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Dividend policy in Indonesia: Survey evidence from executives

Article · January 2012

DOI: 10.1108/15587891211191399

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Dividend policy in Indonesia: survey
evidence from executives
H. Kent Baker and Gary E. Powell
H. Kent Baker is University
Professor of Finance and
Kogod Research Professor
at Kogod School of
Business, American
University, Washington DC,
USA. Gary E. Powell is
based at the McColl School
of Business, Queens
University of Charlotte,
North Carolina, USA.
Received: 10 March 2009
Accepted: 18 November 2009
DOI 10.1108/15587891211191399
Abstract
Purpose – This study aims to survey managers of dividend-paying firms listed on the Indonesian Stock
Exchange (IDX) to learn their views about the factors influencing dividend policy, dividend issues, and
explanations for paying dividends. The study also aims to focus on Indonesia, the largest national
economy in Southeast Asia, because relatively few studies examine why Indonesian firms pay
dividends.
Design/methodology/approach – The primary means of gathering data is a mail survey. The two-page
survey instrument consists of three main sections: 22 factors for determining a firm’s dividend policy; six
questions that provide background information about the respondents and their firms; and 27
statements about dividend policy in general. Of the 163 firms surveyed, 52 firms responded, resulting in
a response rate of 31.9 per cent.
Findings – The evidence shows that managers view the most important determinants of dividends as
the stability of earnings and the level of current and expected future earnings. They also believe that the
effects of dividends on stock prices and needs of current shareholders are important determinants. The
evidence shows that managers of Indonesian firms perceive that dividend policy affects firm value.
Managers seem to agree that multiple theories including signaling, catering, and life cycle explanations
help to explain why their firms pay dividends.
Research limitations/implications – The study focuses on a limited number of factors and issues
involving dividend policy. While non-response bias could potentially limit making generalizations to the
population of IDX firms, statistical tests show no significant differences between respondents and
non-respondents on various firm characteristics.
Practical implications – The evidence suggests that no universal set of factors is likely to be applicable
to all firms when setting dividend policy.
Originality/value – This study presents new evidence on the perceptions of managers of
dividend-paying IDX-listed firms about the factors influencing dividend policy, dividend issues, and
explanations for paying dividends.
Keywords Dividend policy, Dividend puzzle, Dividends, Business policy, Indonesia
Paper type Research paper
Introduction
Since Black (1976) referred to the interest in dividends by shareholders and the practice of
firms paying dividends as the ‘‘dividend puzzle,’’ researchers have tried to understand the
determinants of dividend policy. Dividend policy remains a topic of ongoing debate among
financial economists (Baker et al., 2002). Although most studies focus on US firms, a
growing body of evidence exists on dividend policy outside of the US. These studies
generally rely on economic modeling approaches instead of obtaining direct evidence about
how investors and managers behave and perceive dividends. Researchers cannot fully
identify factors influencing dividend policy by merely modeling market data, but must also
use interactive tools such as interviews and surveys. As Bruner (2002, p. 50) notes, ‘‘The
task must be to look for patterns of confirmation across approaches and studies much like
VOL. 6 NO. 1 2012, pp. 79-92, Q Emerald Group Publishing Limited, ISSN 1558-7894 j JOURNAL OF ASIA BUSINESS STUDIES j PAGE 79
 one sees an image in a mosaic of stones.’’ To resolve the dividend puzzle, Chiang et al.
(2006) conclude that the cardinal thrust of academic research must turn toward learning
about the motivation for making managerial decisions and the perceptions upon which this
motivation is based.
We study dividend policy from the perspective of Southeast Asian managers. Specifically, we
explore the perceptions of managers of Indonesian Stock Exchange (IDX) traded firms about
dividend policy. We focus on Indonesia, the largest national economy in Southeast Asia,
because relatively few studies examine why Indonesian firms pay dividends. Indonesia has a
market-based economy in which the government plays an important role by owning more than
164 state-owned enterprises. The government also administers prices on such basic goods
as fuel, rice, and electricity. Capital markets are developing and the previous two stock
exchanges merged into the Indonesia Stock Exchange in 2007. Between 2000 and 2009,
Indonesia experienced an average economic growth rate of more than 5 percent but suffered
below normal gross domestic product growth in 2009 due to the worldwide financial crisis.
Our study investigates four major questions:
1. What are the most important factors that managers perceive as influencing the dividend
policies of IDX-listed firms?
2. Do the overall perceptions about the factors influencing dividend policy differ between
managers of Indonesian firms and those of US or Canadian firms?
3. What views do managers of Indonesian firms have on dividend processes and patterns,
dividend policy and firm value, and residual dividend policy? And
4. What level of support do managers of Indonesian firms give to various explanations for
paying dividends?
This study is important because it updates and expands previous survey-based research on
dividends. Survey evidence on Indonesian dividend policy is limited and more than a
decade old (see, for example, Kester et al., 1995-1996; Ang et al. 1997). These studies
occurred before the Asian financial crisis of 1997-1998 and the 1998 coup deposing the
long-time Indonesian ruler Suharto. Since this crisis the Indonesian government has initiated
programs of structural reform to help remedy inadequacies of governance mechanisms,
which were a major cause of the crisis. Sawicki (2009) shows a relationship between
corporate governance and dividend policy in East Asian countries. She also finds that
governance scores improved after the onset of the crisis and dividends fell dramatically.
Further, our study examines issues not previously addressed in surveys involving managers
of Indonesian firms. Our study uses the same survey instrument to compare the views of
Indonesian managers with those of their US and Canadian counterparts. Given differences
among these three countries, our survey results may differ from those reported in previous
US and Canadian studies.

Literature review
Because the literature on dividend policy is voluminous, this section focuses on two main
topics: factors influencing dividend policy and explanations for paying dividends. Baker
(2009) provides an extensive discussion of dividends and dividend policy while Baker et al.
(2010) provide a synthesis of the major US and non-US studies based on survey evidence.

Factors influencing dividend policy

Over the past half-century, numerous researchers have attempted to identify different
factors influencing the payment of dividends. For example, in his seminal study, Lintner
(1956) reports that past dividends and current earnings are the primary determinants of
current dividends and managers prefer to maintain stable dividends and make periodic
adjustments toward a target payout ratio. In a recent study, Brav et al. (2005) benchmark
their findings to Lintner. They find that the perceived stability of future earnings still affects
dividend policy but the link between dividends and earnings is weaker. They also find that

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PAGE 80 JOURNAL OF ASIA BUSINESS STUDIES VOL. 6 NO. 1 2012
managers continue to make dividend decisions conservatively but that the importance of
targeting the payout ratio is not as high. Dividend payers also tend to smooth dividends from
year to year and alter the amount dividends in response to permanent changes in earnings.
In their review of the literature on dividend determinants since Lintner, Baker et al. (2010)
conclude that managers tend to share some commonly-held beliefs about the factors that
affect dividend policy. The evidence suggests that the key determinants that influence
dividend policy appear to have remained fairly stable over more than 50 years. Some of the
more important and consistent determinants of payout policy include the pattern of past
dividends, stability of earnings or cash flows, and the level of current and expected future
earnings. Such firm-specific factors appear to be first-order determinants in making
dividend decisions.
Several non-survey studies examine dividend policy in Indonesia. Sawicki (2003) investigates
the dividend policy of firms in eight East Asian countries including Indonesia. She examines
firm-level effects on dividend policy and finds that past and expected revenue growth, cash
flow adequacy, collateralizable assets, and systematic risk are positively related to payout
ratio. She also shows that inter-industry and inter-country differences are related to legislation,
tax and ownership structure, and socio-cultural and political influences. In a later study,
Sawicki (2009) examines the relationship between dividends and corporate governance in
five East Asian countries, including Indonesia, over the period 1994-2003. She finds evidence
of a pre-crisis negative relationship between dividends and governance, which indicates that
dividends act as a substitute for other corporate governance mechanisms during this period.
Her results show a strong positive relationship between governance and dividends after the
1997-1998 financial crisis. Sawicki interprets this relationship as consistent with substantial
improvements in governance empowering shareholders.
Mahadwartha (2003, 2007) examines the relationship between financial policy (dividends
and leverage) and managerial ownership of Indonesian firms. The results show that a firm’s
financial policy influenced the probability that it engaged in a managerial ownership
program. This evidence is consistent with agency theory prediction that there is substitution
between policies in bonding and monitoring mechanisms to control agency conflicts.

Explanations for paying dividends

Over the past five decades, researchers have devoted considerable study to the question of
why companies pay dividends and have proposed many dividend theories about dividend
payout decisions. Although numerous theories, models, and explanations exist, we focus on
six broad categories, which are not necessarily mutually exclusive. An in-depth discussion
of each theory and the related empirical evidence is available in Baker (2009).
B Bird-in-the-hand theory: Investors prefer cash in the hand rather than a future promise of
capital gains due to lower risk (Gordon, 1962, 1963; Walter, 1963).
B Signaling explanations: Dividends mitigate information asymmetry between management
and shareholders by conveying private information about a firm’s future prospects
(Bhattacharya, 1979, 1980; John and Williams, 1985).
B Taxes and clientele effects: Differentials in tax rates between dividends and capital gains
lead to different clienteles (Elton and Gruber, 1970; Miller and Scholes, 1978).
B Agency theory: Dividends help to reduce the agency costs associated with the
separation of ownership and control (Jensen and Meckling, 1976; Rozeff, 1982;
Easterbrook, 1984; Jensen, 1986).
B Firm life cycle theory of dividends: Dividend policy tends to follow a firm’s life cycle in that
a firm begins paying dividends when its growth rate and profitability are expected to
decline in the future (Mueller, 1972; Fama and French, 2001; DeAngelo et al., 2006).
B Catering theory of dividends: Managers give investors what they currently want. That is,
they cater to investor demand by paying dividends when investors put a stock price
premium on payers, and by not paying when investors prefer nonpayers (Baker and
Wurgler, 2004a, 2004b).

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VOL. 6 NO. 1 2012 JOURNAL OF ASIA BUSINESS STUDIES PAGE 81
 Baker et al. (2010) conclude there is no clear winner among the competing dividend
theories, and no single theory has become the dominant solution to the dividend puzzle.
Some empirical support exists for each theory. They find that the agency costs and signaling
explanations appear to have more convincing empirical support than the tax-preference
explanation. While no theory provides definitive answers, more recent theories, including the
firm life cycle theory of dividends and the catering theory of dividends, provide some useful
insights while still producing mixed results.

Research design
Survey instrument
As our primary means of gathering data, we use a mail survey initially designed by Baker
and Powell (2000) and Baker et al. (2001) for US firms, and later used by Baker et al. (2007)
for Canadian firms. Using the same survey allows us to compare views of Indonesian
managers with those of US and Canadian managers. Finding inter-country differences may
cast doubt on the appropriateness of using a single model to understand the determinants
of dividend policy.
The two-page survey instrument, which was translated from English into Bahasa Indonesia,
consists of three main sections. A copy of the survey instrument is available from the authors
by request. The first section asks respondents to indicate the level of importance of 22
factors for determining their firm’s dividend policy (hereafter called F no.) using a four-point
scale where none ¼ 0, low ¼ 1, moderate ¼ 2, and high ¼ 3. The second section contains
six questions that provide background information about the respondents and their firms.
The third section asks respondents to indicate their level of agreement or disagreement with
each of 27 statements about dividend policy in general (hereafter called S#) using a
five-point scale where strongly disagree (SD) ¼ 22, disagree (D) ¼ 2 1, no opinion
(NO) ¼ 0, agree (A) ¼ þ 1, and strongly agree (SA) ¼ þ2. The survey also contains a
company code number to enable differentiating between respondents and
non-respondents for purposes of testing for non-response bias.

Sample and response rate

The initial sample includes the 163 firms listed on the Indonesian Stock Exchange (IDX) that
paid one or more cash dividends to common stockholders between November 1, 2006 and
January 15, 2009. The Director of Research at the IDX provided the sample. We mailed the
survey instrument to the chief financial officer (CFO) of each firm in March 2009. The mailing
included a cover letter and a stamped return envelope. The cover letter assured recipients
that their answers would be confidential and released only in summary form. If the CFOs
preferred not to respond to the survey, the cover letter instructed them to give it to someone
actively involved in their firm’s dividend decisions or to return a blank questionnaire. As an
inducement to increase the response rate, we offered to provide a summary of our results
upon request. Of the 163 firms, we received responses from 52 firms, resulting in a response
rate of 31.9 percent.

Statistical tests
We conduct several statistical tests. First, we calculate the Spearman rank correlation
coefficient, rs, to determine whether a significant relationship exists between the rankings of
the 22 factors by managers of Indonesian firms and those in the US and Canada. We use a
one-sample t-test to determine whether the mean response for each of the 27 issues
involving dividend policy differs significantly from 0 (no opinion).

Potential limitations
Before presenting the survey results, we address several potential limitations. First, our study
focuses on a limited number of factors and issues involving dividend policy. Second,
non-response bias could limit our ability to make generalizations to the population of IDX
firms. We took the normal precautions to reduce this bias, including guaranteeing

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PAGE 82 JOURNAL OF ASIA BUSINESS STUDIES VOL. 6 NO. 1 2012
confidentiality, providing a stamped return envelope, and offering a free summary report as
an incentive to complete the questionnaire. The relatively high response rate lessens the
concern about non-response bias to some extent.
To test for non-response bias, we compare characteristics of responding firms to those of
non-responding firms. If the characteristics of the two groups are similar, this would lessen
the concern about potential non-response bias. Interpretation of the t-tests for differences in
means suggests that the responding firms closely correspond to the non-responding firms
regarding the following characteristics: total assets, sales, market value of equity, and
dividend payout. These results are available from the authors upon request.

Results and discussion

Profile of respondents and firms
Responses to the survey’s six background questions yield the following results. The
52 respondents hold high-level positions in their firms: CFO (36.5 percent), Corporate
Secretary (34.6 percent), Director of Finance (23.1 percent), Controller (3.9 percent), and
other (1.9 percent). The vast majority of respondents (94.2 percent) indicate active
involvement in their firm’s dividend policy decisions. The 52 respondents represent firms
from a wide variety of industry groups, of which the most common are: service (19.2 percent),
manufacturing (17.3 percent), retail (13.5 percent), construction, utility, and mining
(11.5 percent), financial (9.6 percent), real estate/property (7.7 percent), transportation
(&0.7 percent), and oil/gas (7.7 percent), and pharmaceutical (5.8 percent). No other
industry group amounts to as much as 5 percent of the total.
A majority of respondents (69.2 percent) report that their firm has an explicit target payout
ratio. Respondents indicate that the most influential person in developing their firm’s
dividend policy is the CFO (57.7 percent) followed by the CEO (30.8 percent) and Director of
Finance (11.5 percent). Additionally, most responding managers report that their firms
formally reexamine dividend policy annually (78.8 percent), followed by those who do so
quarterly (15.4 percent), and other (5.8 percent).

Factors influencing dividend policy

Our first research question attempts to identify the most important factors that managers of
Indonesian firms perceive as influencing their dividend policies. Table I reports the level of
importance of 22 potential determinants of dividend policy. The results show that at least half
of the respondents view nine factors as being of high importance (F1, F2, F3, F4, F5, F10,
F11, F14, and F20) in determining their firm’s dividend policy. The three most highly ranked
factors involve earnings: the stability of earnings (F1), the level of current earnings (F3), and
the level of expected future earnings (F4). The fourth-highest ranked dividend determinant
concerns liquidity constraints such as the availability of cash (F11). The importance that
managers of IDX-listed firms place on earnings is rational given that earnings tend to be
highly correlated with cash flows and cash serves as the basis for paying dividends. Other
factors that at least half of responding managers view as important are: the concern about
affecting the stock price (F5), needs of current shareholders such as the desire for current
income (F14), the pattern of past dividends (F2), projections about the future state of the
economy (F10), and investment considerations (F20).
Evidence from Table I indicates that at least some respondents view each of the 22 factors as
of high importance. Yet, responding managers perceive only five factors as being of no
importance (F1, F2, F3, F4, and F11) and the first four of these factors are the most highly
ranked among the 22 dividend determinants. Overall, our evidence suggests that no simple
set of determinants of dividend policy exists for all firms. That is, a ‘‘one-size fits all’’
approach is inappropriate in describing the factors that these managers consider most
important. Preferences may reflect firm-level and industry-level effects on dividend policy
documented in previous empirical studies such as Sawicki’s (2003) study of firms in East
Asia.

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VOL. 6 NO. 1 2012 JOURNAL OF ASIA BUSINESS STUDIES PAGE 83
Table I Level of importance attached to factors influencing dividend policy by managers of Indonesian firms
Level of importance Rank
Low Mod High
F no. Factor None 0 1 2 3 Mean IDX NYSE NASDAQ TSX

1 Stability of earnings 0.0 7.7 17.3 75.0 2.67 1 6 2 2

3 Level of current earningsa 0.0 11.5 15.4 73.1 2.62 2 1.5 3 4
4 Level of expected future earningsa 0.0 13.5 15.4 71.2 2.58 3 1.5 4 1
Liquidity constraints such as the availability of
11 cash 0.0 7.7 28.8 63.5 2.56 4 8 14 5
5 Concern about affecting the stock price 1.9 9.6 21.2 67.3 2.54 5 4 5 7
Needs of current shareholders such as the desire
14 for current income 1.9 9.6 30.8 57.7 2.44 6 10 9 9
2 Pattern of past dividends 0.0 17.3 28.8 53.8 2.37 7 3 1 3
10 Projections about the future state of the economy 3.8 11.5 32.7 51.9 2.33 8 18 18 17
Investment considerations such as the
20 availability of profitable investment opportunities 3.8 13.5 32.7 50.0 2.29 9 7 15 11
Desire to pay out, in the long run, a given fraction
13 of earnings 3.8 21.2 38.5 36.5 2.08 10 9 7 6
Signaling incentives such as using dividend
changes to convey information to financial
21 markets 13.5 21.2 32.7 32.7 1.85 11 NA 16 16
7 Availability of alternative sources of capital 17.3 23.1 25.0 34.6 1.77 12 NA 17 15
6 Current degree of financial leverage 13.5 32.7 21.2 32.7 1.73 13.5 NA 10 8
Preference to pay dividends instead of
16 undertaking risky reinvestments 11.5 28.8 34.6 25.0 1.73 13.5 19 20 21
Contractual constraints such as dividend
15 restrictions in debt contracts 13.5 30.8 28.8 26.9 1.69 15 15 21 20
Financing considerations such as the cost of
19 raising external funds (debt and equity) 13.5 28.8 36.5 21.2 1.65 16 12 19 14
Desire to conform to the industry’s dividend
12 payout ratio 15.4 32.7 36.5 15.4 1.52 17 14 13 18
8 Expected rate of return on the firm’s assets 23.1 30.8 30.8 15.4 1.38 18 13 11 10
9 Desire to maintain a target capital structure 17.3 44.2 28.8 9.6 1.31 19 11 6 13
Legal rules and constraints such as paying
18 dividends that would impair capital 17.3 50.0 25.0 7.7 1.23 20 16 12 19
Stockholder characteristics such as the marginal
22 tax rates of the firm’s current shareholders 36.5 32.7 21.2 9.6 1.04 21.5 17 22 22
Desire to avoid giving a false signal to investors
17 by changing the dividend 40.4 23.1 28.8 7.7 1.04 21.5 5 8 12

Notes: This table presents the survey responses for 52 dividend-paying Indonesian firms on the importance of 22 factors in determining
the respondent firms’ dividend policy. The rankings are based on a four-point importance scale were none¼0, low ¼ 1, moderate ¼ 2,
and high ¼ 3, and are listed in declining order of the means of the Indonesian firms. Baker and Powell (2000) and Baker et al. (2001)
provide the rankings for the NYSE and NASDAQ firms, respectively, and Baker et al. (2007) supply the rankings for the TSX-listed
(Canadian) firms; aBaker and Powell (2000) combine these two factors into a single factor (i.e. level of current and expected future
earnings)

Our second research question addresses whether managerial perceptions about the
importance of the factors influencing dividend policy differ between Indonesian firms and
US and Canadian firms. We calculate the Spearman rank order correlation coefficient, rs, to
determine whether a significant relationship exists between the rankings of 22 factors by
managers of IDX and NASDAQ firms, IDX and TSX firms, and NASDAQ and TSX firms. We
do not calculate rs between the rankings of IDX and NYSE firms because the Baker and
Powell (2000) study for NYSE firms contains only 18 of the 22 factors. We include the
rankings of NYSE firms for illustrative purposes.
The resulting rs is 0.479 for IDX-NASDAQ (significant at the 0.05 level), 0.728 for the
IDX-TSX, and 0.835 for NASDAQ-TSX (both significant at the 0.01 level). Overall, these
correlation coefficients show that managers of IDX, NASDAQ, and TSX firms rank the factors
influencing dividend policy in a similar manner despite differing characteristics between
both the firms and markets on which their stocks trade.

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PAGE 84 JOURNAL OF ASIA BUSINESS STUDIES VOL. 6 NO. 1 2012
Not surprisingly, similarities and differences in rankings emerge for individual determinants
of dividend policy. For example, the rankings relating to earnings (F1, F3, and F4) are all
among the most highly ranked by managers of firms on all four markets (IDX, NASDAQ,
NYSE, and TSX). Also, rankings of stockholder characteristics (F22) are consistently low
across these financial markets. By contrast, managers of IDX firms rank the pattern of past
dividends (F2) lower than US and Canadian managers but rank projections about the future
state of the economy (F10) higher than their North American counterparts. The concern
about the economy expressed by managers of Indonesian firms may reflect differences in
the economic climate when the survey was administered. The survey of Indonesian firms
occurred in 2009 during a period of economic downturn in which Indonesia was
experiencing its lowest growth rate in gross domestic product since 2001. By contrast,
studies involving NASDAQ, NYSE, and TSX firms occurred during periods of a robust
economy.

Dividend issues
Our third research question focuses on determining the views of managers of Indonesian
firms on dividend processes, dividend patterns, dividend policy and firm value, and residual
dividend policy. Table II presents the survey results on these four issues. Panel A provides
the respondents’ views on five statements (S4, S5, S6, S7, and S8) based on Litner’s (1956)
behavioral model describing corporate dividend setting. The responses to four of the five
statements (S4, S5, S6, and S7) differ significantly from zero (no opinion) at the 0.01 level.
Thus, these views tend to be consistent with Lintner’s model.
Almost 83 percent of respondents agree with the statement that a firm should set a target
dividend payout ratio and periodically adjust its current payout toward the target (S4). This
response is not surprising given that 69.2 percent of respondents report that their firms have
an explicit target payout ratio. These findings are consistent with previous survey evidence
reported by Kester et al. (1995-1996) that Indonesian executives believe firms should have
target payout ratios.
About 81 percent of respondents agree that a firm should change dividends based on a
sustainable shift in earnings (S5). This finding is consistent with the importance that
responding managers place on earnings as shown in Table I. More than 73 percent of
respondents believe that a firm should avoid increasing its regular dividend if it expects to
reverse the dividend decision in a year or so (S6). Finally, the majority of respondents believe
a firm should strive to maintain an uninterrupted record of dividend payments (S7).
Panel B of Table II presents the results for two statements about the historical pattern of
dividends (S1 and S2). More than 90 percent of respondents express agreement that
dividends generally follow a smoother path than earnings (S2), while about 83 percent
believe that dividend changes generally lag earnings changes (S1). The mean of both
statements differs significantly from zero (no opinion) at the 0.01 level.
Miller and Modigliani’s (1961) seminal paper provides a theoretical proof showing that under
certain simplifying assumptions a firm’s dividend policy is irrelevant. The
dividend-irrelevance theory indicates that dividends have no effect on a firm’s stock price
or cost of capital. Under this theory, investors care little about a firm’s dividend policy when
making their purchasing decision because they can simulate their own dividend policy.
Further, Miller and Modigliani assume that all non-dividend decisions, such as the firm’s
operating, investing, and other financial decisions, are independent of the firm’s dividend
policy. In perfect capital markets, they contend that value results from investment decisions
and that financing decisions are irrelevant. Given a choice between financing new projects
with retained earnings or with new equity, a firm’s managers should be indifferent. Thus,
managing a dividend payment in excess of the residual dividend cannot increase
shareholder wealth. Contrary to this prediction, firms tend to follow deliberate dividend
payout strategies. Ang and Ciccone (2009) provide an in-depth discussion of dividend
irrelevance theory.

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Table II Level of agreement by managers of Indonesian firms on issues involving dividend policy
Disagree Agree
SD D NO A SA
S no. Statement 22 21 0 þ1 þ2 Mean Std. dev. t-value

Panel A. Dividend process

4 A firm should set a target dividend payout ratio and
periodically adjust its current payout toward the
target 0.0 1.9 15.4 30.8 51.9 1.327 1.566 6.112**
5 A firm should change dividends based on
sustainable shifts in earnings 0.0 1.9 17.3 30.8 50.0 1.288 1.540 6.032**
6 A firm should avoid increasing its regular dividend if it
expects to reverse the dividend decision in a year or
so 0.0 1.9 25.0 40.4 32.7 1.038 1.328 5.637**
7 A firm should strive to maintain an uninterrupted
record of dividend payments 5.8 15.4 26.9 32.7 19.2 0.442 1.229 2.596**
8 The market places greater value on stable dividends
than stable payout ratios 7.7 17.3 32.7 28.8 13.5 0.231 1.155 1.441

Panel B. Dividend patterns

2 Dividends generally follow a smoother path than
earnings 0.0 0.0 9.6 34.6 55.8 1.462 1.621 6.502**
1 Dividend changes generally lag behind earnings
changes 0.0 5.8 11.5 34.6 48.1 1.250 1.540 5.852**

Panel C. Dividend policy and firm value

10 A firm should formulate its dividend policy to produce
maximum value for its shareholders 0.0 1.9 15.4 30.8 51.9 1.327 1.566 6.112**
9 A change in a firm’s cash dividends affects its value 0.0 5.8 21.2 30.8 42.3 1.096 1.448 5.457**
11 An optimal dividend policy strikes a balance between
current dividends and future growth that maximizes
stock price 1.9 3.8 30.8 30.8 32.7 0.885 1.328 4.802**
15 A firm’s dividend policy generally affects its cost of
capital 3.8 13.5 36.5 25.0 21.2 0.462 1.188 2.801**
13 A firm’s investment, financing, and dividend
decisions are interrelated 9.6 11.5 26.9 30.8 21.2 0.423 1.299 2.349*

Panel D. Residual dividend policy

12 A firm should view cash dividends as a residual after
funding desired investments from earnings 1.9 1.9 21.2 34.6 40.4 1.096 1.448 5.457**
14 A firm’s expenditures on new capital investments
generally affect its dividend pattern 1.9 7.7 26.9 36.5 26.9 0.788 1.276 4.457**

Notes: This table presents the survey responses for 52 dividend-paying Indonesian firms on 14 statements involving four issues: Panel
A: dividend process; Panel B: dividend patterns; Panel C: dividend policy and firm value; and Panel D: residual dividend policy. Rankings
are based on a five-point scale ranging where disagree (SD) =-2, disagree (D) ¼ 21, no opinion (NO) ¼ 0, agree (A) ¼ +1, and strongly
agree (SA) ¼ +2. Under Panels A –D panel, the statements are shown in declining order of their means. The t-value shows the result of
testing the null hypothesis that the mean response equals 0 (no opinion); *, ** Significant at the 0.05 and 0.01 levels, respectively

Panel C of Table II presents responses to five statements used to help discern whether
managers of IDX firms believe that dividend payout policy affects firm value (S9, S10, S11,
S12, and S15). If respondents support the notion of dividend irrelevance, they should
disagree with each of these five statements. As Panel C shows, the mean for each of these
statements is positive and differs significantly from zero (no opinion) at the 0.05 level or
better. Almost 83 percent of the respondents agree that a firm should formulate its dividend
policy to produce maximum value for its shareholders (S10) while more than 73 percent
express agreement with the statement that a change in a firm’s cash dividends affects its
value (S9). Nearly 64 percent of respondents agree that an optimal dividend policy strikes a
balance between current dividends and future growth that maximizes stock price (S11). The
majority (52 percent) also agree with the notion that a firm’s investment, financing, and
dividend decisions are interrelated while 46 percent of the respondents agree that a firm’s
dividend policy generally affects its cost of capital (S15).

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Overall, our results support the notion that managers of IDX firms generally believe a firm’s
dividend payout policy affects value; hence, the respondents perceive dividends are
relevant. Our evidence is consistent with Kester et al. (1995-1996) who report that
Indonesian executives believe dividend policy affects share prices. They also find that
Indonesian executives believe that a firm’s investment and dividend decisions are more
binding than capital structure decisions.
In theory, value-maximizing managers will only invest in positive net present value projects.
After managers exhaust all such desirable investments, the firm should pay the residual
cash flow as the dividend. Panel D of Table II presents the responses to two statements
involving residual dividend policy (S13 and S14). Our findings show that 75 percent of
respondents believe that a firm should view cash dividends as residual after funding desired
investments from earnings (S12). More than 63 percent think that a firm’s expenditures on
new capital investments generally affect its dividend pattern (S14). The means for these two
responses differ significantly from zero (no opinion) at the 0.01 level. Although this evidence
suggests that the responses of managers of Indonesian firms generally support a residual
dividend policy, further research is needed to determine if they actually follow such a policy.
As Smith (2009) notes, strong arguments exist favoring a residual dividend policy as a way
to optimize the efficiency of corporate resource use. He concludes, however, that most firms
generally a follow a managed payout policy that involves dividend smoothing instead of a
residual dividend policy.

Why firms pay dividends

The final research question examines the level of support that managers of IDX firms give to
various explanations for paying dividends. Table III presents the level of agreement on
13 statements involving six dividend theories. The means of nine of the 13 statements differ
significantly from zero (no opinion) at the 0.01 level. We focus primarily on those statements
in which respondents express the strongest level of agreement or disagreement.
The bird-in-the-hand theory states that dividends are relevant especially if investors face
expropriation. For example, dividend payout can be value enhancing for poorly governed
firms by distributing free cash flow that insiders might otherwise squander. This theory
recognizes that investment, earnings, and dividend streams are uncertain and that
distributions of possible future cash flows replace certain amounts. Advocates of this theory
argue that investors value dividends more than capital gains when making decisions related
to stocks. This theory takes its name from the old saying ‘‘a bird in the hand is worth two in the
bush.’’ In this theory ‘‘the bird in the hand’’ refers to dividends and ‘‘the bush’’ refers to
capital gains. By contrast, Miller and Modigliani (1961), who contend that investors are
indifferent between dividends and capital gains, refer to the bird-in-the-hand theory as a
‘‘fallacy.’’
Panel A of Table III shows the responses to a statement involving the bird-in-the-hand theory.
The results show that respondents, on average, disagree with the notion that investors
generally prefer cash dividends today to uncertain future price appreciation (S16). The
mean response, however, does not differ significantly from zero (no opinion) at the 0.05 level.
In fact, more than 38 percent of respondents offer no opinion on this statement. Thus, our
survey results are inconclusive about how managers view this theory.
According to dividend-signaling theory, firms can use dividend changes to convey
information about the firm’s future growth opportunities. Given information asymmetry
between the firm and the market, investors should consider the announcement of dividend
increases as good news and dividend cuts and reductions as bad news. The firm’s stock
price should respond according to the signal that the dividend announcement conveys. That
is, the stock price should move in the same direction as the dividend. Based on his synthesis
of the literature on asymmetric information and signaling theory, Filbeck (2009, p. 174)
concludes: ‘‘Overall, most empirical evidence tends to support theoretical models regarding
the ability of dividend changes to affect share prices. Unexpected dividend increases
(decreases) are associated with significant share-price increases (decreases).’’

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Table III Level of agreement by managers of Indonesian firms on explanations for paying dividends
Disagree Agree
SD D NO A SA
22 21 0 þ1 þ2 Mean Std. dev. t-value

Panel A. Bird-in-the-hand
16 Investors generally prefer cash dividends today to
uncertain future price appreciation. 9.6 32.7 38.5 9.6 9.6 20.231 1.103 21.509

Panel B. Signaling theory

19 A firm’s stock price generally rises when the firm
unexpectedly increases its dividend 0.0 3.8 9.6 28.8 57.7 1.404 1.639 6.177*
20 A firm’s stock price generally falls when the firm
unexpectedly decreases its dividend 1.9 5.8 15.4 32.7 44.2 1.115 1.508 5.333*
18 Investors generally regard dividend changes as
signals about a firm’s future prospects 5.8 15.4 23.1 28.8 26.9 0.558 1.336 3.011*
17 Investors generally use dividend announcements as
information to help assess a firm’s stock value 7.7 17.3 17.3 32.7 25.0 0.500 1.358 2.656*
22 A firm should adequately disclose to investors its
reasons for changing its cash dividend 15.4 19.2 28.8 26.9 9.6 20.038 1.221 20.227
21 Dividend increases are ambiguous because they can
suggest either future growth or a lack of investment
opportunities 17.3 17.3 28.8 26.9 9.6 20.058 1.245 20.334

Panel C. Taxes and clientele effects

25 Investors generally prefer to invest in firms whose
dividend policies complement their particular tax
circumstances 5.8 11.5 11.5 32.7 38.5 0.865 1.502 4.156*
24 Stocks that pay high (low) dividends attract investors
in low (high) tax brackets 19.2 17.3 26.9 25.0 11.5 20.077 1.299 20.427

Panel D. Agency theory

27 The payment of dividends encourages a firm’s
managers to act in the interest of the firm’s outside
shareholders 5.8 5.8 15.4 25.0 48.1 1.038 1.584 4.727*
26 The payment of dividends forces a firm to seek more
external (debt or equity) financing, which subjects the
firm to additional investor scrutiny 27.5 33.3 17.6 19.6 2.0 20.647 1.319 23.503*

Panel E. Firm life cycle theory of dividends

3 The pattern of cash dividends generally changes
over a firm’s life cycle 7.7 9.6 21.2 32.7 28.8 0.654 1.386 3.401*

Panel F. Catering theory of dividends

23 A firm should be responsive to the dividend
preferences of its shareholders 0.0 5.8 17.3 36.5 40.4 1.115 1.442 5.579*

Notes: This table presents the survey responses for 52 dividend-paying Indonesian firms (except S26 where n ¼ 51) on 13 statements
involving six explanations for paying dividends: Panel A dividend policy. Rankings are based on a five-point scale where strongly
disagree (SD) ¼ 22, disagree (D) ¼ 21, no opinion (NO) ¼ 0, agree (A) ¼ +1, and strongly agree (SA) ¼ +2. Under Panels A –D panel,
the statements are shown in declining order of their means. The t-value shows the result of testing the null hypothesis that the mean
response equals 0 (no opinion); * Significant at 0.01 levels

Panel B of Table III presents managers’ opinions on six statements about signaling theory.
The means of four of these statements (S17, S18, S19, and S20) are positive and differ
significantly from zero (no opinion) at the 0.01 level. The results show that the majority of
respondents (about 56 percent) agree that investors generally regard dividend changes as
signals about the firm’s future prospects (S18). Almost 87 percent of respondents express
agreement with the statement that a firm’s stock price generally rises when the firm
unexpectedly increases its dividend (S19), while nearly 77 percent agree that a firm’s stock
price generally falls when the firm unexpectedly decreases its dividend. These two
statements (S19 and S20) rank the highest among the 13 statements. Almost 58 percent of

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PAGE 88 JOURNAL OF ASIA BUSINESS STUDIES VOL. 6 NO. 1 2012
respondents agree that investors generally use dividend announcements to help assess a
firm’s stock value (S17). In general, this evidence lends support to the signaling theory.
Kester et al. (1995-1996) report that Indonesian executives seem to be aware of signaling.
Taxes may be an important consideration for investors if dividends and capital gains are
taxed at different rates. According to tax preference theory, investors should prefer the
return taxed at the lower rate. Based on their review of the theoretical and empirical literature
on taxes and clientele effects, Saadi and Dutta (2009, p. 128) note that ‘‘despite extensive
research, researchers still dispute the effect of dividend taxation on dividend policies largely
because of the lack of compelling tax variations and fully convincing research designs.’’
In Indonesia, a differential exists between the tax rate on dividends and capital gains for both
individuals and corporations. As of January 1, 2009, the withholding tax on dividends for
individuals was 10 percent; however, the maximum capital gains tax rate was 30 percent.
Based on the tax preference explanation, investors should prefer that firms retain cash
instead of paying dividends because the tax rate on dividends is higher than on capital
gains. For corporations, dividends distributed to shareholders are not taxable in Indonesia if
the following requirements have been met: the dividend originates from the reserve of
retained earnings; and for a limited liability company, state-owned enterprise, and regional
government-owned enterprise that receives the dividend, the share ownership at the agency
that provides a dividend is a minimum of 25 percent of the amount of paid-up capital.
Additionally, for corporations the capital gain from the sale of shares of publicly-listed
companies is subject to final tax at the rate of 0.1 percent from the selling price at the IDX.
Panel C of Table III provides survey responses to two statements about taxes and clientele
effects (S24 and S25). The mean is statistically different from zero (no opinion) at the 0.01
level only for S25. As Table I shows, more than 71 percent of respondents believe that
investors generally prefer to invest in firms whose dividend policies complement their
particular tax circumstances (S25). Similar to Kester et al. (1995-1996), our findings suggest
that Indonesian executives seem to be aware of clientele effects.
According to agency theory, conflicts of interest may occur between management and
shareholders. For example, Easterbrook (1984) suggests that dividends may help reduce
the agency costs associated with separation of ownership and control. Because managers
cannot be perfectly monitored, Easterbrook argues that paying dividends forces managers
to raise funds in the financial markets and therefore subjects them to scrutiny by outside
professionals. Thus, dividends help prevent managers from taking self-serving actions that
are costly to the firm’s shareholders. Jensen (1986) also realizes that self-interested
managers have incentives to invest excess cash in unnecessary perks and investments. He
suggests that one way to solve the over investment problem is to extract surplus cash from
management control by paying dividends, which reduces the agency cost of free cash flow.
Megginson (1996, p. 377) suggests that ‘‘the agency cost model is currently the leading
mainstream economic model for explaining observed dividend payouts.’’ Mukherjee (2009)
provides a synthesis of the research on the agency theory of dividends.
Panel D of Table III provides the responses to two statements about agency theory (S27 and
S26). Respondents express strong views about each statement, with the means differing
significantly from zero (no opinion). The responses, however, are generally consistent with
agency theory for S27 but not for S26. More than 73 percent of respondents agree that the
payment of dividends encourages a firm’s managers to act in the interest of the firm’s outside
shareholders (S27). These views support the agency theory of dividends. Yet, almost
61 percent of respondents disagree that the payment of dividends forces a firm to seek more
external (debt or equity) financing, which subjects the firm to additional investor scrutiny.
Hence, the managers of IDX firms hold mixed and conflicting views about agency theory.
Mueller (1972) proposes a formal theory that states that a firm follows a relatively
well-defined life cycle and then traces the implications of this theory to dividend policy. The
optimal dividend policy of a firm relates to the position of a firm in its life cycle. For example,
the theory predicts that a firm begins paying dividends when it transitions from a high-growth
phase to a mature phase of its life cycle. Thus, a change in dividend policy signals a life

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VOL. 6 NO. 1 2012 JOURNAL OF ASIA BUSINESS STUDIES PAGE 89
 cycle change within the firm. Bulan and Subramanian (2009, p. 211) conclude: ‘‘Overall, the
empirical evidence favors the firm life cycle theory of dividends in terms of dividend payment
propensity and life cycle characteristics.’’
Panel E of Table III presents managers’ judgment about the life cycle theory of dividends.
More than 61 percent of the responding managers of IDX-listed firms agree that the pattern
of cash dividends generally changes over a firm’s life cycle (S3). The mean response differs
significantly from zero at the 0.01 level. Thus, the majority of respondents express
agreement with the firm life cycle theory of dividends.
Baker and Wurgler (2004a) develop a catering theory of dividends in which investor demand
drives the decision to pay dividends. Managers cater to investors by paying dividends when
investors put a stock price premium on payers, and not paying when investors prefer
nonpayers. The theory mainly addresses whether firms pay dividends, and not how much
they pay. In their review of the catering theory of dividends, De Rooij and Renneboog (2009,
p. 235) conclude the empirical results are ‘‘far from conclusive or unanimous as to whether
the catering theory of dividends can explain the dividend payout.’’
As Panel F of Table III shows, almost 77 percent of respondents express agreement with the
statement that a firm should be responsive to the dividend preferences of its shareholders
(S23). This evidence is consistent with an underlying tenet of catering theory that managers
base their dividend decisions on investor sentiment. In fact, the mean of this statement is tied
as second highest among the 13 statements about explanations for paying dividends and
differs significantly from zero (no opinion) at the 0.01 level.
Based on the evidence shown in Table III, respondents appear to agree most strongly with
signaling, catering, and life cycle theories while showing mixed views on explanations
involving taxes and clientele effects and agency theory. The bird-in-the-hand theory receives
little support. These results indicate that managers of Indonesian firms view multiple
explanations for paying dividends as being credible.

Summary and conclusions

This study presents new evidence on the perceptions of managers of dividend-paying
IDX-listed firms about the factors influencing dividend policy, dividend issues, and
explanations for paying dividends. According to responding managers, the most important
determinants of dividends are the stability of earnings and the level of current and expected
future earnings. They also view the effect of dividends on stock prices and needs of current
shareholders as important determinants. Comparing the overall rankings of 22 factors by
managers of IDX firms to those of US and Canadian firms reveals a significant correlation.
Yet, differences exist among the rankings by Indonesian, US, and Canadian managers on
specific factors influencing dividend policy. Overall, our findings suggest that while no
universal set of factors is likely to be applicable to all firms, some factors are consistently
more important than others.
Based on our results, managers of IDX firms perceive that dividend policy affects firm value.
Because dividend decisions can affect firm value and shareholder wealth, dividend policy is
worthy of management attention. Unlike recent US and Canadian surveys (Baker and
Powell, 2000; Baker et al., 2001, 2007), managers of Indonesian firms generally express
agreement with a residual dividend policy in which firms pay out as dividends all cash flows
after profitable investments. Managers of IDX firms seem to agree with multiple theories for
paying dividends including signaling, catering, and life cycle explanations.

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Corresponding author
H. Kent Baker can be contacted at: kbaker@american.edu

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