Topic: Determinants of Dividend Payout Ratio

Prepared by:
Ahmad Farrukh Saeed

Submitted to:
Ms. Zehra Raza

December 13, 2016

Lahore School of Economics

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Contents
Introduction: ............................................................................................................................................... 3
Overview: ................................................................................................................................................. 3
Background: ............................................................................................................................................ 4
Significance in Global Context: ............................................................................................................. 5
Significance in Pakistani Context: ......................................................................................................... 6
Research Question/ Significance of Research: ..................................................................................... 7
Literature Review: ...................................................................................................................................... 8
Theoretical Framework: ...................................................................................................................... 14
Regression Equation: ........................................................................................................................ 14
Bibliography: ............................................................................................................................................. 15
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Introduction:

Overview:

There are two ways a company can distribute its earnings among its shareholders, by giving

dividends and by buying back the shares. Dividend is the amount paid by the company typically

every year to its shareholders from its overall earnings. Payout ratio is a key measure of

sustainability of a companys earnings and ultimately the dividend payments. The payout ratio is

determined by the company and decisions are made whether the current year, investors should be

paid in dividends or the company should retain the earnings in order to invest later in the company.

Not every firm is liable to pay the dividends, but only those which have issued shares and collected

capital from the investors. Dividend payout ratio varies from company to company and that is,

most of the time, the reason of more investors investing in a company with attractive dividend

policy. Dividends also vary industry to industry, and like most of the financial ratios, the dividend

payout is a very useful measure of performance within an industry. For example, real estate

investment fund is liable to maintain a dividend payout ratio of 90% and in return, they enjoy tax

exemptions from the Government.

Dividend payout is not the only way companies return value to their shareholders.

Companies often buyback the shares from their shareholders at a higher price. There are multiple

factors that determine the dividend payout policy of the company. Companys earnings, capital

structure, its size, the overall risk, its growth, and return on assets (ROA). There are investors who

prefer low dividend payouts as they want the company to retain and fuel its future growth. Some

investors prefer higher dividend payout as they want to enjoy the return on their investment in the

short-run. Companys profitability is the most important factor that make the company determine

its dividend payout policy according to the earnings for the respective year.
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Background:

In the past, there has been many researches explaining why some firms have low dividend

payout while other pay higher dividends. Then, there were studies describing what are the crucial

factors making a firm decide whether it should pay high or low dividends. Firms need outside

capital, debt, in their capital structure to finance their capital investment needs and expansion

requirements. History shows that firms divide their capital structure in to debt and equity for the

tax-shield. Mostly firms are dependent more on debt to enjoy the tax savings. Upon debt, firms

will be making fixed payments of interest. This will decrease their earnings before taxes,

subtracting less taxes from the operating income. The researchers have found that the firms cannot

be only debt financed, or equity financed. The benefit of being equity financed is that, company is

not obligated to pay the dividends like the interest payments on debts.

It has also been found that poor market capitalization of the firms leads to less payouts.

When the firms pay less, investors lose interest in investing in that firm. A firms free cash flows

is another factor that influence the dividend payout. A firm with larger cash reserves may pay

higher dividends than that of having lower cash on hand. A study on U.S. public firms shows that

these firms pay 24% of the profits as dividends. (Michaely & Roberts, 2011) For several reasons,

this issue of dividend policy is very crucial. Firstly, researchers found that the company uses this

dividend payout scheme as a metric for financial performance and stability for the investors. It was

also considered as a growth measure for the firm. As mentioned above, dividends play a vital role

in the firms financing structure. There has been a research on the relationship between the

dividend of a company and its investment decisions.

There is a concept of residual theory that was introduced, states that company is not

liable to pay dividends when it is considering the lucrative investment opportunities. A firms stock
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price is another factor that is affected by the dividend policy. It has been researched that firms do

not prefer to cut or reduce dividends. (Woolridge and Ghosh, 1991) Moreover, firms announce the

initiation or enhancement of dividends when they are sure of their financial position and

performance in the future to attract investors. In the past, it has been proved through different

statistical techniques that, firms dividend payout ratio is dependent upon their past growth rate,

future growth rate, non-diversifiable risk, and sometimes the number of shareholders.

If the company has an increasing growth rate, means that the company is expanding and

paying less dividends making the relationship inverse. The research in the past has also witnessed

that regulation of a firm has a significant impact upon the dividend payout polices of the firms.

The researchers have stressed upon only the developed markets, like U.S., Europe, China, but very

little devotion has been given to the study of developing markets. Different researches have been

developed to find and prove the determinants of dividend payout policies. Prime determinants are

firms earnings, cash flow, growth rate, debt/equity ratio or leverage of the firm.

Significance in Global Context:

Dividend payout ratio has been a very attractive topic of different studies around the world.

Most of the researches are done on the developed markets of U.S., United Kingdom, and China

etc. According to Henderson (2016), global dividends rose by 1.2% to 421 billion. 80% of the

European companies have increased their dividends in the past 3 years as due to the strong Yen,

Japanese markets earned billions of dollar in profits, showed growth in dividend payouts. All over

the world, there are multiple factors determining the payout ratio. At the sustainable position,

global companies are more focused on the stability of dollar strength around the globe. U.S. market

controls the entire market of the world as every nation is invested in United States. Interest rate is

another factor in the global context which determines the capital structure of a firm, making itself
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an important variable in calculation of the year-end profits which determines the payout ratios.

Investors in developed markets around the world are very much concerned with the dividends a

firm is offering in long-run. Dividend payout ratio and a firms policy for payouts in the future

attracts the investors to capitalize the firm for their benefits.

Significance in Pakistani Context:

Major studies have been conducted in the developed markets, and a very little research is

done in the emerging markets like Pakistan. With respect to Pakistan economy, ROA and ROE

have a noteworthy effect upon dividend yield. The research shows that Pakistani firms pay

dividends only when they make a profit and firms that have high net cash flows have enhanced net

income. Firms size is another important factor, but has a negative impact in Pakistan. Some of the

corporations in Pakistan are Government backed and pay higher dividends, as Fauji Fertilizers pay

80-85% of its earnings in dividends every year. Pakistani economy is unaffected due to the major

changes in the international economies. In Pakistani firms, earnings, firms size, growth,

profitability, corporate tax, and financial leverage are the most prominent and imperative factors

in determination of dividend payouts for investors. With expansion in assets of a company,

investors expect a larger upward movement in payout graph. In Pakistan, dividends are taxed twice

under the concept of double taxation which implies on the corporation while paying the dividend

and on shareholders while receiving the dividends. In Pakistan, dividend payout ratio has positive

effect on sectorial economic growth. High dividend payouts leads to high growth in a related sector

in future.
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Research Question/ Significance of Research:

How firms earnings, size, growth, profitability, risk, and ROA are impacting the dividend payout

ratio?

This research will be very beneficial in Pakistani context as very slight study has been

conducted with these determinants affecting the payout ratio. Also, this research will provide new

aspects of determining the dividend payout ratio as providing the different combinations of these

factors. This study will be valuable, not only for manufacturing firms but for academic purposes

as well.
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Literature Review:

This literature review will examine the determinants of the dividend payout ratio and find

out how these factors are affecting the corporate dividend payout ratio. This literature review will

also explain the methods used to conduct the impact of the determinants on dividend payout policy.

Allen et.al. (2012) in their research, study how the loan financing to a specific firm impacts

the dividend payouts to the stockholders. Loan, accounting and stock earnings data for each fiscal

year ranging from 1990-2006 had been collected for the research as a sample. Different statistical

techniques as descriptive statistics (Mean, Minimum, Maximum, and Standard Deviation),

regression analysis, correlation, and robustness tests have been applied to the data where dividend

payout ratio is a dependent variable and dependent upon the intensity of banks lending. It has

been concluded that both the variables has an inverse relationship, means that if the firm is more

dependent upon loan financing, then it is going to have a lower dividend payout ratio.

Imran, Usman & Nishat (2013) in their research, examine the different factors that regulate

the dividend payout strategy for financial sector. For this particular research, data of sixteen banks

are used which are listed at KSE. The methods that had been used to study the impact of different

factors is OLS method that is the most basic estimation method in panel data sets. This method

deals with the uncorrelated variables in a specific time period. The results of this study shows that

earning per share (EPS), Previous dividend outgoings, Capital Structure and the banks Size are

the most significant factors which regulate the dividend payouts and the cash flows of the bank

being in inverse relation with dividend ratio.

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Kasim & Rasheed (2015) has researched the impact of the capital structure of a firm on the

dividend payouts of KSE 30 Index. Capital structure consists of debt and equity taken by the firm.

For this study, 21 corporations had been selected from the KSE 30 Index from 2001-2011. Panel

data method has been used to prove the hypothesis that capital structure impacts the dividend

payouts. Panel Data model inspect firm-specific effect and time effects. The outcomes of the

methodology shows that the higher proportion of equity in the capital structure of a firm and higher

ROE outcome in higher dividend payouts.

Michaely & Roberts (2012) in this research, aim to find the forces determining the

corporate dividend payouts by associating dividend plans of both public and private firms. Public

firms pay more dividends that are more prone to investment opportunities than private firms. In

this research, capital structure and investment are independent variables which influences the

Dividend payout policies. The sample for this study comprises of all non-financial and non-

government firms issuing consolidated financial reports in the FAME database. Linear model of

dividends has been used for all firms in the sample and the results shows the capital structure,

investment opportunities and incentives do influence dividend payout in positive way. But there

is a difference between the dividend plans of private and public firms. Private firms with discrete

capital structure pay lower dividends than the public ones. Dividend smoothing affects the payouts

positively whether for a private or public firm.

Francis et.al. (2012) in this study, probed to find the relationship between corporate

governance and dividend payout ratio, whether firms size, investment opportunity, growth rate,

and profitability affects the dividend payouts of the company. The sample consists of all NYSE,

NASDAQ, and AMEX firms in the United States. Descriptive statistics (Mean, Minimum,

Maximum, and Standard Deviation), regression analysis, and robustness tests have been applied
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to prove the hypothesis. The evidence from this study shows strong positive relationship between

corporate governance and dividend payout policy. Firms size, investments, growth and

profitability influence its dividend payouts.

Gill, Biger & Tibrewala (2010) with the help of this study, aim to find whether dividend

payout ratio is affected by debt/equity ratio, sales growth, profit margin, and tax. The sample for

this research consists of 500 public companies and their financial reports from 2007. Out of these

500, only 266 financial reports were usable. Descriptive statistics have been applied as to prove

the argument. The results show that for manufacturing companies, profit margin, corporate tax,

and market/book value influence the dividend payout ratio. For service providers, sales growth, ,

debt/equity ratio, and profit margin influence the payout ratio.

Zhou & Ruland (2006) in this research, examine the relationship between the dividend

payout ratio and the companys future earnings growth. High dividend payout eventually reduce

the funds available for further investments. The sample comprises of a large number of

corporations over the fifty ears time period. The study has applied a company-by-company

analysis to find the relationship. Dependent variable is dividend payout ratio which is influenced

by companys earnings. Descriptive analysis, Sensitivity tests, Uni-variate analysis, and Multi-

variate analysis has been applied on the sample. The results show a positive relationship between

companys earnings and dividend payout ratio.

Benavides, Berggrun & Perafan (2016) examines the payout strategies of the six Latin

American countries from 1995-2013. Data is collected from the consolidated financial statements.

This studys purpose is to find the relationship between profitability & dividend payout, debt/assets

ratio & investment opportunities, and illiquidity & dividend payout. Lintner survey, pecking order

model, trade-off model, and the lifecycle theory had been applied on these dividend policies. The
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results depict that firms pay substantial thoughtfulness to their existing payout policies while

deciding for the future policies. Moreover, the profitability of the firm is directly related to

dividend payouts but debt and investment opportunities are negatively related to a firms dividend

payouts.

Ali & Sadiq (2012) in this study, investigate the influence of earning supervision on

dividend payout strategy in Pakistan. The sample that had been used in this research is the KSE

100 Index listed companies from year 2005-2009. The dividend policy had been devised by the

payout ratio while the earning management has been measured discretionary accruals. Modified

cross-sectional model, discretionary accruals and regression analysis by using both balance sheet

and cash flow statement approach. The results show that earning management is inversely related

to dividend payout policy, but the relationship is as weak as having nearly no impact. Discretionary

accruals have impact on dividend policy in Pakistan.

Rehman, et.al. (2012) in their study, focus upon the relationship of economic reforms,

dividend payout ratio, sectorial economic growth and corporate governance. The sample covers

the manufacturing sector and financial sector from the time period of ten years from 1998-2008.

Descriptive statistics and Two Staged Regression model had been applied upon this sample. The

results have shown that sectorial economic growth has a positive relationship with dividend payout

policy. High sectorial growth results in higher dividend payments which comes as an attraction for

the investors. Results show a very high dividend payout ratio in financial sector but a low ratio in

manufacturing sector.

John & Muthusamy (2010) aim to determine the factors affecting the dividend payout ratio

for the Indian paper industry. Sales growth, EPS, P/E ratio, Market/Book value, Cash Flow,

Debt/Assets, Liquidity, and ROE are independent variables influencing just one, dependent
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variable as dividend payout ratio. Using the Lintners Dividend Model and Ordinary Least Square

Regression (OLS), it has been found that 87% of these variables determine the firms dividend

payout ratio. Sales growth, EPS, Market/Book value, liquidity ROA are negatively related to

dividend payout ratio. The results show a relationship between the leverage of a firm to its dividend

payout ratio.

Rafique (2012) aimed to reveal the insight of determination of dividend payout by studying

on a sample of non-financial firms listed in KSE 100 Index. The independent variables are

earnings, firm size, growth, profitability, corporate tax, and Debt/Assets ratio influencing dividend

payout ratio. The sample was of 53 companies which have been paying out dividends continuously

for the past six years. Descriptive statistics, Multi-variate Regression analysis, and Ordinary Least

Square Regression analysis were applied on this sample of companies. Results show that firms

size and corporate tax had a noteworthy relationship with dividend outgoings. The rest if the 4th

variable had no significant relationship with the payout ratio.

Ashraf & Mohsin (2012) studied the relationship between the cost of funds and dividend

payout ratio. Aim of this research is to answer the question whether macro-economic variables

influence dividend payout ratio, mainly under the monetary policy restrictions. The sample

considered for this study consists of 100 firms listed at KSE within the period of 2001-2009.

Descriptive statistics and an enhanced version of Lintners Dividend Model is applied which

proposes that the cost of funds is inversely related to dividend payout ratio. To retain as much as

possible for the future investment and internal financing, dividend payout decreases.

Gupta et. al. (2011) in this research, aim to explore the influence of the growth rate, non-

diversifiable, and overall risk on the optimum dividend payout ratio. Sample comprises of all the

firms listed on NYSE, NASDAQ, and AMEX and the time period is from 1969-2009. A dividend
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policy model had been created based upon the assumptions of a perfect market being zero

transaction cost and no taxes between dividends and capital gains. Fixed-effect model had been

applied upon the sample selected and in the results, it is clear that when the growth rate of a firm

increases, the firm reduces its dividend payouts. Moreover, non-linear relationship had been found

between the risk and dividend payout ratio. Means that these two variables have an inverse

relationship.
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Theoretical Framework:

Regression Equation:

Y = + 1 (Firms earnings) + 2 (Growth) + 3 (Profitability) + 4 (Firm Size) + 5 (Systematic

Risk) + 6 (ROA)

Where:

Y = Dividend Payout Ratio

= Intercept or Regression constant

16 = Regression Co-efficient
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Bibliography:

Abdul, J. & Muhammad, A. (2015). Does capital structure influence payout? A study on KSE -30

Index. African Journal Of Business Management, 9(4), 157-169.

Allen, L., Gottesman, A., Saunders, A., & Tang, Y. (2012). The role of banks in dividend policy.

Financial Management, 41(3), 591-613.

Ashraf, M. S., & Mohsin, H. M. (2012). Monetary policy restriction and dividend behaviour of

Pakistani firms: an empirical analysis. The Pakistan Development Review, 683-693.

Benavides, J., Berggrun, L., & Perafan, H. (2016). Dividend payout policies: Evidence from Latin

America. Finance Research Letters, 17, 197-210.

Francis, B. B., Hasan, I., John, K., & Song, L. (2011). Corporate governance and dividend payout

policy: A test using antitakeover legislation. Financial Management, 40(1), 83-112.

Gill, A., Biger, N., & Tibrewala, R. (2010). Determinants of dividend payout ratios: evidence from

United States. The Open Business Journal, 3(1).

Haider, J., Ali, A., & Sadiq, T. (2012). Earning management and dividend policy: Empirical

evidence from Pakistani listed companies. European Journal of Business and

Management, 4(1), 83-90.

Imran, K., Usman, M., & Nishat, M. (2013). Banks dividend policy: Evidence from Pakistan.

Economic Modelling, 32, 88-90.

John, S. F., & Muthusamy, K. (2010). Leverage, growth and profitability as determinants of

dividend payout ratio-evidence from Indian paper industry. Asian Journal of Business

Management Studies, 1(1), 26-30.

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Leary, M. T., & Michaely, R. (2011). Determinants of dividend smoothing: Empirical evidence.

Review of Financial studies, 24(10), 3197-3249.

Lee, C. F., Gupta, M. C., Chen, H. Y., & Lee, A. C. (2015). Optimal payout ratio under uncertainty

and the flexibility hypothesis: Theory and empirical evidence. In Handbook of Financial

Econometrics and Statistics (pp. 2135-2176). Springer New York.

Michaely, R., & Roberts, M. R. (2012). Corporate dividend policies: Lessons from private firms.

Review of Financial Studies, 25(3), 711-746.

Rafique, M. (2012). Factors affecting dividend payout: Evidence from listed non-financial firms

of Karachi stock exchange. Business Management Dynamics, 1(11), 76-92.

Rehman, R., Hasan, M., Mangla, I. U., & Sultana, N. (2012). Economic reforms, corporate

governance and dividend policy in sectoral economic growth in Pakistan. The Pakistan

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Zhou, P., & Ruland, W. (2006). Dividend payout and future earnings growth. Financial Analysts

Journal, 62(3), 58-69.