in response to various levels of political, financial and economic risks,

which have implications for dividend policies. Given the diversity in corporate

objectives and environments, it is conceivable to have divergent dividend policies that

are specific to firms, industries, markets, or regions. Researchers may try to

investigate the extent to which dividend policy is affected by environmental variables,

and interactions among the environmental variables in three sectors chosen for study.

Further impact of legal systems, institutional factors on dividend policies can be

examined. Dividend policy decisions and their linkage with level of investor

protection in India could also be ascertained in line with the studies done by La Porta

et al. (2000).

However, till date little attention has been paid to the market reaction of dividend

initiation announcements, which, according to Asquith and Mullins (1983), are less

likely to be anticipated. A dividend initiation is defined as dividend payments by a

firm for the first time in its entire corporate history or after a hiatus of more than three

years. Several studies in USA and UK have been undertaken to study the impact of

dividend initiation on shareholders’ wealth. Most prominent and popular studies in the

area are Asquith and Mullins (1983), Dielman and Oppenheimer (1984), Healy and

Palepu (1988), Michaely et al. (1995), Mitra and Owers (1995), Howe and Shen

277

(1998) and Alangar and Bathala (1999). The present research focuses exclusively on

finding the impact of dividend announcement on shareholders’ wealth in IT, FMCG

and Services sector. An attempt can be made in future to study the dividend initiation

impact in these three sectors as most of studies done in Indian context have focused

stocks listed on Bombay stock exchange.

The share price reaction to dividend initiation may also differ according to the

information environment in which the firms operate. Therefore the empirical studies

may be extended to study share price reaction to initial dividend announcements

across different information environments. Conceptually, dividend information

announcement should provoke stronger price reaction to a “low information

environment” relatively to a “high information environment”. Similarly, the volatility

increase during the event period should also be higher for “low information

environment” firms due to higher uncertainty compared to “high information

environment” firms. Therefore, a study can be done in three sectors under question to

examine how initiation impact varies for a firm operating in “low information

environment” to a “high information environment”.

At the same time the estimation of post announcement stock price and profitability

performance for dividend-initiating firms across different information environments

should also be examined.

This research has made an endeavor to find the impact of cash dividend

announcements (whether increases or decreases) on shareholders’ wealth. Future

research in this area can focus on examining the impact of cash dividend increases and

decreases announcements on shareholders wealth separately. The impact of alternative

modes of dividend distribution like bonus issue and stock buybacks on shareholders’

wealth can also be investigated. This is because it is presumably a possibility that

market returns of the companies declaring dividend through alternative modes can be

higher as these alternative forms are gradually gaining popularity.

Therefore, it is well understood that despite promising theoretical and empirical work,

more research is needed to provide a satisfactory theoretical model; more explicitly

specified empirical tests, and guidance to managers concerning optimal dividend

policy.

278

Finally, according to Baket et.al (2002,p.257) “ Researchers have identified all the

key pieces of the dividend puzzle but need to focus their attention on developing firm-

specific dividend model. If this puzzle is jigsaw puzzle, different firms use different

combinations of puzzle pieces to form different pictures of the firm. This results

because each firm has different characteristics, managers, and stockholders”. In

nutshell, further work is necessary to explore the possibility of additional factors that

will suggest added guidelines in setting an optimal dividend policy.

Dividend puzzle has remained unexplained over half a century and still it can be

stated: “The harder we look at the dividend picture, the more it seems like a puzzle,

with pieces that just don’t fit together”. This research work is a humble contribution

to solve dividend puzzle existing in the field of Corporate Finance.

This thesis is an attempt to covey the true economic meaning of the dividend

phenomenon to the investors and financial decision makers. If this thesis can make a

contribution towards the better understanding of dividends, and dividend policy, the

untold number of trees that were required to print the thesis were not cut down for

naught.

279

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