STOCK MARKET REACTION TO DIVIDEND ANNOUNCEMENT
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Transcript of STOCK MARKET REACTION TO DIVIDEND ANNOUNCEMENT
A Final Project Report
on
‘‘STOCK MARKET REACTION TO DIVIDEND
ANNOUNCEMENT’’
Submitted to
PUNJAB TECHNICAL UNIVERSITY
JALANDHAR
In the partial fulfillment of the requirement for the
award of degree of
Master of Business Administration (MBA)
Submitted by Project Guide
Shaina Swara Ms Neha Kalra
1172467 Assistant Professor
SESSION (2011-2013)
APEEJAY INSTITUTE OF MANAGEMENT TECHNICAL CAMPUS
JALANDHAR
1
PREFACE
As MBA course requires equal attention towards practical as well as theoretical aspects
of business, various problems are to be dealt with in that course. That’s why research
programs are there to give deep as well as thorough knowledge of subjects and problems
that are practical whenever one entered in the profession. A research project constitutes
the backbone of any management education program. A management student has to quite
frequently do the research work during his entire span. Research programs are included in
the curriculum of various management courses so as to provide students with practical
knowledge and exposure to professional life.
My project entitled ‘Stock Market Reaction To Dividend Announcement’. A sincere
effort has been made to bring about clear facts and I hope that this report meets the given
expectations and various requirements of the research. I am highly gratified that I have
done this project and I am highly obliged to those respected persons who chosen us for
this work. And I duly ensure this work as an original work of mine and not a copy work.
The most motivating aspect associated with pursuing a course in management or business
studies is the dynamism associated with it. Dynamism of adding a new perspective to
one’s personality and vision by accumulating wider knowledge, developing analytical
skills not only by traditional ways of teaching and learning but by observing ‘things at
work’. The project is an opportunity to see the application part of what we study or learn
in classrooms. Management is that function of an enterprise that concerns itself with the
direction and control of the various activities to attain business objectives. It is the
science and art of preparing, organizing and directing human efforts to control the force
and utilize the materials of nature for the benefit of men. As a matter of fact, the
management thereby provides the scientific technique to deal with the various problems
in the areas of management and the manager mixes some art to it and tries to shorten the
gap of ignorance. It provides a chain of solution to critical problems of manager.
2
ACKNOWLEDGEMENT
Nothing concrete can be achieved without an optimal combination of inspiration and
perspirations. I owe a sense of gratitude to the intelligence and co-operation of those
people who had been so easy to let me understand what i need from time to time for
completion of this exclusive project. I am greatly indebted to Mr. Rajesh Bagga
(Director), Ms. Neha Kalra and Ms. Nitika Sehgal (Assistant Professor) for their
advice and help which enabled me to finish this project report properly in time. I am also
thankful to all the respondents whose valuable information helped me considerably in the
successful completion of the study. I have furthermore to thank my friends for all their
help, support, interest, valuable hints and much needed motivation. Last but not the least,
I am very grateful to all those who had helped me in one way or the other at every stage
of my work.
Date: Shaina Swara
3
CERTIFICATE
This is to certify that the project report entitled “Stock Market Reaction to Dividend
Announcement” submitted by Shaina Swara is a bonafide piece of work conducted
under my direct supervision and guidance. No part of this work has been submitted for
any other degree of any other university. The data sources have been duly acknowledged.
It may be considered for evaluation in partial fulfillment of the requirement for the award
of degree of Master of Business Administration.
Date: Ms. Neha Kalra
Asst Professor
4
TABLE OF CONTENTS
Preface
Acknowledgment
Certificate
2
3
4
CHAPTER NO. CHAPTER TITLE PAGE NO.
1. Introduction 6-34
2. Review of Literature 35-38
3. Need, Scope & Objectives of the Study 39-41
4. Research Methodology 42-46
5. Data Analysis & Interpretation 47-50
6. Findings of the Study 51-52
7. Conclusion 53-54
References 55-56
Annexure
A. Questionnaire
57-61
5
Chapter 1INTRODUCTION
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1. The Indian Stock Market
In India, there are 19 recognised stock exchanges. However, as per the legal structure,
these stock exchanges are divided into two main groups. One group consist of 16 stock
exchanges namely Madras Stock Exchange, Cochin Stock Exchange, Bhubaneswar Stock
Exchange, OTCEI, Inter-connected Stock Exchange, Guwahati Stock Exchange,
Bangalore Stock Exchange, Vadodara Stock Exchange, Delhi Stock Exchange, Calcutta
Stock Exchange, Pune Stock Exchange, Jaipur Stock Exchange, Uttar Pradesh Stock
Exchange, Ludhiana Stock Exchange, National Stock Exchange (NSE), Coimbatore stock
exchange that were started by companies which were limited by shares or by guarantees.
The second group consist of 3 stock exchanges namely Bombay Stock Exchange (BSE),
Madhya Pradesh Stock Exchange and Ahmedabad Stock Exchange which earlier were
established as an association of persons and then transformed into companies later.
In India, all the stock exchanges are supervised and regulated by the Securities and
Exchange Board of India (SEBI), a regulatory authority. SEBI was set up in April, 1992
as a regulatory authority to protect investor's interest and to regulate and develop the
securities market in India. As per SEBI's regulations all the stock exchanges needed to
complete the process of demutualisation and corporatisation. However, except for
Coimbatore stock exchange the remaining 18 stock exchanges are operating as profit
companies limited by shares which have been demutualised and corporatized.
Although there are 19 stock exchanges, the BSE and NSE are the two main and important
stock exchanges functioning in India. For the study undertaken in this paper, firms listed
in BSE 100 are taken into consideration.
In Asia, BSE is the oldest stock exchange by being in existence for 133 years starting in
1875.However, in 1956 as per the Securities Contracts (Regulation) Act (1956), BSE
received a permanent recognition making it to become the first stock exchange to get
such recognition in the country by the Government of India. As of today, among
exchanges it ranks at the first position for the number of companies listed and for number
of transactions it ranks at the fifth position. As on 31st December 2007, BSE had a
market capitalization of about USD 1.79 trillion. BSE has aided in the growth of the
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corporate sector in India by enabling the firms to take to their advantage and efficiently
benefit from the various resources offered by the BSE. Majority of the companies have
raised resources using the services of BSE from the capital market. The Bombay Stock
Exchange provides 21 indices out of which 12 are sectoral indices.
BSE 100 is one of the indices offered by the Bombay Stock Exchange. It was launched
on 3rd January 1989 as was earlier called BSE National Index.BSE 100 consist of 100
scrips i.e. companies from various industry sectors and trading on different exchanges.
The BSE 100 index covers movement of share prices of companies on national level.
Since 2004 it has adopted the free float methodology for computation. This is a method to
construct an index which is based on the concept of free float where the shares that are
readily available for trade in the market in the normal course. It excludes the shares that
are held by any strategic investors, government holdings and the promoter holdings. Such
a way of calculation thus reduces the market capitalisation of a company to only the
number of shares that could be traded in the market every day. This helps to trace the
current trends in the market easily. It does not allow only a few companies with large
market capitalisations to dominate the index thus making the index a very broad based
one. Free float index is beneficial for investors having both active and passive style of
investment. An active investor can compare his or her realised returns to a benchmark
which is a closer representation of an investible index. In case of a passive investor it
reduces the tracking error. Free float mechanism has been notably adopted by various
developed market index providers like MSCI, FTSE, S&P and STOXX. In this regard,
firms listed on BSE 100 made an ideal choice to be the sample for this study.
1.1 INTRODUCTION ABOUT BOMBAY STOCK EXCHANGE (BSE)
Established in 1875, BSE Ltd. (formerly known as Bombay Stock Exchange Ltd.), is
Asia’s first Stock Exchange and one of India’s leading exchange groups. Over the past
137 years, BSE has facilitated the growth of the Indian corporate sector by providing it an
efficient capital-raising platform. Popularly known as BSE, the bourse was established as
"The Native Share & Stock Brokers'Association"in1875.
8
BSE is a corporatized and demutualised entity, with a broad shareholder-base which
includes two leading global exchanges, Deutsche Bourse and Singapore Exchange as
strategic partners. BSE provides an efficient and transparent market for trading in equity,
debt instruments, derivatives, mutual funds. It also has a platform for trading in equities
of small-and-medium enterprises (SME). Around 5000 companies are listed on BSE
making it world's No. 1 exchange in terms of listed members. The companies listed on
BSE Ltd command a total market capitalization of USD Trillion 1.06 as of May 15, 2012.
BSE Ltd is world's fifth most active exchange in terms of number of transactions handled
through its electronic trading system. It is also one of the world’s leading exchanges (5th
largest in May 2012) for Index options trading
BSE also provides a host of other services to capital market participants including risk
management, clearing, settlement, market data services and education. It has a global
reach with customers around the world and a nation-wide presence. BSE systems and
processes are designed to safeguard market integrity, drive the growth of the Indian
capital market and stimulate innovation and competition across all market segments. BSE
is the first exchange in India and second in the world to obtain an ISO 9001:2000
certification. It is also the first Exchange in the country and second in the world to
receive Information Security Management System Standard BS 7799-2-2002 certification
for its On-Line trading System (BOLT).
It operates one of the most respected capital market educational institutes in the country
(the BSE Institute Ltd.). BSE also provides depository services through its Central
DepositoryServicesLtd.(CDSL)arm.
BSE’s popular equity index SENSEX - is India's most widely tracks stock
market benchmark index. It is traded internationally on the EUREX as well as leading
exchanges of the BRCS nations (Brazil, Russia, China and South Africa).
Vision
Emerge as the premier Indian stock exchange with best-in-class global practice in
technology, products innovation and customer service.
9
Heritage
BSE Ltd, the first ever stock exchange in Asia established in 1875 and the first in the
country to be granted permanent recognition under the Securities Contract Regulation
Act, 1956, has had an interestingrisetoprominenceoverthepast137years.
While BSE Ltd is now synonymous with Dalal Street, it was not always so. The first
venue of the earliest stock broker meetings in the 1850s was in rather natural environs -
under banyan trees - in front of the Town Hall, where Horniman Circle is now situated. A
decade later, the brokers moved their venue to another set of foliage, this time under
banyan trees at the junction of Meadows Street and what is now called Mahatma Gandhi
Road. As the number of brokers increased, they had to shift from place to place, but they
always overflowed to the streets. At last, in 1874, the brokers found a permanent place,
and one that they could, quite literally, call their
own.Thenewplacewas,aptly,calledDalalStreet(Brokers'Street).
The journey of BSE Ltd. is as eventful and interesting as the history of India's securities
market. In fact, as India's biggest bourse in terms of listed companies and market
capitalisation, almost every leading corporate in India has sourced BSE Ltd. services in
raising capital and is listed withBSELtd.
Even in terms of an orderly growth, much before the actual legislations were enacted,
BSE Ltd. had formulated a comprehensive set of Rules and Regulations for the securities
market. It had also laid down best practices which were adopted subsequently by 23 stock
exchanges which weresetupafterIndiagaineditsindependence.
BSE Ltd., as a institutional brand, has been and is synonymous with the capital market in
India. Its SENSEX is the benchmark equity index that reflects the health of the Indian
economy.
BRAND IDENTITY
Bombay Stock Exchange has now adopted only its initials as the new name (BSE),
positioning itself better position as a national multi-asset financial infrastructure
institution. BSE’s strategic shift in approach, attitude and business focus is reflected in its
newtagline- ExperiencetheNew.
10
With renewed zeal and focus on new business opportunities, product and service
innovation, upgrades in technology, increased investor and member focus, BSE is always
pushing the envelope on all fronts. The ambition is to continually improve and adopt new
and better ways of conduction of business.
As the first stock exchange in Asia and the pioneer of securities transaction business,
BSE prides itself on being at the forefront of bringing innovations to the Indian capital
markets while creating diverse investment opportunities for the investor community in
India throughout its long history.
BSE continues to undertake several initiatives to build on its strong brand, legacy and
market position to create value for its stakeholders and the financial system.
ACHIEVEMENTS
At par with international standards, BSE Ltd. has been a pioneer in several areas over the
decades and has many firsts and key achievements to its credit. BSE is the first exchange
in India to
Launch a special platform for trading in SME securities
Introduce Equity Derivatives
Launch a Free Float Index - SENSEX
Launch Exchange Enabled Internet Trading Platform
Obtain ISO certification for a stock exchange
Exclusive facility for financial training – BSE Institute Ltd.
Launch its website in Hindi and regional languages
Host the popular opening-bell ceremony in Indian capital markets
Launch mobile-based trading in India in Sept 2010
Become securities market infrastructure member of SWIFT in India and provide
corporate actions to custodians in ISO 15022 format
Launched SENSEX Realized Volatility (REALVOL) Index in Nov 2010
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Besides the above, BSE has taken large strides in product and service innovation for the
benefit of its members and investors, notable ones being
Launch of a reporting platform for corporate bonds
Launch of the BSE IPO index and PSU website
Revamp of its website with wide range of new investor-friendly features
Launch of trading in SENSEX futures on EUREX and leading exchanges of the
BRICS nation bloc
Launched Smart Order Routing for members and investors
Introduced SACT (SMS alert & Complaint Tracking system)
Launched co-location facility at BSE premises in November 2010
Reduction in membership fees to Rs. 10 lakh for new memberships to promote
financial access and inclusion
Launch of web-based mutual fund trading platform for investors
AWARDS AND RECOGNITION
As a pioneering financial institution in the Indian capital market, BSE has won several
awards and recognitions that acknowledge the work done and progress made.
The Golden Peacock Global CSR Award for its initiatives in Corporate Social
Responsibility
BSE has won NASSCOM - CNBC-TV18’s IT User Awards, 2010 in Financial
Services category
BSE has won Skoch Virtual Corporation 2010 Award in the BSE StAR MF
category
Responsibility Award (CSR), by the World Council of Corporate Governance
Annual Reports and Accounts of BSE have been awarded the ICAI awards for
excellence in financial reporting for four consecutive years from 2006 onwards
Human Resource Management at BSE has won the Asia - Pacific HRM awards
for its efforts in employer branding through talent management at work, health
management at work and excellence in HR through technology.
12
CSR (Corporate Social Responsibility)
Corporate Social Responsibility (CSR) in BSE is aligned with its tradition of creating
wealth in the community with a three pronged focus on Education, Health and the
Environment. Besides funding charitable causes for the elderly and the physically
challenged, BSE has been supporting the rehabilitation and restoration efforts in
earthquake-hit communities of Gujarat. BSE has been awarded the Golden Peacock
Global - CSR Award for its initiatives in Corporate Social Responsibility (CSR) by the
World Council of Corporate Governance.
Overview Of The Corporate Sector
As compared to corporate governance in developed countries, Indian corporate
governance is quite different. In India, the corporate sector is not homogenous but
contains a mixture of companies from government and private sector. The private sector
again is a mixed bag of firms where the ownership ranges from multinationals to family
business or individually owned firms. Various activities of corporate like share holders'
rights, company's administration and governance, dividend announcements and various
other disclosures etc take place under the legal framework of the Companies Act
(1956).This legal framework has been fairly stable over the years.
As observed in various other emerging markets, the structure of ownership of corporate
firms in India is also categorized by large shareholders. Generally the largest
shareholders are given incentives and also the right to manage key decisions (e.g.
dividend payout).In India also, the discretion of how much dividend to announce or
whether not to announce any dividend only is solely dependent of the company's
directors.
The Companies Act (1956), section 205 has set up certain rules and guidelines for all
corporate firms which announce or pay dividend during any financial year. Under the
section 205 (2),dividends announced or paid by firms must be out of its profits for that
year or previous year after taking depreciation into consideration for that year or previous
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year respectively or could be out of both the profits. Another option under section 205
allows companies to pay or announce dividends from the money which the Central or a
State government provides towards the dividend payment in order to fulfil any guarantee
which the Government has given. Under section 205 (A),any company declaring
dividend should deposit the dividend amount within 5 days from the dividend declaration
date in a separate bank account and within 30 days form dividend announcement date
should pay the dividend declared.
Generally in India, companies announce and pay dividends two times in a year which is
known in form an interim and a final dividend. As seen companies pay dividend out of its
profits and is like giving shareholders part of its earnings. Hence for shareholders
dividends act as a source of income. In India, to actually understand amount a company
pays out of its profits and the amount it retains to plough back for enhancing the business,
dividends announced are generally conveyed on basis of ‘per share' like for example Rs 4
per share. To better understand the above mentioned sentence let's take an example. For
instance, a company has Rs 8 earnings per share in the year and declares and pays Rs 4
dividend per share which implies that the company is distributing to its shareholders half
of its profits and retaining other half to plough back into the business. This acts as a
signal to the shareholders that the company is prospering leading to further investments
and leading to increase in share price when a company announces to pay dividends.
Hence in case the company declares a decrease in dividend per share, the market reacts
looking at the stock as a growth opportunity for their investment since the company is
now investing an increased surplus of funds in much more profitable ventures. Therefore
in India, amount a company declares as dividend on per share basis is very crucial as
investors judge the future prospects of the company on the amount it retains for
reinvestment into profitable business activities based on the dividend per share declared.
1.2 DIVIDEND
Dividends are payments made by a corporation to its shareholder members. It is the
portion of corporate profits paid out to stockholders. When a corporation earns a profit or
surplus, that money can be put to two uses: it can either be re-invested in the business
14
(called retained earnings), or it can be distributed to shareholders. There are two ways to
distribute cash to shareholders: share repurchases or dividends. Many corporations retain
a portion of their earnings and pay the remainder as a dividend.
A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a
dividend in proportion to their shareholding. For the joint stock company, paying
dividends is not an expense; rather, it is the division of after tax profits among
shareholders. Retained earnings (profits that have not been distributed as dividends) are
shown in the shareholder equity section in the company's balance sheet - the same as its
issued share capital. Public companies usually pay dividends on a fixed schedule, but
may declare a dividend at any time, sometimes called a special dividend to distinguish it
from the fixed schedule dividends.
Cooperatives, on the other hand, allocate dividends according to members' activity, so
their dividends are often considered to be a pre-tax expense.
Dividends are usually paid in the form of cash, store credits (common among retail
consumers' cooperatives) and shares in the company (either newly created shares or
existing shares bought in the market.) Further, many public companies offer dividend
reinvestment plans, which automatically use the cash dividend to purchase additional
shares for the shareholder.
The word "dividend" comes from the Latin word "dividendum" ("thing to be divided")
Joint stock company dividends
A dividend is allocated as a fixed amount per share. Therefore, a shareholder receives a
dividend in proportion to their shareholding.
Forms of payment
Cash dividends (most common) are those paid out in currency, usually via electronic
funds transfer or a printed paper check. Such dividends are a form of investment income
and are usually taxable to the recipient in the year they are paid. This is the most common
15
method of sharing corporate profits with the shareholders of the company. For each share
owned, a declared amount of money is distributed. Thus, if a person owns 100 shares and
the cash dividend is USD $0.50 per share, the holder of the stock will be paid USD $50.
Dividends paid are not classified as an expense, but rather a deduction of retained
earnings. Dividends paid does not show up on a Income Statement but does appear on the
Balance Sheet.
Stock or scrip dividends are those paid out in the form of additional stock shares of the
issuing corporation, or another corporation (such as its subsidiary corporation). They are
usually issued in proportion to shares owned (for example, for every 100 shares of stock
owned, a 5% stock dividend will yield 5 extra shares). If the payment involves the issue
of new shares, it is similar to a stock split in that it increases the total number of shares
while lowering the price of each share without changing the market capitalization, or total
value, of the shares held.
Property dividends or dividends in specie (Latin for "in kind") are those paid out in the
form of assets from the issuing corporation or another corporation, such as a subsidiary
corporation. They are relatively rare and most frequently are securities of other
companies owned by the issuer, however they can take other forms, such as products and
services.
Interim dividends are dividend payments made before a company's annual general
meeting (AGM) and final financial statements. This declared dividend usually
accompanies the company's interim financial statements.
Other dividends can be used in structured finance. Financial assets with a known market
value can be distributed as dividends; warrants are sometimes distributed in this way. For
large companies with subsidiaries, dividends can take the form of shares in a subsidiary
company. A common technique for "spinning off" a company from its parent is to
distribute shares in the new company to the old company's shareholders. The new shares
can then be traded independently.
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Reliability of dividends
There are two metrics which are commonly used to gauge the sustainability of a firm's
dividend policy.
Payout ratio is calculated by dividing the company's dividend by the earnings per share.
A payout ratio greater than 1 means the company is paying out more in dividends for the
year than it earned.
Dividend cover is calculated by dividing the company's cash flow from operations by the
dividend. This ratio is apparently popular with analysts of income trusts in Canada.
Dividend dates
Any dividend that is declared must be approved by a company's Board of Directors
before it is paid. For public companies, there are four important dates to remember
regarding dividends. These are discussed in detail with examples at the Securities and
Exchange Commission site
Declaration date is the day the Board of Directors announces its intention to pay a
dividend. On this day, a liability is created and the company records that liability on its
books; it now owes the money to the stockholders. On the declaration date, the Board
will also announce a date of record and a payment date.
In-dividend date is the last day, which is one trading day before the ex-dividend date,
where the stock is said to be cum dividend ('with [including] dividend'). In other words,
existing holders of the stock and anyone who buys it on this day will receive the
dividend, whereas any holders selling the stock lose their right to the dividend. After this
date the stock becomes ex dividend.
Ex-dividend date (typically 2 trading days before the record date for U.S. securities) is
the day on which all shares bought and sold no longer come attached with the right to be
paid the most recently declared dividend. This is an important date for any company that
has many stockholders, including those that trade on exchanges, as it makes
17
reconciliation of who is to be paid the dividend easier. Existing holders of the stock will
receive the dividend even if they now sell the stock, whereas anyone who now buys the
stock will not receive the dividend. It is relatively common for a stock's price to decrease
on the ex-dividend date by an amount roughly equal to the dividend paid. This reflects
the decrease in the company's assets resulting from the declaration of the dividend. The
company does not take any explicit action to adjust its stock price; in an efficient market,
buyers and sellers will automatically price this in.
Book closure Date Whenever a company announces a dividend pay-out, it also
announces a date on which the company will ideally temporarily close its books for fresh
transfers of stock.
Record date Shareholders registered in the stockholders of record on or before the date
of record will receive the dividend. Shareholders who are not registered as of this date
will not receive the dividend. Registration in most countries is essentially automatic for
shares purchased before the ex-dividend date.
Payment date is the day when the dividend cheques will actually be mailed to the
shareholders of a company or credited to brokerage accounts.
Effect on stock price
After a stock goes ex-dividend (e.g. the financial obligation for the company to pay the
dividend to the holder), the stock price should drop.
To calculate the amount of the drop, the traditional method is to view the financial effects
of the dividend from the perspective of the company. Since the company has paid say $x
in dividends per share out of its cash account on the left hand side of the balance sheet,
the equity account on the right side should decrease an equivalent amount. This means
that a $x dividend should result in a $x drop in the share price.
A more accurate method of calculating this price is to look at the share price and dividend
from the after-tax perspective of a share holder. The after-tax drop in the share price (or
capital gain/loss) should be equivalent to the after-tax dividend. For example, if the tax of
18
capital gains Tcg is 35%, and the tax on dividends Td is 15%, then a $1 dividend is
equivalent to $0.85 of after tax money. To get the same financial benefit from a capital
loss, the after tax capital loss value should equal $0.85. The pre-tax capital loss would be
$0.85/(1-Tcg) = $0.85/(1-35%) = $0.85/65% = $1.30. In this case, a dividend of $1 has
led to a larger drop in the share price of $1.30, because the tax rate on capital losses is
higher than the dividend tax rate.
Finally, security analysis that does not take dividends into account may mute the decline
in share price, for example in the case of a Price–earnings ratio target that does not back
out cash; or amplify the decline, for example in the case of Trend following.
Other corporate entities
Cooperatives
Cooperative businesses may retain their earnings, or distribute part or all of them as
dividends to their members. They distribute their dividends in proportion to their
members' activity, instead of the value of members' shareholding. Therefore, co-op
dividends are often treated as pre-tax expenses. In other words, local tax or accounting
rules may treat a dividend as a form of customer rebate or a staff bonus to be deducted
from turnover before profit (tax profit or operating profit) is calculated.
Consumers' cooperatives allocate dividends according to their members' trade with the
co-op. For example, a credit union will pay a dividend to represent interest on a saver's
deposit. A retail co-op store chain may return a percentage of a member's purchases from
the co-op, in the form of cash, store credit, or equity. This type of dividend is sometimes
known as a patronage dividend or patronage refund, as well as being informally named
divi.
Producer cooperatives, such as worker cooperatives, allocate dividends according to their
members' contribution, such as the hours they worked or their salary.
19
Trusts
In real estate investment trusts and royalty trusts, the distributions paid often will be
consistently greater than the company earnings. This can be sustainable because the
accounting earnings do not recognize any increasing value of real estate holdings and
resource reserves. If there is no economic increase in the value of the company's assets
then the excess distribution (or dividend) will be a return of capital and the book value of
the company will have shrunk by an equal amount. This may result in capital gains which
may be taxed differently than dividends representing distribution of earnings.
Mutuals
The distribution of profits by other forms of mutual organization also varies from that of
joint stock companies, though may not take the form of a dividend.
In the case of mutual insurance, for example, in the United States, a distribution of profits
to holders of participating life policies is called a dividend. These profits are generated by
the investment returns of the insurer's general account, in which premiums are invested
and from which claims are paid. The participating dividend may be used to decrease
premiums, or to increase the cash value of the policy. Some life policies pay
nonparticipating dividends. As a contrasting example, in the United Kingdom, the
surrender value of a with policy is increased by a bonus, which also serves the purpose of
distributing profits. Life insurance dividends and bonuses, while typical of mutual
insurance, are also paid by some joint stock insurers.
Insurance dividend payments are not restricted to life policies. For example, general
insurer State Farm Mutual Automobile Insurance Company can distribute dividends to its
vehicle insurance policyholders.
When a company distributes to its shareholders the profits earned by it, it is said that it
has paid dividends to its shareholders. Thus, dividend is the payment made by a company
to its shareholders out of its distributable profits. It is calculated as a percentage of the
nominal value of their shares, which is fixed for holders of preference shares and
20
fluctuating for holders of equity or ordinary shares. Distributable profits are the profits of
a company that are legally available for distribution as dividends.
Dividends are usually payable for a financial year after the final accounts are ready and
the amount of distributable profits is available. Dividend for a financial year of the
company (which is called 'final dividend') are payable only if they are declared by the
company at its annual general meeting on the recommendation of the directors. But
sometimes dividends are also paid by the directors themselves between two annual
general meetings without declaring them at an annual general meeting (which is called
'interim dividend').
The size of the dividend payment is determined by the Board of directors of a company,
who decide how much to pay out to shareholders and how much profit to retain in the
business; these amounts may vary from year to year. This is called 'recommendation of
dividend'. There is no specific provision in the Act to this effect. However, this is implied
from the provision in section 217(1)(c), according to which the Board of directors must
state in the Directors' Report the amount, if any, which it recommends should be paid by
way of dividend.
The dividend recommended by the Board of directors in the Board's Report must be
'declared' at the annual general meeting of the company. This constitutes an item of
ordinary business to be transacted at every annual general meeting. This does not apply to
interim dividend.
SEBI GUIDELINES
Provisions governing declaration and payment of dividend
The provisions governing declaration and payment of dividend by a company are
provided in the Companies Act, 1956 (referred to as “Act”) and the Rules made there
under including the Companies (Transfer of Profits to Reserve) Rules, 1975, Companies
(Declaration of Dividend out of Reserves) Rules, 1975. Further, in case of companies
listed on the Stock Exchanges, the relevant clauses of Listing Requirements are to be
21
followed. The Companies Act allows dividends to be paid out of three sources namely (a)
Profits of the company for the year for which dividends are to be paid. (b) Undistributed
profits of the previous financial years. (c) Moneys provided by the Central Government
or a State Government for the payment of dividends in pursuance of a guarantee by the
Government concerned.
Determination of Dividend
Section 205 of the Act only prescribes that dividend shall be paid out of profits of the
company. As dividends can only be declared out of surplus earnings, there must be an
exact method of determining whether surplus earnings for that purpose actually exist. But
the Companies Act do not provide any guidance in this regard. In the matter
of Hariprasad Vs. Amalgamated Commercial Traders the Chief Justice of Madras High
Court observed that the Companies Act, 1956 does not say further how those profits have
to be ascertained. There is nothing at all in the Act about how dividends are to be paid,
nor how profits are to be reckoned; all that is left and very judiciously and properly left,
to the commercial world.
Further, it has become obligatory for a company to provide for depreciation as required
by Section 205(2) of the Act. Depreciation has to be provided for the current year as well
as for arrears of depreciation if any. It further states that the depreciation must be
provided to the extent specified in the Section 350 of the Act. If we refer this Section, it
states that the depreciation is to be calculated at the rate specified in Schedule XIV of the
Act. Further, it is to be noted that if the Act makes no provision for a particular kind of
asset, then its depreciation may be worked out on a basis approved by the Central
Government in this regard. A company has got two choice to arrive at depreciation i.e.
either to adopt the above said procedure or to work out depreciation by dividing ninety
five percent of the original cost of the depreciable asset by the specified period in respect
of such asset.
22
But, if any asset is sold, discarded, demolished or destroyed for any reason before
depreciation for such asset has been provided for in full, the excess, if any of the written
down value of such asset over its sale proceeds or its scrap value shall be written off in
the financial year in which it is sold. It is to be noted that the Act does not require any
provision to be created for depletion of a wasting asset.
Further, the previous years’ losses, if any must also be set off against the profits of any
subsequent year or years before any dividend can be paid.
The proviso (c) of Section 205(1) of the Act empowers the Central Government to waive
in any particular case, the requirement of providing for depreciation. The word loss also
includes depreciation (as declared in the case of Garden Silk Weaving Factory Vs.
CIT (1991) SC). There is no reason to give the word “loss” as used in Section 205 a
different meaning from one in which it is ordinarily understood only because it has to be
read with Section 115 of the Income Tax Act, 1961 (V.V.Trans-Investments (P) Ltd Vs
CIT (1999) SC)
Declaration of Dividend
A company cannot declare dividend in the following circumstances:-
a) When a Company is not having profit i.e. is a loss making company.
b) When a Company fails to redeem its preference shares as per the provisions of
Section 80A of the Companies Act. (Sub Section 2B)
Further, a Company cannot declare a dividend without the prior approval of Financial
Institution, in case if the covenants of the loan agreement stipulates in this regard. Section
205(3) stipulates that no dividend shall be payable except in cash.
Dividends cannot be declared out of the Securities Premium Account or the Capital
Redemption Reserve Account or Revaluation Reserve or Amalgamation Reserve or out
of the Profit on re-issue of forfeited shares or out of profit earned prior to the
incorporation of the Company.
23
Compulsory Reserves
Section 205 (2A) of the Act prescribes that before any dividend is declared or paid,
certain percentage of profits as may be prescribed by the Central Government, but not
exceeding 10% will have to be transferred to the reserves of the Company. The company
may, however, voluntarily create more than the prescribed percentage and transfer to the
reserves of the Company. If in a particular year, on account of inadequacy of profit, the
company has to pay dividends out of the previous year’s reserves, it should follow such
rules as may be made by the Central Government. In case of any deviation from such
rules, then the company can do so only with the previous approval of the Central
Government. The term “Reserve” meant in the said Rules means “Free Reserves” i.e.
reserve which are not created or set apart or intended for any special purpose. For e.g.
Development Rebate Reserve, Capital Reserve or Special Reserve will not come under
the category of free reserves for the purposes of this rule.
According to the Companies ( Transfer of Profits to Reserves) Rules 1975, before
declaration or payment of dividend, profits shall be compulsorily transferred to reserves
at the following rates:-
Rate of proposed dividend Amount to be transferred to Reserves
Not exceeding 10% Nil
Exceeding 10% but not exceeding 12.5% 2.5% of current profits
Exceeding 12.5% but not exceeding 15% 5% of current profits
Exceeding 15% but not exceeding 20% 7.5% of current profits
Exceeding 20% 10% of current profits.
Under the Companies Bill 2009, it is left to the discretion of the company to determine
the percentage of profits to be transferred to reserves.
24
Capitalisation of Profits
The proviso to Section 205 further states that there is no prohibition for capitalisation of
profits or reserves for the purpose of issuing fully paid up bonus shares or paying up any
amount for the time being unpaid on any shares held by the members of the company.
Thus, a company may in general meeting, on the recommendation of the Board of
Directors resolve and convert into capital any sum standing to the credit of profit or loss
account or reserve fund account or otherwise available for distribution. As a general rule
only such funds can be capitalised as would be available for dividend distribution.
Entitlement -Equity Shareholders
A company can pay dividend only to the shareholders of that company
a) whose name appears on the Register of members maintained by the Company (in
case the shares are held in physical form) or
b) whose name appear on the register of beneficial owners maintained by a
depository (in case the shares are held in dematerialised form)
Preference shareholders
(a) Preference shares carry a preferential right as to dividend in accordance with the terms
of the issue and the Articles, and hence preference shareholders are paid dividend before
the dividend is paid to the equity shareholders of the company.
(b) Preference shares may be cumulative or non-cumulative. Dividend in arrears on
cumulative preference shares can be paid in the subsequent years where there are profits
sufficient for such payment. In case of non-cumulative preference shares, if no dividend
is paid in a year, there is no right to receive it in future years.
Further if any shares are delivered to a Company for registration and the same have not
been registered by the Company then any dividend to be paid on those shares need to be
transferred to the unpaid dividend account.
25
Dividend entitlement for shares with Differential voting rights/dividend
As per Section 86(a) (ii) of the Companies Act, 1956 and also according to the
Companies ( Issue of Share Capital and Differential Voting Rights) Rules, 2001, a
company can issue shares with differential rights as to voting as well as dividend subject
to fulfilment of certain conditions given thereunder. In fact such issue of shares with
Differential voting rights were also upheld by Company Law Board in Anand Pershad
Jaiswal Vs.Jagatjit Industries Limited.(2009) stating that issue is well within the scope of
Section 86 of the Companies Act as well as the Companies ( Issue of Share Capital and
Differential Voting Rights) Rules, 2001. In this connection, it must be stated that CLB
did not have the opportunity to get into much deeper details of this case, as it was settled
through a consent order. Based on this judgement, a limited number of companies have
come forward to issue shares with differential voting rights as well as dividend. Tata
Motors is one such example which had issued shares both with differential rights as to
vote as well as dividend.
In July, 2009 SEBI amended the Listing Agreement to state that listed Companies are
prohibited from issuing shares with “superior” voting rights and Clause 28A was inserted
in the Listing Agreement. It states that “ The Company agrees that it shall not issue
shares in any manner which may confer on any person, superior rights as to voting or
dividend vis-à-vis the rights on equity shares that are already listed.” So, after this
amendment a Company whose equity shares are already listed on the Stock Exchange,
cannot issue shares in any manner conferring superior rights as to voting and dividend on
equity shares.
It is to be noted that under Clause 37 of the Companies Bill, 2009, the different kinds of
share capital which can be issued by a company excludes issue of equity share capital
with differential voting rights. Thus, the Companies Bill prohibits issue of equity share
capital with differential voting rights as well as differential dividend. But there is no
transitory provision in the Bills for those companies which had already issued share
capital with differential rights or dividend. So, it is utmost necessary that the Bill should
include certain period to allow the companies which had issued equity share capital with
26
differential voting or dividend to bring back their capital structure in accordance with the
provisions of the Bill.
Declaration of dividend out of profits earned by earlier years
Section 205 of the Act, provides that a company can declare dividend out of the profits
of the previous years. But, Clause 110 of the Companies Bill, 2009 stipulates further
conditions to declare dividend in such cases. It stipulates that if owing to inadequacy or
absence of profits in any Financial Year, the Company proposes to declare dividend out
of the profits of the previous financial year or years and transferred to its reserves, such
declaration shall be passed by a resolution at the Board Meeting with the consent of all
the directors and approval of the financial institution whose term loans are subsisting and
also to be passed by the shareholders by a special resolution at the Annual General
Meeting. Already the Ministry has received suggestions, stating that the resolution passed
by the Board should be approved by all the directors present at the Board Meeting and
not by with the consent of all the directors of the company.
Procedure for declaration of Dividend
A company which intends to declare and pay dividend should adopt the following
procedures. Further, in case the company’s shares are listed on the Stock Exchanges,
additional requirements relating to Listing Agreements are to be followed.
1) Recommendation by Board of Directors:-
Dividend can be declared only on the recommendation of the Board of Directors of the
Company. The shareholders do not have any power to declare any dividend. The Board
of Directors after considering and approval of the financial statements of the Company,
determines the rate of dividend to be declared and then recommends the same to the
shareholders. For this purpose, a Board Meeting shall be convened to pass the resolution
for a) rate of dividend and the amount of dividend to be paid. b) book closure date for
dividend purposes c) date of annual general meeting d) Bank with which the account
shall be opened for the purpose of remittance of dividend.
27
2) Approval by the Shareholders:-
The dividend recommended by the Board of Directors is declared by a resolution passed
at the Annual General Meeting by the shareholders. The declaration of dividend should
form part of an ordinary business item to be transacted in the notice of the Annual
General Meeting. While approving the rate of dividend at the Annual General Meeting,
the shareholders have power to declare a lower rate of dividend than what is
recommended by the Board but they have no power to increase the amount or the rate of
dividend so recommended by the Board of Directors. Dividend when declared becomes
debt against the company.
3) Dividend now includes interim dividend:-
After the Companies (Amendment) Act, 2000, interim dividend is now recognised as a
part of final dividend (clause 14A of Section 2). Interim dividend can be declared by the
Board of Directors and they have authority to do so. Further, the provisions contained in
Section 205, 205A, 205C, 206, 206A and 207 shall apply to interim dividend.
4) Dividend to be deposited in a separate bank account:-
The Company should deposit the dividend amount ( including interim dividend) within 5
days of its declaration in the separate bank account opened for this purpose. It means that
the interim dividend will have to be deposited in a bank account within 5 days of the
Board Meeting whereas final dividend will have to be deposited within 5 days from the
date of Annual General Meeting in which it was approved by the shareholders. Also
Section 205 (1B) stipulates that the amount so deposited shall be used only for the
purpose of payment of dividend ( whether interim or final).
5) Dividend to be paid by cheque or warrant
Section 205(5)(b) of the Companies Act, 1956 provides that the dividend payable in cash
may be paid either by cheque or warrant.
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6) Time frame for payment of dividend
As per Section 207 of the Companies Act, 1956, the dividend warrants shall be
despatched within 30 days of declaration of dividend.
7) Transfer of unpaid dividend
As per Section 205A of the Act, where a dividend has been declared by a company but
has not been paid (or claimed) within 30 days from the date of declaration to any
shareholder entitled to the said payment of dividend, the Company shall within 7 days
from the expiry of the said period of 30 days transfer the total amount of dividend which
remains unpaid or unclaimed within the said period of 30 days to a special account to be
opened by the Company in that behalf with any Scheduled Bank which is called “unpaid
Dividend Account of ----- company Limited. Interest at the rate of 12% p.a. is payable by
the Company for delay in making the above transfer.
8) Transfer of unpaid or unclaimed dividend to the Investor Education and
Protection Fund:-
Any amount of dividend which remains unpaid or unclaimed for a period of 7 years from
the date it became due for payment shall be transferred by the company to the Investor
Education and Protection Fund. When making a transfer to the Fund, the Company shall
furnish to the authority appointed by the Central Government, the details relating to a) all
sums included in such transfer b) nature of the sums, c) names and last known addresses
of the persons entitled to receive the sum. D) the amount to which each person is entitled
and such other particular as the case may be prescribed. The said fund shall be utilised for
promotion of investor awareness and protection of the interests of investors in accordance
with the Investor Education and Protection Fund Rules, 2001.
Further as per Section 205B of the Act, once any amount on account of unpaid /
unclaimed dividend has been transferred to the Investor Education and Protection Fund in
pursuance of Section 205C, no claim, for payment for any sum, from any person shall be
entertained by the Fund. Thus, any person claiming to be entitled to any dividend
29
Clause 113 of the Companies Bill 2009 stipulates that the amount lying in the Investor
Education and Protection Fund established under section 205C of the Companies Act,
1956 shall stand credited to the Investor Education Protection Fund established under sub
section (1) of Section 112 of the said Bill. Further Clause 112 of the Bill stipulates that
the fund shall be utilised for the refund in respect of unclaimed dividends, application
monies due for refund and interest thereon etc. which is different from the present
provisions. Also, the said fund shall be used for protection of investors’ education,
awareness and protection in accordance with the Rules as may be prescribed.
9) Directors Report
Section 217(1)(c) of the Companies Act, 1956 requires that the report of the Board of
directors shall state the amount, if any, which it recommends should be paid by way of
dividend. The Board may choose not to declare any dividend even though the company
has made profit and the same be captured in the Directors Report with reasons.
Compliance relating to Listing Agreement:--
1) Clause 12A (4)
As per this clause, the company should adhere to the provisions of Section 206A as well
as Section 27 of the Securities Contracts (Regulations) Act, 1956, wherein it is the duty
of the company to keep dividend, offer of rights shares and bonus shares in abeyance in a
situation where such dividend, right etc. are declared in the interval between lodgement
of a valid instrument for transfer of shares with the company and its eventual registration.
2) Clause 16
The Company agrees to close its transfer books for the purpose of declaration of dividend
and will give notice to the Stock Exchange at least 7 working days in advance of the date
of closure of transfer books and will also intimate the purpose for which the transfer
books are closed. Regarding the book closure, advertisement should be issued in the
newspapers and copies of such advertisements shall be sent to Stock Exchanges ( As per
Section 154 of the Companies Act, 1956).
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3) Clause 19
The company will give prior intimation to the Stock Exchange about the Board Meeting
at which proposal for recommendation of dividend and or passing over of dividend due to
be considered at least 2 working days in advance. Further, the Company will recommend
or declare dividend at least 5 days before commencement of the closure of its transfer
books.
4) Clause 20A
The company agrees to declare and disclose the dividend on per share basis only.
5) Clause 21
The Company will fix and notify the Stock Exchange at least 21 days in advance of the
date on from which the dividend on shares will be payable and will issue simultaneously
the dividend warrants/cheques which shall be payable at par at such centres as may be
agreed to between the Exchange and the Company and which shall be collected at par,
with collection charges, if any, being borne by the Company, in any bank in the country
at centres other than the centres agreed to between the Exchange and the company so as
to reach the holders of shares on or before the date fixed for payment of dividend.
6) Clause 28A
The Company agrees that it shall not issue shares in any manner which may confer on
any person, superior rights as to voting or dividend vis-à-vis the rights on equity shares
that are already listed.
7) Clause 34
The Company agrees that it will not forfeit unclaimed dividends before the claim
becomes barred by law and that such forfeiture, when effected will be annulled in
appropriate cases. Further, the Company agrees that if any amount be paid up in advance
of calls on any shares, it will stipulate that such amount may carry interest but shall not in
respect thereof confer a right to dividend or to participate in profit.
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8) Clause 41
In respect of requirements as to financial figures, the Company shall disclose the
following to the Stock Exchanges, the dividends paid or recommended for the year,
including interim dividends:-
a) the amount of dividend distributed or proposed for distribution per share and the
amounts in respect of different classes of shares shall be distinguished and the
nominal values of shares shall also be indicated.
b) Where dividend is paid or proposed to be paid pro-rata for shares allotted during
the year, the date of allotment and number of shares allotted, pro-rata amount of
dividend per share and the aggregate amount of dividend paid or proposed to be
paid on pro-rata basis.
9) Clause 49
In respect of complaint received from any shareholder regarding non-receipt of dividend,
a board committee under the chairmanship of a non-executive director shall be formed to
specifically look into the redressal of shareholder. This Committee shall be designated as
‘Shareholders/Investors Grievance Committee’. Further, under the matters to be placed
before the Board Meeting, one of the item is to place the non-compliance relating to
payment of dividend. Hence a listed company will have to compulsorily place before the
Board of Directors any grievances relating to shareholders with respect to non-payment
of dividend.
10) Shareholders’ Information under Corporate Governance Report
Under the Corporate Governance Report, the dividend payment date should be mentioned
under the heading “ Shareholders’ Information”.
Interim Dividend –Whether a statutory debt
The declaration of an interim dividend does not create a debt against the
company. Dividends can be declared only by a resolution of the shareholders in
accordance with the Directors’ recommendation at a general meeting. But, if so permitted
by the Articles of Association of the company, the Directors can declare an interim
32
dividend between two Annual General Meetings. While declaring interim dividend, the
Board should carefully assess and examine the financial statements and should ensure
that the company has adequate profits. However, it does not create a debt enforceable
against the company, because, the Directors can very well rescind the resolution before
payment. Thus, the shareholders do not get any vested right under a Directors’ resolution
declaring an interim dividend. It is to be noted that Section 207 of the Companies Act
which applies to interim dividend also, stipulates penalty for failure to distribute dividend
to the shareholders within 30 days of its declaration. The penalty prescribed under the
Act is that the directors shall be punishable with simple imprisonment of three years
along with a fine of Rs.1000 for every day during which such default continues and the
company shall be liable to pay simple interest at the rate of 18% p.a. during the period for
which such default continues. Further, since the penalty prescribed is by way of both fine
and imprisonment, the offence is also not compoundable under Section 621A of the
Companies Act. Thus, going by the principle, in law one cannot take advantage of his
own default, the Board of Directors have got power to rescind the payment of dividend
only upto the 29th day of its declaration and not thereafter. It is because, after the 30 th day,
it becomes a statutory default.
Clause 110(3) of the Companies Bill, 2009 also stipulates that the board of directors of a
company may declare interim dividend during any financial year out of the profits of the
company for part of the year.
When dividend need not be paid
In the following cases, a company need not pay dividend within 30 days from the date of
declaration:-
a) Where dividend could not be paid by reason of the operation of any law.
b) Where a shareholder has given directions to the company regarding payment of
dividend and those directions cannot be complied with.
c) Where there exist a dispute regarding the right to receive the dividend.
d) Where dividend is lawfully adjusted by the company against any sum due to its
from the shareholder.
33
e) Where the non-payment of dividend is not due to any default of the company.
Conclusion
The payment of dividend will instil confidence to the shareholders of the company, after
all a company can declare and pay dividend only if it makes profit. Further, payment of
dividend consistently over a period of time would enhance the image of the company.
The company would also stand to benefit as whenever it requires additional funds for
expansion, it can very easily tap the capital markets (as investors would be ready and
willing to invest) without resorting to huge borrowings from Banks and Financial
Institutions. The shareholders can be rewarded by other means i.e. declaring bonus
shares, rights shares etc. but since dividend is paid in cash it is considered one of the best
reward a company can do to its shareholders for enhancing their wealth. The shareholders
also enjoy additional benefit since the dividend which they receive is tax free and need
not pay any tax on dividend.
34
Chapter 2REVIEW
OFLITERATURE
35
The researchers and academicians in India as well as abroad have made contribution in
their researches on dividend policies and announcement effect of dividends on stock
price
Lynn R(1991) examined the importance attached to revenue forecasts by firms and the
market and whether these forecasts were value-relevant conditional on earnings forecasts.
The study was divided into parts. First, it examined whether the capital market reaction to
earnings and revenue announcements had an association with revenue forecast errors
conditional on earnings forecast errors. Second, it investigated existence of differential
valuation effects associated with meeting or exceeding analysts’ revenue expectations
over and above meeting/exceeding analysts’ earnings expectations.
Carol P (1993) tested the signaling and free cash flow hypotheses of the information
content of share repurchases using UK open market share repurchases between January
1999 and December 2004. The five day mean announcement abnormal return of the
sample was low at 1.28% but it was statistically significant at the 5% level.
Ganapathi N (1995) identified previously undocumented source of predictable cross-
sectional variation in Standardized Unexpected Earnings’ autocorrelations viz. the sign of
the most recent earnings realization and presented evidence that the market ignored this
variation (loss effect). It was possible to earn returns higher than from the Bernard and
Thomas strategy by incorporating this feature.
Minnick N and Kristina L. (1996) examined the cross sectional determinants of the
decision to take write offs. A hand collected dataset on write-offs was used that was
much more comprehensive than existing write-off datasets. It was found that quality of
governance was positively related to write-off decisions in the cross section. The results
36
also suggested that poor governance companies waited to take write-offs until it became
inevitable while well-monitored companies took write-offs sooner.
Hardjo K (1998) examined in their study whether managers deliberately used accruals to
convey information regarding firm future profitability. The contemporaneous earnings
and dividend announcement data was used as research setting as it reduced the possibility
of opportunistic income smoothing by managers and hence increased the validity of the
inference on the accrual signaling hypothesis.
Kanwal A (2001) observed profitability as always been considered as a primary indicator
of dividend payout ratio. Apart from profitability, numerous other factors like cash flows,
corporate tax, sales growth and market to book value ratio were also considered rampant.
Juho K(2003) examined stochasticity of stock return volatility by questioning the
assumption that the conditional expectations of future dividends react to the same new
information. The stochastic evolutions of conditional dividend expectations were
characterized by extending the information process to dividend paying stocks.
Paul H(2004) examined how institutional investors respond to accounting restatements.
The study showed that transient institutional investors defined as institutions with shorter
investment horizons and higher portfolio turnover significantly reduced their holding in a
restating firm at least one quarter prior to the quarter of the restatement. He examined the
relation between revenue surprises and future stock returns. The study investigated how
analysts updated their earnings forecasts followed by announcements of revenue and
earnings surprises. The results indicated that the stock price reaction on the earnings
announcement date was significantly related to both revenue surprises and earnings
surprises.
Yael V and Janice Y (2006) examined the effects of venture capital backing on the
corporate governance of the firm following the IPO. The study conducted three
independent sets of tests which examined effectively how governance and monitoring
37
differed for venture and non-venture backed firms. observed that in a relatively less
litigious environment like Australia it was common to find IPO firms that voluntarily
provided forecasts in their prospectus. 158 Australian industrial IPOs listed from 1991 to
1997 were used in the study to examine the impact of the disclosure and accuracy of
earnings and dividend forecasts on equity pricing.
Nikolaos F and Elaine H(2008) discovered that existence of a long term dividend policy
stood partly unaffected by the level of current period earnings. He presented a theoretical
model on dividend policy for distributed profit taxation which is the corporate taxation
regime of Estonia. He examined market reactions to firm’s earnings announcements. The
study extended the examination to include a broad range of concurrent disclosure
contained in earnings press releases, the financial disclosures captured as accounting
ratios and verbal components of disclosure which were captured using elementary
computer based content analysis.
Gil S and Apostolos D(2011) examined negative tunneling within a chaebol and used a
large sample of earnings announcements made by firms belonging to Korean chaebols.
The study found out that the announcement increased (decreased) earnings over the
previous year by a chaebol-affiliated firm had a positive (negative) effect on the
abnormal return for the value -weighted portfolio of other non-announcing affiliates in
the same group. He investigated the stock market reaction of the Athens Stock Exchange
to cash dividend announcements for the period 2000-2004. In particular, the study
examined both the stock price and trading volume response to company announcements
about dividend distributions. The dividend distribution in Greece featured remarkable
differences from those of US, UK and other developed markets.
38
Chapter 3NEED, SCOPE
&OBJECTIVES
39
3.1 Need
After conducting a review of researches done by various professionals, gaps have been
identified. The researcher had analyzed that stock prices react positively to the dividend
increase announcements. But a few researchers had studied whether changes in dividend
policy affect the efficiency of the stock market announcing these changes; via stock
prices, and what can be the reasons for the stock price reactions, on announcements of
dividend policy and how to analyze the stock price behavior around one particular
dividend policy i.e. dividend increase. This had been identified and had led to the current
research being undertaken. In this, all the aspects of need had been tried to cover.
3.2 Scope
The scope of the study was limited to the BSE companies listed in BSE 500 covering the
time period from 2006 to 2012
3.3 Objectives
Following were the various objectives for carrying out the study:
To analyze the reasons for stock price reactions on dividend announcements.
To analyze the stock price behavior around one particular dividend policy i.e.
dividend increase and to further test for information signaling hypothesis.
To analyze whether changes in dividend policy affect the efficiency of the stock
market on announcements.
3.4 Testing of Hypothesis
To empirically prove the above objectives, the null hypotheses were framed as follows:
Watts (1973), Woolridge (1983), Rao (1994) and Bjaj and Vijh (1995) recognized the
positive impact of dividend increase announcements on stock prices as a confounding
40
event and assessed weather dividend announcements have greater information content.
Travles and Vafeas (2001) and Fuller and Thakor (2002) found a positive market
reaction to dividend increase announcements and experience a higher abnormal returns in
response to dividend change.
H01: Dividend increase has no effect on the stock price returns meaning thereby that the
average abnormal returns around the announcement will be zero.
H02: The stock market will be inefficient meaning thereby that the cumulative abnormal
returns will be far away from zero (on the tenth trading day after the formal
announcement i.e. event).
41
Chapter 4RESEARCH
METHODOLOGY
42
RESEARCH METHODOLOGY
Research is a common parlance which refers to search for knowledge. It is a procedure of
logical and systematic application of the fundamentals of science to the general and
overall questions of a study and scientific technique, which provide precise tools, specific
procedures, and technical rather philosophical means for getting and ordering the data
prior to their logical analysis and manipulating different type of research designs is
available depending upon the nature of research project, availability of manpower and
circumstances.
According to D. Slesinger and M. Stephenson research may be defined as” the
manipulation of things, concepts or symbols for the purpose of generalizing to extend,
correct or verify knowledge, whether that knowledge aids in the construction of theory or
in the practice of an art”. Thus it is original contribution to the existing stock of
knowledge of making for its advancement. In short, the search of knowledge through
objective and systematic method of finding solution to a problem is research.
4.1 Research Design
A research design is the arrangement of conditions for collection and analysis of data in a
manner that aims to combine relevance to the research purpose with economy in
43
procedure. In fact, the research design is the conceptual structure within which research is
conducted. This research was descriptive, quantitative and conclusion-oriented in nature.
4.1.1 Conclusion-Oriented Research
The research was a conclusion Oriented research because this research aimed at
highlighting the stock price reaction to the dividend increase announcements.
4.1.2 Descriptive Research
The research was a descriptive research. Descriptive studies, as the name implies was
concerned with specific predictions, with narration of reasons for stock price reactions on
dividend announcements.
4.1.3 Quantitative Research
The research was quantitative as the concerned topic can be measured in numeric terms
only and contains quantitative factors.
4.2 Data Collection and Analysis
4.2.1 Data Collection
The secondary data was used for data collection.
4.2.1.1. Secondary Data
Secondary data is the data collected from already been use or published information like
journals, diaries, books, etc. In this research project, secondary data was collected in
following ways:
The secondary data was collected through the websites of BSE.
4.2.2 Data Analysis
4.2.2.1 Tools of Presentation
It means what all tools are used to present the data in a meaningful way so that it
becomes easily understandable. In this research tables were used for presenting the data.
4.2.2.2 Tools of Analysis
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In this research, to study the impact of the announcement of dividend increase, on the
stock return, a methodology i.e., the standard event study methodology with the market
model to estimate the normal return for a security had been employed.
4.2.2.2.1 Standard Event Study Methodology
The market model assumes a linear relationship between the return of the security to the
return of the market portfolio. The BSE 500 Sensex had been taken as the benchmark
index. The stock returns had been regressed to BSE 500 Sensex returns for a period of
120 trading days ending ten trading days before the announcement date. The ‘α’ and ‘β’
so calculated had been used to calculate the expected abnormal returns for the event
window, starting ten trading days before the event to ten trading days after the event.
The abnormal return for each of the day in the event window was the difference between
the actual stock return during that day and the expected normal return according to the
BSE 500 Sensex as per the ‘α’ and ‘β’ of the concerned stock.
For being able to draw overall inference on the abnormal returns, the abnormal returns
for the scrips were summed up trading day wise. This gave the average abnormal return
for each trading day‘t’ in the event window. Then, the cumulative average return was
computed for each trading day‘t’ in the event window by adding AAR of each period.
In brief, this approach involved the following sequence:
Daily abnormal returns for the security ‘i’ from 121 days before to 120 days after the
announcement (including announcement day) of the dividend increase had been
computed as:
ARi,t = Ri,t – E(Ri,t)
Where t = day measured relative to the dividend increase announcement day (t=0)
ARi,t = abnormal return on security ‘i’ for day ‘t’
Ri,t = raw return on security ‘i’ for day ‘t’ which was calculated as:
45
Ri,t =
Where MPi,t = market price of security ‘i’ on day ‘t’
MPi,(t-1) = market price of security ‘i’ on day ‘t-1’
E(Ri,t) = expected return on security ‘i’ during day ‘t’ which had been estimated through
market model using BSE 30 Sensex as follows:
E(Ri,t) = α1 + β1Rm + εi
Where Rm = return on the BSE 30 Sensex and α1, β1are the parameters of the market
model and εi is assumed to indicate the abnormal returns.
Average abnormal returns for each relative day had been calculated by:
AARi = i,t
Where N = Number of securities with abnormal returns during day‘t’.
4.3 Limitations of Study
The following were the limitations of the study:
4.3.1 Shortage of Time
The time period of study was very limited. It was very difficult to have in detail study on
project work due to limited time period. The period of 4 to 6 weeks was not enough for
the proper study of the project.
4.3.2 Inadequate Data
The data provided was not up to the mark due to which we faced problems in the
research.
46
4.3.3 Lack of Scientific Method
The lack of scientific training in methodology of research was great impediment in this
research program, which led to the delay of research.
Chapter 5
DATA ANALYSIS
47
& INTERPRET
ATION
Event Study Results
Abnormal returns are calculated using the market model. The study of Cable and Holland
(1999) argued that the market model compares favorably to other models proposed in the
literature. For that reason, reference has been made only to the results from the market
model. Table 7 outcome is based on cumulative average abnormal returns (CAAR)
results of 50 companies dividend announcements for trading days -120 to +120.
Table 7: Cumulative Average Abnormal Returns Results
Merger Announcements Cumulative Average Abnormal Return in %
(p-values)
Pre- -120 to -1 2.1303(.000)*
48
Announcement -90 to -1
-60 to -1
2.2402(.000) *
1.7746(.000) *
-30 to -1 1.6892(.000) *
-10 to -1 2.0497(.000) *
.Post-
Announcement
+1 to +10 .9737(.000) *
+1 to +30 .3037(.121)
+1 to +60
+1 to +90
-.7966 (.000) *
-1.3918(.000) *
+1 to +120 -1.2980(.000) *
Source: Author’s Own.
*Significant at .05 level
Inspection of Table 7 reveals that the pre-announcement and post-announcement periods
contain little new information. The results confirm the notion that the stock returns react
very strongly to dividend announcements both during the pre-announcement and post-
announcement period. It can be observed that the market witnessed positive abnormal
returns in the pre-announcement periods. In order to further testify the association
between pre and post returns due to dividend for corporations (refer table 8), paired t-test
has been applied for different event windows: very short (-10 to +10 days), short (-30 to
+30 days), medium (-60 to +60 days) and long (-120 to +120 days).
Table 8: Pre and Post CAAR: Results of Paired t-test
Event Windows (p-values)
-10 to + 10 .000*
-30 to +30 .000*
-60 to +60 .000*
-120 to +120 .000*
Source: Author’s Own.
*Significant at .05 level
49
It can be observed from the results of paired t-test presented in table 8 that the market
witnessed positive abnormal returns during the entire period under study, indicating that
the impact of dividend announcements on the share prices for all windows, insignificant
results have been obtained. The findings indicated the presence of lag in reflecting and
adjusting the effects of merger announcements by Indian stock market, thereby, giving
chance to the investors to earn abnormal returns. Considering the momentum of the share
price adjustment to the new information coming from dividend announcements, it has
been observed that there is lagging response to the same, thus, indicating the inefficiency
of the Indian stock market. It reveals that Indian stock market responds to the corporate
news contained in dividend announcements for all event windows starting from very
short event windows and continuing upto the largest window for the current study, giving
enough chance to the investors to beat the market, and hence, generating abnormal
returns. On the basis of the results, the null hypothesis (H02) of insignificant (zero) share
price response to merger announcements and has been rejected. Also from the results it
can be inferred that Indian stock market possesses information inefficiency as the effects
are shown in shorter as well as longer duration of any announcements as the investors are
given chance to earn the abnormal returns. Thus, the null hypothesis (H03) that Indian
stock market is efficient has been rejected.
The perusal of the results on the basis of accounting performance measures and event
study reflect that there is significant impact of dividend announcements on the financial
performance and share prices.
50
51
Chapter 6FINDINGS OF THE
STUDY
52
FINDINGS OF THE STUDY
The findings of the study are presented below in the best possible way. For this we have
studied the Indian stock market and have applied t - test for the same and have seen that
null hypothesis have been rejected. The perusal of the results on the basis of accounting
performance measures and event study reflect that there is significant impact of financial
results announcements on the share prices. The findings are presented below:
It can be observed from the results of paired t-test that the market witnessed
positive abnormal returns during the entire period under study. The findings
indicated the presence of lag in reflecting and adjusting the effects of merger
announcements by Indian stock market, thereby, giving chance to the investors to
earn abnormal returns.
Considering the momentum of the share price adjustment to the new information
coming from financial results announcements, it has been observed that there is
lagging response to the same, thus, indicating the inefficiency of the Indian stock
market.
It reveals that Indian stock market responds to the corporate news contained in
financial results announcements for all event windows starting from very short
event windows and continuing up to the largest window for the current study, thus
giving enough chance to the investors to beat the market, and hence, generating
abnormal returns.
On the basis of the results, the null hypothesis (H01) of insignificant (zero) share
price response to financial results announcements and has been rejected.
Also from the results it can be inferred that Indian stock market possesses
information inefficiency as the effects are shown in shorter as well as longer
duration of any announcements as the investors are given chance to earn the
abnormal returns. Thus, the null hypothesis (H02) that Indian stock market is
efficient has been rejected.
53
Chapter 7CONCLUSION
54
CONCLUSION
For studying the impact of stock prices on financial results, we have studied the Indian
stock market and have studied in detail 50 companies of Bombay stock exchange. The
detail study includes the last announcement date of financial results for quarter 4
corresponding to the close price and BSE-500. We have taken 121 days prior to the
announcement date and 120 days after the announcement date for studying the impact of
stock prices on financial results. Thereafter, t – test have been applied and it is observed
that null hypothesis has been rejected.
In a nutshell, we observed that the market witnessed positive abnormal returns during the
entire period under study. The findings indicated the presence of lag in reflecting and
adjusting the effects of merger announcements by Indian stock market, thereby, giving
chance to the investors to earn abnormal returns. Considering the momentum of the share
price adjustment to the new information coming from financial results announcements, it
has been observed that there is lagging response to the same, thus, indicating the
inefficiency of the Indian stock market. It reveals that Indian stock market responds to
the corporate news contained in financial results announcements for all event windows
starting from very short event windows and continuing up to the largest window for the
current study, giving enough chance to the investors to beat the market, and hence,
generating abnormal returns. On the basis of the results, the null hypothesis (H01) of
insignificant (zero) share price response to financial results announcements and has been
rejected. Also from the results it can be inferred that Indian stock market possesses
information inefficiency as the effects are shown in shorter as well as longer duration of
any announcements as the investors are given chance to earn the abnormal returns. Thus,
the null hypothesis (H02) that Indian stock market is efficient has been rejected.
Thus, it has been observed that the accounting performance measures and event study
reflect that there is significant impact of financial results announcements on the share
prices.
55
REFERENCES
56
Lynn R (1991) “Stock Markets:
http://www.independent-stock-investing.com/Dividends-Declared.html”.pp95-14
Carol P(1993) “ Effect of dividend announcement on atock market- An
Empirical”, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=981885 ,Vol. 19,
Ganpathi N (1995) “Dividend announcements and the abnormal;stock returns
RIVALS”http://www.skirec.com/images/download/apjrbm/APJRBM-DEC-10/13.pdf
Nomura Capital Market Review, Vol. 8, No.3, pp. 14-20, Autumn 2005
Minnick N (1995) “The Behavior of Stock Market Prices. Journal of Business,38,
34-105
Hardjo K (1996) “Dividend Policy, Growth and the Valuation of Shares. Journal
of Business, 34, 411-433Vol. VIII, No. 9, pp. 7-17,
Kanwal A. (2000). The Effect of Annual Earnings Announcements on the Indian
Stock Markets. International Advances in Economic Research, 12, 318-326
Juho K(2003) The impact of initiating dividend payments on shareholders’
wealth, Journal of Business 56, 77-96.
Nikolaos F (2008) “Abnormal Stock Returns for the Event Firm and its Rivals,
following the Event Firm’s Large One Day Stock Price Drop. Journal of
Managerial Finance,37,151-172
Gil S (2011) “The Response of Stock Prices to Permanent and Temporary
Shocks to Dividends. Journal of Financial and Quantitative Analysis, 30, 1-22.
57
58
ANNEXURE
NO. COMPANIES EVENT DATE
1 ACC Ltd 29-Jun-112 Ambuja Cements 18-Feb-083 Asian Paints 30-Jun-104 Axis Bank 8-Jun-115 Bajaj Autos 2-Jul-096 Bharat Petroleum 8-Sep-107 Bharti Airtel 24-Jul-098 BHEL 30-Aug-079 Bhushan Steels 8-Sep-11
10 Ceat Ltd 14-Jul-1011 Cipla Ltd 12-Aug-0812 Coal India Ltd 8-Sep-1113 DLF 27-Jul-1114 GAIL 30-Jan-0915 Grasim inds 10-Aug-1016 Gujarat Hotels 15-Jul-1117 HCL 22-Oct-0818 HDFC Bank 10-Jun-1019 Hero Moto Corp 30-Aug-1020 Hindalco Inds 14-Sep-1121 HUL 7-Nov-0722 ICICI Bank 22-Jun-11
59
23 Infosys 26-May-1024 ITC 10-Jun-1125 Jaiprakash Asso 15-Sep-1026 Jindal Steel and Power LTD 13-Sep-1027 Kotak Mahindra 30-Jun-1028 Larsen n Tourbo 18-Aug-0929 Lupin ltd 20-Jul-0930 Mahindra n Mahindra 3-Jul-0831 Maruti suzuki Ltd 14-Aug-0832 NTPC Ltd 8-Sep-1133 ONGC 8-Sep-0834 Power grid corp of India 11-Jan-1035 Punjab National Bank 29-May-0836 Ranbaxy lab 28-Apr-1137 Reliance Inds 10-May-1038 Reliance infrastructure 2-Jul-0939 SBI 20-May-1140 Sesa Goa ltd 30-Jun-1141 Siemens 18-Jan-1142 Sterlite Inds 15-Jul-1143 Sun Pharmaceuticals 21-Aug-0944 Tata Motors 10-Aug-1045 Tata Power co.ltd 2-Aug-1146 Tata steel co 12-Jul-1047 TCS 18-Jun-0848 Ultratech cements 25-Aug-1149 Varun Shipping 28-Jul-1150 WIPRO 29-Jun-11
60
No.
Companies Event Date Total Assets(Cr)
No.Of Shares
1 ACC Ltd 29-Jun-11 7703 187,745,3562 Ambuja Cements 18-Feb-08 6636 1,525,617,5113 Asian Paints 30-Jun-10 2039.45 95,919,7794 Axis Bank 8-Jun-11 285627.8 413,203,9525 Bajaj Autos 2-Jul-09 3439.69 289,367,0206 Bharat Petroleum 8-Sep-10 33029.49 361,542,1247 Bharti Airtel 24-Jul-09 41776.12 3,797,530,0968 BHEL 30-Aug-07 10869.39 489,520,0009 Bhushan Steels 8-Sep-11 27595.93 212,358,310
10 Ceat Ltd 14-Jul-10 1404.05 34,243,53411 Cipla Ltd 12-Aug-08 5290.99 802,921,35712 Coal India Ltd 8-Sep-11 20738.29 6,316,364,40013 DLF 27-Jul-11 26471.67 1,698,385,71914 GAIL 30-Jan-09 18279.38 1,268,477,40015 Grasim inds 10-Aug-10 8947.49 91,698,77816 Gujarat Hotels 15-Jul-11 15.62 3,787,51517 HCL 22-Oct-08 4001.97 679,998,59218 HDFC Bank 10-Jun-10 277352.6 465,225,68419 Hero Moto Corp 30-Aug-10 4447.22 19968750020 Hindalco Inds 14-Sep-11 46604.38 191454230821 HUL 7-Nov-07 1527.76 218211980222 ICICI Bank 22-Jun-11 473647.1 115271444223 Infosys 26-May-10 24501 57415155924 ITC 10-Jun-11 18870.98 781842430025 Jaiprakash Asso 15-Sep-10 30930.41 212643318226 Jindal Steel and Power LTD 13-Sep-10 20804.01 934269031
61
27 Kotak Mahindra 30-Jun-10 50850.66 73687150428 Larsen n Tourbo 18-Aug-09 25112.47 60780500929 Lupin ltd 20-Jul-09 3437.36 44590205030 Mahindra n Mahindra 3-Jul-08 18.34 59658707531 Maruti suzuki Ltd 14-Aug-08 10043.8 28891006032 NTPC Ltd 8-Sep-11 120629.5 824546440033 ONGC 8-Sep-08 94771.12 213887253034 Power grid corp of India 11-Jan-10 62092.11 420884123035 Punjab National Bank 29-May-08 246918.6 31530250036 Ranbaxy lab 28-Apr-11 6258.36 42203169037 Reliance Inds 10-May-10 218937 327337400838 Reliance infrastructure 2-Jul-09 19267.09 24487026239 SBI 20-May-11 1335519 67104483840 Sesa Goa ltd 30-Jun-11 16512.32 86910142341 Siemens 18-Jan-11 3962.6 34029490042 Sterlite Inds 15-Jul-11 30067.61 336120753443 Sun Pharmaceuticals 21-Aug-09 5747.47 103558195544 Tata Motors 10-Aug-10 35912.05 53827228445 Tata Power co.ltd 2-Aug-11 20954.12 237307236046 Tata steel co 12-Jul-10 76745.77 95921445047 TCS 18-Jun-08 13486.62 195722099648 Ultratech cements 25-Aug-11 16667.95 27406530149 Varun Shipping 28-Jul-11 3522.82 15000777350 WIPRO 29-Jun-11 29595.7 2,458,756,228
Analysis:
From the above analysis, it is seen that Bharti Airtel have highest total assets among all
the fifty companies and Grasim industries has the smallest total assets.
62