An Empirical Analysis of the

Relationship between Cash Flow

and Dividend Changes in Nigeria
Olatundun J. Adelegan*
The purpose of this study is to re-evaluate the incremental information content of cash flows
in explaining dividend changes, given earnings. I carry out an 882 firm-year study by
analysing the dividend changes–cash flow relationship on a sample of 63 quoted firms in
Nigeria over a wider testing period from 1984 to 1997. Despite the fact that I used a wider
testing period than previous studies and more refined cash flow measures than previous
studies, I also introduced dummy variables to capture economic policy changes in the
economy. The association of cash flows with dividend changes is tested using the modified
Lintner–Brittain model as adopted in Charitou and Vafeas (1998) on pooled cross sectional/
time series data from the full sample of observations from 1984–97. The models are estimated
using the ordinary least squares (OLS) method and I do find a significant relationship
between dividend changes and cash flow unlike previous studies. The empirical results reveal
that the relationship between cash flows and dividend changes depend substantially on the
level of growth, the capital structure choice, size of each firm and economic policy changes.

1. Introduction flows are a more direct measure of liquidity and

liquidity is likely to be a contributing factor in

T he association between earnings and divi-

dend changes has been established for the
past four decades (Lintner, 1956). Subsequent
research attempts to study the relationship
between cash flow and dividend changes, given
earnings, has not been successful (Hagerman and
Huefner, 1980, Crum et al., 1988; Simons, 1994;
Charitou and Vafeas, 1998).
Notwithstanding the outcome of previous
studies, two reasons have been advanced to
explain the superiority of cash flow over earnings
in explaining dividend changes. First, managers
may manipulate earnings to maximize their
bonus awards (Healy, 1985) or to side step
restrictive debt covenant violations. The fact
that accrual components of earnings can be
manipulated makes the cash flow component a
more reliable indicator of corporate performance
than the accrual component. Secondly, cash
setting dividend policy. Therefore, even if there is
no difference between the market valuation of
accruals and cash flows in measuring corporate
performance, cash flows are expected to be more
useful than accruals in determining dividend
changes.
Prior studies concentrate on developed mar-
kets and have not been able to find a significant
relationship between dividend changes and oper-
ating cash flows. However, because of differences
in institutional contexts, the empirical relation-
ship between dividend changes and cash flow in
an emerging market like Nigeria may be different
from what obtains in the developed market. This
study therefore carries the debate to Nigeria.
An 882 firm-year study was carried out by
analysing the dividend changes–cash flow rela-
tionship on a sample of 63 quoted firms in
Nigeria over a wider testing period from 1984

* Lecturer in Accounting and Finance, Department of Economics, University of Ibadan, Nigeria and Research Fellow,
Centre for Econometrics and Allied Research (CEAR), University of Ibadan, Nigeria; e-mail: adelegan@
pop.skannet.com

R&D Management 15, 1, 2003. # Blackwell Publishing Ltd, 2003. Published by Blackwell Publishing Ltd 35
9600 Garsington Road, Oxford OX4 2DQ, UK and 350 Main Street, Malden, MA 02148, USA.
O.J. Adelegan
to 1997. In addition to using a wider testing
period than previous studies and more refined
cash flow measures than previous studies,
dummy variables were also introduced to capture
economic policy changes in the economy.
Moreover, drawing from the traditional
finance theory — Jensen (1986) and Charitou
and Vafeas (1998) — I hypothesize that the rela-
tionship between cash flows and dividend
changes depend on each firm’s growth opportun-
ities. I also improved on prior research by sug-
gesting two additional factors that potentially
mitigate the dividend changes and cash flow rela-
tionship, namely capital structure and size. I
therefore partition the data into three classes
each based on growth opportunities, level of
gearing and firm size.
The empirical results reveal that the relation-
ship between cash flow and dividend changes
depend substantially on the level of growth, the
capital structure choice and size of each firm and
economic policy changes such as the Structural
Adjustment Programme.
The rest of the paper is organized as follows.
The next section gives a background description
of the Nigerian environment, followed by a
review of literature and a theoretical develop-
ment of the four hypotheses. The fifth section
describes the methodology and the sample. The
penultimate section contains the analyses and
results, followed by the conclusions of the study
in the final section.
2. Background Description of the
Nigerian Environment
In Nigeria, the capital market is an ‘engine of
growth which is still classified by the Inter-
national Finance Corporation as underdeveloped
and emerging’ (Inanga, 1999). The thinness of
trading, low market capitalization, low percent-
age of turnover level and illiquidity of the mar-
ket can be attributed to barriers to foreign
investors, imposition of price caps on share
price movement and political instability among
others (Inanga and Emenuga, 1997; Ogwumike
and Omole, 1997).
The decision between paying dividend and
retaining earnings as a source of further invest-
ment has been taken seriously by both investors
and management and has been the subject of
considerable research and scrutiny by equity ana-
lysts and economists in developed nations. ‘As a
result, a fairly detailed, if incomplete picture of
36 R&D Management 15, 1, 2003
dividend policy is available for the major developed
countries’ (Glen et al., 1995).
However, with the exception of Izedonmi and
Eriki (1996) who used data from 1984 to 1989,
studies of dividend policy on Nigerian corporate
firms have been limited and clustered around
1969–76, which is the period surrounding the
first indigenization decree (Uzoaga and
Alozieuwa, 1974; Inanga, 1975, 1978; Soyode,
1975; Oyejide, 1976; Odife, 1977). There has
been several economic policy changes since then,
such as the Structural Adjustment Programme
(1986), the Second Indigenization Decree (1989)
and the Investment Promotion Decree (1995).
This study carries the dividend debate further,
with a view to determining whether or not the
dividend policy of corporate firms in Nigeria con-
form with the acceptable norms in developed
countries.
Furthermore, the size of dividend payments
relative to corporate profit after tax, are very
important because they negatively affect the
level of business savings, which is in turn, an
important source of capital formation and one
of the most critical determinants of a country’s
economic performance. An understanding of the
issues that drive dividend decisions of the corpor-
ate firms will enhance a proper evaluation of the
private sector’s contribution to Nigeria’s eco-
nomic performance. This will assist in furnishing
the government with the required information
around which appropriate policy can be designed
to guide the pattern and process of its economic
growth (Oyejide, 1976; Ariyo, 1983).
For years, it has been over-emphasized to
developing countries that financial liberalization
is necessary for prosperity. Instead of discour-
aging foreign investors, they were advised to open
up so as to have access to global savings that can
be invested to accelerate their growth. The Niger-
ian capital market is now more liberalized than
before. The bottlenecks to inflow of foreign cap-
ital such as the Nigeria Enterprise Promotion
Decree (1989), the Exchange Control Act (1962)
and the Capital Gains Tax have been abolished,
and the Nigeria Investment Promotion Decree 16
and Foreign Exchange (Monitoring and Miscel-
laneous Provision) Decree 17 (1995) was promul-
gated. Nigeria is now open to international
capital, and dividend policy has now increased
in importance in the post economic liberalization
period. Restrictions on foreign ownership of
shares of limited liability companies registered
and/or incorporated in Nigeria have been abol-
ished. It is therefore imperative for corporate
# Blackwell Publishing Ltd, 2003

firms to pursue sound dividend policies in order
to attract and retain local and foreign investors.
Foreign and local equity holders and managers
are now more concerned about their dividend
policy now than they were in the past. This is
further augmented by the increased role of the
government, which acts as a protector of both
minority shareholders and creditors in dividend
policy decisions (ss. 379–385 of the Companies
and Allied Matters Decree 1990). This study,
therefore, helps to educate foreign and local
investors and economists about the dividend pol-
icy of Nigerian companies and through that pro-
cess, promote further interest in the Nigerian
stock market.
3. Literature Review
Dividend payment modelling work starts from
Lintner’s (1956) ground-breaking study, which
argued that the main determinants of changes
in dividend are current earnings and preceding
dividend level. The model further indicates that
year to year changes in dividend payments are
explained by current earnings levels in conjunc-
tion with a target pay-out ratio. However, yearly
adjustment towards the target pay-out ratio is
partial considering the reluctance of management
to reduce dividend.
Prior attempts to determine the association
between dividend changes and cash flows have
not been successful (Fama and Babiak, 1968;
Hagerman and Huefner, 1980; Crum et al.,
1988; Simons, 1994; Charitou and Vafeas, 1998).
Using Lintner’s model and Lintner–Brittain
modified versions, Fama and Babiak (1968) and
Hagerman and Huefner (1980) observed signifi-
cant empirical support for Lintner’s model. They
conclude that historical cost is a better predictor
of dividend changes than cash flows and cash
flows are found to be insignificant in predicting
changes in dividend.
However, their findings do not conclusively
preclude the ability of cash flows to explain divi-
dend changes because they define cash flow as
income plus depreciation. This measure has been
shown to be a proxy for profitability and not
liquidity (Largay and Stickney, 1980; Gombola
and Ketz, 1983; Bowen et al., 1986; Charitou and
Vafeas, 1998).
Simons (1994), Crum et al. (1988) and Charitou
and Vafeas (1998) analysed the dividend changes–
cash flow relationship using more refined cash
flow measures.
# Blackwell Publishing Ltd, 2003
Cash Flow and Dividend Changes in Nigeria
Crum et al. (1988) conclude that the most
important predictors of dividend changes are
prior year dividends, current net income plus
depreciation and working capital from operat-
ions. Simons (1994) studied the dividend–cash
flow relationship by isolating firms for which
the relationship between dividend changes and
cash flow is weak, but none of the three liquidity
measures proposed in the study had an associa-
tion with changes in dividend, given earnings,
and he concluded that the relationship between
dividend changes and cash flow remains elusive.
Researchers in the United Kingdom have also
advocated support for cash flow reporting
because it avoids arbitrary allocation of funds
and are therefore useful to users of financial
statements for estimating future dividend flows
(Lawson and Stark, 1975, 1981).
Using aggregate data for German companies,
Lawson and Moeller (1996) challenge the view
that historical cost retained earnings constitute
internally generated finance and opined that peri-
odic changes in earnings may not necessarily be
accompanied by an equal liquidity change. Not-
withstanding the fact that Lawson (1996)
obtained empirical evidence to show that divi-
dend policies are based on accrual earnings, he
suggests that such policies are not consistent with
an ex ante shareholder value creation (SVC)
model because organizations should invest in
the projects with positive net present values
(NPV) and consider firm liquidity in attempting
to maximize firm value. This view was upheld in
Lawson and Stark (1981) and Lee (1983).
Appropriation of after-tax earnings of corpo-
rate firms did not receive any serious attention
among academic scholars in Nigeria until
Uzoaga and Alozienwa (1974) highlighted the
pattern of dividend policy pursued by Nigerian
firms, particularly since and during the period of
indigenization and participation defined in the
decree (i.e., 1969–73). They claimed that dividend
levels were raised by corporate firms in the wake
of indigenization and they checked but ‘found
very little evidence’ to support the classical influ-
ences that determine dividend policies in Nigeria
during those periods. Inanga (1975) and Soyode
(1975) challenged the ‘fear and resentment’ the-
ory put forward in the study of Uzoaga and
Alozienwa. Among others, Inanga (1975, 1978)
identified under-pricing of the new issues of com-
panies affected by the indigenization decree by
the Capital Issue Commission as a major con-
tributory factor to the ‘significant upward change
in the rates and level of dividend distribution
R&D Management 15, 1, 2003 37
O.J. Adelegan
by affected companies shortly before the
[indigenization] decree was implemented’.
Soyode finds excess liquidity as a result of cash
inflows from Nigerianized shares responsible for
the high dividend pay-out during the indigeniza-
tion decree. Nevertheless, Oyejide (1976) exam-
ined empirically the factors driving dividend
policy of companies in Nigeria using Lintner’s
(1956) model as modified by Brittain (1964); he
observed that there is substantial support in
Nigeria for Lintner’s model. Moreover, Odife
(1977) criticized Oyejide’s study for failing to
adjust for stock dividend while Izedonmi and
Eriki (1996) using data from 1984 to 1989
found support in Nigeria for Lintner’s model.
However, studies of dividend policy in Nigeria,
though few, have resulted in mixed, controversial
and inconclusive results.
4. Hypotheses
Modern finance theory argues that the value of
the firm depends on its stream of future cash
flows. However, earnings are widely used by
investors and creditors as a summary measure
of firm performance, as well as in executive com-
pensation contract and in debt covenant agree-
ments. The primary appeal of earnings over cash
flows is that they mitigate timing problems in
revenue recognition and in matching revenues
with appropriate costs in time. Cash flows are
considered a noisier measure of firm perform-
ance than earnings because of timing and
matching problems and accrual components of
earnings is incrementally important in measuring
firm performance. To the extent that firm perform-
ance determines dividend changes as in Lintner’s
model, both cash flows and aggregate accruals
should be significantly associated with dividend
changes (Charitou and Vafeas, 1998).
However, while cash flows and accruals are
important in explaining dividend changes, two
plausible reasons exist to expect cash flows to
be significantly more important than accruals.
The first pertinent issue is that accruals are
recognized partly at the discretion of the man-
agers. Managers have incentives to manipulate
accruals to their advantage because earnings are
often used as a performance criterion in compen-
sation contracts where managers have personal
interests (Healy, 1985, Charitou and Vafeas,
1998). Therefore, manipulated accruals may be
less important than cash flows in explaining divi-
dend changes. Nevertheless, recent studies docu-
38 R&D Management 15, 1, 2003
ment mixed evidence as to the extent of accruals
manipulation by managers (Dechow, 1994;
Dechow et al., 1995; Gaver and Gaver, 1993).
Secondly, it appears that pay-out policy is
dependent on cash availability. An organiza-
tion’s decision to reduce, increase or maintain
dividend partly reflects its liquidity position,
therefore operating cash flow should reflect firm
liquidity for cash flow to be a significant deter-
minant of dividend changes, given earnings.
These arguments suggest operating cash flows
are likely to be a better predictor of dividend
changes than accruals. Hypothesis 1 is as follows:
H1: Operating cash flows are positively
related to dividend changes, given earnings.
Initially I argued that cash flows should be sig-
nificant in setting dividend policy both as a per-
formance and as a liquidity measure. Prior
studies have rejected hypothesis 1 and these
results stimulate further research on the issue. I
replicate the tests documented in earlier empirical
studies on Lintner’s (1956) model.
However, my empirical results are in contrast
to the notion that the Lintner (1956) model and
its variants explain the dividend level of corpo-
rate firms in Nigeria. This therefore points
towards further testing on this issue. In particu-
lar, are there any conditions under which after-
tax earnings, preceding dividend level and eco-
nomic policy changes are significant determin-
ants of dividend policy in Nigeria?
Following prior capital market studies, my
research approach on the assessment of the use-
fulness of the modified Lintner (1956) model in
explaining dividends has been to use aggregate
data, assuming that the relationship between
these variables is homogenous across firms.
As previously argued, the underlying assump-
tion that investors react identically to earnings
and preceding dividend level of all firms implying
constant response coefficients is not realistic.
Previous studies provided empirical evidence
that the response coefficients are not constant,
but they are affected by firm-specific, industry-
specific and economic factors, such as firm size,
industry classification, magnitude of accruals,
quality of earnings and economic policy changes
(Easton and Zmijewski, 1989; Collins and
Kothari, 1989; Dechow, 1994; Charitou and
Vafeas, 1998; and Adelegan, 2000).
In line with this argument, I investigate
contextual factors that are potentially important
in mitigating the relationship between current
# Blackwell Publishing Ltd, 2003

earnings, preceding dividend level and dividend
yield. This study hypothesized that the homo-
geneity of the dividend policy equation across
firms does not hold as a result of cross-firm
variation in certain contextual factors such as
firm growth, magnitude of debts (that is the
level of leverage) and firm size.
In this study I argue that (1) the cash flow–
dividend relationship is stronger for firms with
moderate growth rates, (2) cash flows are a more
important predictor of dividend changes when
firms are highly levered and (3) cash flows are a
better predictor of dividend changes for small-sized
firms. My reasoning for (1) above is as follows.
Future growth is expected to mitigate the rela-
tionship between dividend changes and cash flows,
therefore the cash flow–dividend changes relation-
ship depends on the extent of future growth oppor-
tunities. As operating profits are generated, firms
have to choose between reinvesting versus return-
ing these funds to shareholders. Optimally, corpo-
rate firms will invest in all projects that have
positive net present values and return a portion
of the remaining after-tax earnings to shareholders
in the form of dividends or share repurchases. The
amount of money invested depends mainly on each
firm’s growth opportunities. High growth com-
panies prefer to capitalize on their favourable
investment prospects and have clear disincentives
in paying operating cash flows and profits as divi-
dend (Gaver and Gaver, 1993; Charitou and
Vafeas, 1998; Adelegan, 2000). Managers in busi-
ness firms with low growth may also prefer to
invest after-tax earnings rather than paying add-
itional dividends due to personal incentives (Jensen,
1986). Therefore we expect the relationship between
profit after tax and dividend behaviour to be
the strongest in moderate growth firms because
these firms have lower opportunity cost of
dividends than high growth firms. Furthermore,
managerial and shareholder interests are more
closely aligned, compared to these parties’ interests
in low growth companies (Charitou and Vafeas,
1998).
From the above discussion one can infer that
cash flow coefficient is expected to be higher for
moderate-growth firms. The research hypothesis
to be tested is:
H2: Cash flows are a better predictor of divi-
dend changes for firms with moderate growth
prospect, given earnings.
Alternatively, cash flows are a more important
predictor of dividend changes when firms are
# Blackwell Publishing Ltd, 2003
Cash Flow and Dividend Changes in Nigeria
highly levered. A firm’s ability to alter its divi-
dend policy sometimes depends on its liquidity
position. When there is adequate liquidity, a firm
can set its dividend policy according to its per-
formance. However, when cash flows are inade-
quate, the ability of the firm to change its
dividend policy is constrained. Hence, when
operating cash flows are low, cash flows are
expected to play a significant role in setting divi-
dend policy (Charitou and Vafeas, 1998). The
relationship between after-tax earnings and divi-
dend behaviour is expected to be significantly
positive for business firms that are highly levered.
Size has a positive influence on leverage and
growth. A company that is highly levered has
more debt obligations and interest to pay.
Large firms have better access to debt (Marsh,
1982; Baskin, 1989; Chang and Rhee, 1990;
Bennets and Donnelly, 1993; Charitou and Vafeas,
1998; Adedeji, 1998) and is likely to be less liquid
when compared with small firms. Shareholders are
likely to expect more dividends and the debt-
holders will also expect interest and the principal
on the other hand. During periods of inflation,
firms employ more debt in their capital structure
because the real cost of debt falls. As more debt
is introduced the company will be able to pursue
more profitable ventures and the cost of equity
will rise in response to an increase in debt. A
highly levered firm will therefore be expected to
change its dividend policy in line with its liquidity
position coupled with its performance. We expect
Lintner’s model and structural and economic
policy changes such as the Structural Adjustment
Programme to be significant in explaining the
dividend behaviour of highly geared firms. The
research hypothesis to be tested is as follows:
H3: The relationship between operating cash
flow and dividend changes is significantly
positive for firms that are highly levered,
given earnings.
Furthermore, the cash flow–dividend changes
relationship is conditioned on the size of firms.
Size is expected to have a positive influence on
leverage and growth. Large firms have better
access to debt and should be highly geared on
the one hand (Marsh, 1982; Baskin, 1989, Chang
and Rhee, 1990; Bennets and Donnelly, 1993;
Charitou and Vafeas, 1998; Adedeji, 1998). On
the other hand, small firms pay more to issue
new equity and also somewhat more to issue
long-term debt. This suggests that small firms
may be more leveraged than large firms and
R&D Management 15, 1, 2003 39
O.J. Adelegan
may prefer to borrow short term (through bank
loans) rather than issue long-term debt because
of the lower fixed cost associated with this alter-
native.
Small-sized firms are therefore expected to
have low cash flows because of repayment of
short-term loans and interest and dividend to
shareholders. Cash flows are therefore expected
to be significant in setting their dividend policies,
leading to the following research hypothesis:
H4: Cash flows are a better predictor of
dividend changes for small-sized firms, given
earnings.
This hypothesis is investigated by regressing
dividend yield on the traditional model and its
variants.
Hypothesis 1 examines the usefulness of cash
flows in explaining dividend changes using aggre-
gate data in accordance with prior capital market
studies assuming that the relationship between
these variables is homogenous across firms.
However, it has been argued that the underlying
assumptions that investors react identically
to earnings and cash flows of all firms are
unrealistic.
Empirical evidence that the response coeffi-
cient is affected by firm-specific, industry-specific
and economic factors such as firm size, industry
classification, magnitude of accruals and quality
of earnings abound (Easton and Zmijewski,
1989; Collins and Kothari, 1989; Dechow, 1994;
Charitou and Falas, 1996; Charitou and Vafeas,
1998; Adelegan, 2000). In line with this argument
this study hypothesized that the homogeneity
across firms does not hold due to cross-sectional
differences in firm growth opportunities (hypoth-
esis 2) and the magnitude of leverage (hypothesis
3) and firm size (hypothesis 4).
In this paper, investigation of the dividend
changes–cash flow relationship was performed
through the examination of four hypotheses:
H1: Operating cash flows are positively
related to dividend changes, given earnings.
H2: Cash flows are a better predictor of divi-
dend changes for firms with moderate growth
prospect, given earnings.
H3: The relationship between operating cash
flow and dividend changes is significantly
positive for firms that are highly levered,
given earnings.
40 R&D Management 15, 1, 2003
H4: Cash flows are a better predictor of
dividend changes for small-sized firms, given
earnings.
5. Methodology
5.1 Data Sources, Nature and Scope
The sample contains 63 companies quoted on the
first and second tier securities market of the
Nigerian stock exchange (NSE) as at 1984.
There are currently 170 companies listed on the
first tier market and 16 companies listed on the
second tier securities market of the NSE. Com-
panies listed on the first tier securities market are
expected to have a trading record of at least five
years, not less than 25 per cent shares in the hand
of the public, and not less than 500 shareholders.
Such companies are also expected to give quar-
terly, half-yearly and yearly reports and there is
no limit to the amount of money that they can
raise from the securities market.
The second tier securities market was intro-
duced in 1986 with less stringent conditions to
accommodate more companies. Companies listed
on the second tier securities market of the NSE
are expected to have a track record of at least
three years, not less than 25 per cent shares in the
hands of the public, not less than 100 share-
holders and they cannot raise more than 20 mil-
lion naira from the securities market.
Sample firms cover all sectors according to the
NSE’s classification, namely agriculture, auto-
mobile and tyre, banking, breweries, building
materials, chemical and paints, conglomerates,
commercial services, computer and office equip-
ment, construction, engineering technology,
food, beverage and tobacco, footwear, health-
care, industrial/domestic products, insurance,
investment companies, machinery (marketing),
packaging, petroleum (marketing), publishing
and textiles. We have a full sample of 882 firm-
year observations for the period 1984 to 1997.
A firm is included in the sample if the follow-
ing financial and market information necessary
to estimate the various pooled cross-sectional/
time series models are available in the summar-
ized annual reports in the Nigerian Stock
Exchange Factbooks for 1984 to 1997: profit
after tax (PAT), cash flow (CF), total distribut-
able earnings (TDE), dividend per share (DPS),
market price per share (MPS), market value of
equity (MVE) and book value of assets (BVA) at
the year end for the period 1984 to 1997.
# Blackwell Publishing Ltd, 2003

Data used in this study are mainly from sec-
ondary sources, namely the Nigerian Stock
Exchange Factbooks of 1989/90 to 1998, annual
reports of companies, and daily official lists of
the NSE for the last day of trading in each of the
years covered in the study.
5.2 Measurement of Variables
The analysis focuses on the relationship between
changes in dividend yield (
DV) and profit after
tax (PAT), cash flow (CF), total distributable
earnings (TDE), and preceding year dividend
per share (DVL). The variables are defined as
follows:
* Dividend changes (
DV): current year divi-
dend per share deflated by the end of current
year market price per share minus prior year
dividend per share deflated by the end of pre-
vious year market price.
* Dividend par share (DPS): current year cash
dividend plus current year stock dividend.
* Profit after tax (PAT): profit after tax but
before extraordinary items, discontinued
operations, special and non-operational items
divided by the end of the year market value of
equity.
* Cash flow (CF): working capital from operat-
ions deflated by the end of the year market
value of equity.
* Lagged dividend yield (DVL): previous year
dividends deflated by the preceding year mar-
ket value of equity.
* Total distributable earnings (TDE): profit
after tax plus distributable/revenue reserves.
* Growth (market-to-book ratio, MBV): market
value of equity divided by the book value of
total assets.
* Size (TA): natural logarithm of total assets
deflated by the current year market value of
equity.
* Leverage (LEV): total debt deflated by the
current year market value of equity.
The regression models were structured using the
ordinary least square (OLS) method. A market
value deflator was used in the regression model
because it avoids historical cost bias that is inher-
ent in other deflators such as the book value of
equity and total assets.
Moreover, it is widely believed that dividend
policy is driven by market performance; any
study of changes in dividend policy should there-
fore be measured in the backdrop of each firm’s
market value (Christie, 1987; Kothari, 1992;
# Blackwell Publishing Ltd, 2003
Cash Flow and Dividend Changes in Nigeria
Alford et al., 1993; Ali and Pope, 1995; Charitou
and Vafeas, 1998).
5.3 Model Specification
The following regression equations were esti-
mated using the ordinary least squares (OLS)
method to provide bearing on the hypothesis
indicated above.

DVit ¼b0 þ b1PATit þ b2DVLit þ : b3CFit
þ b4TDEit þ Uit ð1Þ

DVit ¼ b0 þ b1PATit þ b2DVLit þ Uit ð2Þ

DVit ¼ b0 þ b2DVL þ b3CFit : þ Uit ð3Þ

DVit ¼b0 þ b1PATit þ b2DVLit
þ b3CFit : þ Uit ð4Þ

Davit ¼b0 þ b1PATit þ b2DVLit
þ b3Fit : þ D1 þ D2 þ Uit ð5Þ
where
DVit is the change in dividend; PATit is
the profit after tax; DVLit is the preceding divi-
dend level; TDEit is the total distributable earn-
ings; CFit are cash flows; D1 is assigned the value
1 for the period 1984–85, and 0 for 1986–97; D2
is assigned the value 1 for the period 1984–94,
and 0 for 1995–97.
From hypotheses 1 we expect the coefficient of
profit after tax (b1) to be positive and cash flows
(b3) to be positive and statistically significant.
We also expect the coefficient of DVL (b2) to
be negative.
To test for the effect of growth opportunities
in dividend changes–cash flows relationship
(hypothesis 2), the sample firms are ranked
according to market-to-book ratio and parti-
tioned into three portfolios based on average
growth rate of each firm.
We expect the cash flow regression estimate (b3)
to be positive and statistically significant for the
group of moderate growth firms (sub-sample 2).
We then estimate models 1 to 3 above separately
for each portfolio.
In testing the effect of leverage on the associ-
ation between cash flows and dividend changes
(hypothesis 3), we partitioned firms into three
observation portfolios based on the average
level of each firm’s total debt.
We expect the cash flow regression estimate (b3)
to be positive and statistically significant for the
group of highly levered firms (sub-sample 3). We
then estimate models 1 to 3 above separately for
each portfolio.
R&D Management 15, 1, 2003 41
O.J. Adelegan

In order to test for the effect of size on the cash
flows–dividend relationship (hypothesis 4), we
similarly rank firms according to the natural
logarithm of their total assets. We then assign
firms into three portfolio classes and estimate
models 1 to 3 for the three sub-samples separ-
ately. The coefficient of cash flows (b3) is
expected to be significantly positive for the ‘low
size’ portfolios, primarily portfolio 1.
In testing for hypotheses 1 the data is pooled
across firms and years. This pooling approach
assumes that the dividend policy equation is the
same for all the firms in the sample; it therefore
assumes that firm-specific independent variable
coefficients are not systematically different from
one firm to the other. By partitioning the data in
testing for hypotheses 2, 3 and 4, also assumes
that each sub-sample firm-specific variable coef-
ficients are the same across firms.
6. Empirical Analysis and Results
6.1 Sample Summary Statistics
The summary statistics of the sample are in
table 1. The table indicates that on average the
rate of dividend changes is 1.93 per cent and the
mean lagged dividend yield is 7.6 per cent, while
the market-to-book ratio and cash flows have a
mean of 1.72 and 0.61 respectively. Earnings
after tax (PAT), total distributable earnings
(TDE), total debt (LEV) have higher standard
deviation than other variables signifying that
they are noisier measures.
The correlations of the variables in table 1 are
summarized in table 2.
The correlation between CF and
DV is positive
and the lagged dividend yield (DVL) is negatively
correlated with cash flows. CF is also positively
correlated with PAT. Lagged dividend yield (DVL)
is negatively correlated with earnings. The correla-
tions of the variables are generally low. However,
these correlations’ coefficients primarily have
descriptive values and conclusions about our
hypothesis rely on the regression (multivariate tests).
6.2 Regression Results
The empirical results relating to the four research
hypotheses are discussed here.
From hypothesis 1, we expect a positive relation-
ship between dividend changes and cash flows,
given earnings. The reasons given for these expect-
ations are, first, managers have incentives to
manipulate accruals to their advantage because
earnings are used in measuring performance in

Table 1. Sample summary statistics for 882 firm-year observations.

Variablea Mean Std. dev Minimum Maximum

DVL 0.053528 0.000968 0.052843 0.054213

PAT 0.150316 0.002867 0.148289 0.152343
TDE 1.160904 0.873239 0.543431 1.778377
CF 1.021796 0.955961 0.34583 1.697763
MBV 2.222111 0.160733 2.108455 2.335767
SZ 11.70987 1.399727 10.72011 12.69962
LEV 0.841222 0.170581 0.720603 0.961841

DV 0.099251 0.103714 0.025914 0.172587
a
DVL ¼ preceding dividend level; PAT ¼ profit after tax; TDE ¼ total distributable earnings; CF ¼ cash flows; MBV ¼ market to
book value; SZ ¼ natural logarithm of fixed assets as a proxy for firm size; LEV ¼ total debt;
DV ¼ change in dividend. PAT,
CF, TDE, LEV and DVL are deflated by the stock price at the end of the fiscal year.

Table 2. Correlation matrix for 882 firm year observations from 1984 to 1997a.

DVL PAT CF TDE MBV SZ LEV
DV

DVL 1
0.101219 0.281966 0.074237
0.551945
0.282177 0.400635
0.587387

PAT 1
0.234454 0.906651
0.449016
0.668733
0.28068 0.160274
CF 1 0.078078
0.329963
0.35338 0.760592 0.361898
TDE 1
0.561806
0.832532
0.11586 0.132361
MBV 1 0.814775
0.28689
0.24893
SZ 1
0.03446
0.261821
LEV 1 0.195761

DV 1
a
For an explanation of the variables, see table 1.

42 R&D Management 15, 1, 2003 # Blackwell Publishing Ltd, 2003

 Cash Flow and Dividend Changes in Nigeria

compensation contracts. Manipulation of accruals
is expected to reduce its usefulness in measuring
firms’ performance (Healy, 1975; Charitou and
Vafeas, 1998). Secondly, it appears that dividend
pay-out policy is dependent on cash availability
and a firm’s ability to increase or decrease dividend
partly mirrors its liquidity position.
This hypothesis is examined by regression divi-
dend changes (
DV) on profit after tax (PAT),
cash flows (CF), lagged dividend yield and total
distributable earnings (TDE). Dummy 1 and 2
are always introduced into the hypothesis in
equation (4).
Dummy 1 (D1) is used to reflect the impact of
the Structural Adjustment Programme introduced
in 1986 on dividend policy from 1984 to 1985
(value zero) and for 1986 to 1999 (value one)
while Dummy 2 (D2) is used to reflect the impact
of investment promotion decree introduced in
1995 (from 1984 to 1994, D2 is assigned the
value zero and the value one from 1995 to 1997).
The regression results for hypothesis 1 are pre-
sented in table 3 for the 882 firm year study.
Consistent with previous studies, PAT is posi-
tively associated to dividend changes and DVL is
negatively related with dividend changes. The
model’s adjusted R2 is 21.2 per cent. These results
reaffirm the importance of earnings and preced-
ing year dividends in determining changes in
dividend pay-out, but it also shows that only
21.2 per cent of the variation in dividend changes
is explained by PAT and DVL (Model 3).
We tried to introduce more variables into the
equation by bringing in total distributable earn-
ings (TDE), cash flows (CF) and D1 and D2.
However, this further reduced the adjusted R2
to 20.4 per cent (Model 5); while the changes in
economic policy, D1 (effect of the SAP) on divi-
dend changes is found to be significant.
In Model 1, the dummy variables are excluded
from the equation and the adjusted R2 become
better at 62.6 per cent.
On the basis of low adjusted R2 values one
may be tempted to conclude that the models are
not suitable in terms of the explanatory power.
This temptation should be resisted since it is not
unusual for the R2 values which result from
regression equations dealing with the differences
in variables (rather than level of variables) to be
generally low. A reason advanced for this is that
by using change rather than level data, we omit
the variance to be explained by trend thus redu-
cing R2 leaving only the cyclical and random
components. The random component is actually
magnified, because the change data add the ran-
dom elements in two adjacent level observations.
As the equation is not expected to explain ran-
dom movement, this further reduces the R2
(Keran and Riordan, 1976; Oyejide, 1976).
Model 2 excludes TDE from the equation and
the adjusted R2 dropped to 58.5 per cent. Model
4 substitutes PAT for CF in the Lintner model.
The coefficient of CF is positive and highly sig-
nificant, while the explanatory power, R2
increases to 56.9 per cent. In all the five equa-
tions specified, the coefficients of PAT and DVL
have the expected positive and negative relation-
ships respectively with dividend changes.
In equations (1)–(4), CF is positively signifi-
cant with
DV at 1 per cent. The t-statistics are

Table 3. Cross-sectional OLS regression results for 882 firm-year observations from 1984 to 1997a.

Variable Model 1 Model 2 Model 3 Model 4 Model 5

Intercept 0.3728 0.6596 0.5299 0.4453
0.0173

(1.5623) (2.0403)** (2.222)** (1.8162)* (
1.4883)
PAT 0.1877 0.01726 0.03929
0.0337
(1.6628) (0.3786) (1.1595) (
0.7147)
DVL
9.4021
8.2693
10.7325
10.6058
0.0534
(
3.251)*** (
2.145)** (
3.630)*** (
3.653)** (
2.120)**
CF 0.9903 0.6477 0.7063 0.01967
(3.259)*** (2.778)*** (3.014)*** (1.5078)
TDE
0.1687
(
1.3716)
D1 0.0142
(3.108)***
D2 0.0032
(0.4625)
Adj R2 62.60% 21.20% 56.90% 58.50% 20.40%
F-Stat. 5.607 2.4799 8.26 6.1656 1.5645
a
t-values are in parentheses. ***, ** and * indicate values are significant at the 1%, 5% and 10% level. The estimates reported
here are obtained by using OLS regression procedure in E-views (1995 version).

# Blackwell Publishing Ltd, 2003 R&D Management 15, 1, 2003 43

O.J. Adelegan
shown in parentheses under the parameter esti-
mates. This could be explained by the peculiari-
ties of Nigerian companies. Soyode (1978) and
Oyejide (1987) have documented that most
Nigerian companies rely on retained earnings
for financing their activities because of the illu-
sion of costlessness usually associated with
retained earnings. The decision to allocate the
available cash flow between worthwhile invest-
ment opportunities and payment of dividend
makes it important for firms to consider cash
flow in dividend decisions, more so when divi-
dend can only be paid out of available cash
flows. In summary, by employing a wider testing
period than prior studies, our regression results
show that there is a significant relationship
between dividend changes and cash flows, given
earnings unlike previous studies (Simon, 1994;
Charitou and Vafeas, 1998). We therefore accept
hypothesis 1.
Our research approach on the relationship
between dividend changes and cash flows in
hypothesis 1 was based on pooled cross-sectional
time series data; assuming that the relationship
between these variables are homogeneous across
firms. This assumption is based on prior capital
market studies.
However, empirical studies have provided evi-
dence that the response coefficients are affected
by firm-specific, industry-specific, and economic
factors, firm size, industry classification, quality
of earnings and magnitude of accruals (Easton
and Zmijewski, 1989; Collins and Kothari, 1989;
Dechow, 1994; Charitou and Vafeas, 1998).
We therefore investigate contextual factors
that are potentially important in mitigating the
relationship between dividend changes and cash
flows. This study hypothesized that the homogen-
eity of the dividend policy equation does not hold
across firms because of variation in certain con-
textual factors such as (1) firm growth (hypothesis
2), (2) firm level of leverage (total debt hypothesis
3) and (3) firm size (natural logarithm of total
assets, hypothesis 4). The results and discussions
are presented below.
Hypothesis 2 predicts that cash flows are bet-
ter predictors of dividend changes for firms with
moderate growth prospect. This is because as
cash flows are generated, firms have to choose
between reinvesting versus returning the funds to
investors. Optimally, firms are expected to invest
in all projects that will yield positive net present
values (NPV) and distribute only free cash flow
to shareholders in the form of dividend. The
amount of money invested is expected to depend
44 R&D Management 15, 1, 2003
on each firm’s growth opportunities (Charitou
and Vafeas, 1998; Gaver and Gaver, 1993).
However, managers in firms with low growth
may also prefer to invest operating cash flows,
rather than paying additional dividends (Jensen,
1986). Managerial and shareholders’ interests are
more closely aligned in moderate growth firms
than parties’ interest in low growth firms; we
therefore expect the relationship between operat-
ing cash flows and dividend changes to be the
strongest in moderate growth firms because these
firms have a lower opportunity cost of dividends
than high growth firms (Charitou and Vafeas,
1998).
In table 4 hypothesis 2 was tested by empir-
ically estimating the dividend policy equation
separately for each of the three sub-samples,
which are partitioned, based on firm growth.
Consistent with prior studies, the coefficient
of PAT is positive and that of DVL is negative,
but while the coefficient of DVL and CF is sig-
nificant for low growth firms, the coefficient of
PAT is not significant. However, the coefficient
of PAT is significant for moderate and high
growth firms, while that of CF is not significant
(Model 1). Model 1 has an adjusted coefficient of
determination R2 that is 38 per cent, which is
low.
Model 2 (Lintner’s model) was also estimated
for low growth firms and it revealed PAT as
having a negative significant relationship with
dividend changes, while DVL has a significant
relationship (not reported here). CF was substi-
tuted for PAT in Lintner’s model (Model 3) and
the coefficient of CF revealed a positive and sig-
nificant relationship at the 5 per cent level
between dividend changes and cash flows for
low growth firms with adjusted R2 of 45 per
cent. Cash flow is not statistically significant for
moderate growth firms. The result revealed that
cash flows have a positive statistically significant
relationship with dividend changes of low growth
and high growth firms. This is not consistent
with prior findings where CF is not found signifi-
cant in the extreme portfolios (Charitou and
Vafeas, 1998).
This can be partly explained by the overdepen-
dence of Nigerian firms on retained earnings for
corporate financing (Soyode, 1978; Oyejide,
1987). Low growth firms are less liquid because
they have less access to debt than moderate
growth and large growth companies. If pay-out
policy is dependent on cash availability, their
decision to reduce or decrease dividends must
partly reflect liquidity. High growth firms on
# Blackwell Publishing Ltd, 2003
 Cash Flow and Dividend Changes in Nigeria

Table 4. Cross-sectional OLS regression results for 882 firm-year observations from 1984 to 1997a.

Variable Sub-sample 1 Sub-sample 2 Sub-sample 3

Low growth Moderate growth Highest growth

Panel A, Model 1:
DV ¼ b0 þ b1PAT þ b2DVL þ b3CF þ b4TDE

Intercept 0.0659 0.01147 0.0285
(2.8012)** (0.105) (0.4827)
PAT 0.01928 0.1269 0.226
(0.9204) (1.5981)* (4.728)***
DVL
0.7165
0.2047
0.0804
(2.2173)* (
0.1106) (
0.2252)
CF 0.0679 0.1773 0.49
(2.2172)** (0.1334) (1.5282)
TDE
0.0187 0.418 0.4039
(0.8662)* (2.405)** (1.0229)
R2 63% 57% 92%
Adj. R2 38% 32% 87%
F-Stat. 1.1478 2.3149 18.97
Panel B, Model 3:
DV ¼ b0 þ b2DVL þ b3CF
Intercept 0.0644 0.072 0.0948
(3.881)*** (0.5295) (1.1726)
DVL
0.6188 1.1673 1.3906
(
3.144)*** (0.5075) (2.1761)**
CF 0.0467 0.219 1.2765
(2.1082)** (0.125) (1.397)*
R2 56% 3% 35%
Adj. R2 45%
18% 20%
F-Stat. 5.0885 0.1479 2.379
a
Firms are partitioned into three according to the firm growth. t-values are in parentheses. ***, ** and * indicate values are
significant at the 1%, 5% and 10% level. The estimates reported here are obtained by using OLS regression procedure in E-views
(1995 version).

the other hand may have projects competing for
the available fund. They therefore need to con-
sider the available cash flow in deciding on the
distribution of available cash between projects
that will yield positive NPV and shareholders in
the form of dividend.
The positive significant relationship between
cash flow and dividend changes in the extreme
portfolios could also be partly due to our defini-
tion of cash flow as working capital, which is free
cash flow. Hypothesis 2 is therefore rejected.
Hypothesis 3 predicts that the relationship
between operating cash flows and dividend
changes is significantly positive for firms that
are highly levered, given earnings. This is because
a firm’s ability to change its dividend policy
sometimes depends on its liquidity position. A
company that is highly levered has more debt
obligations and interest to pay. Size has a posi-
tive influence on leverage and growth. Large
firms have better access to debt (Marsh, 1982;
Baskin, 1989; Chang and Rhee, 1990; Bennets
and Donnelly, 1993; Charitou and Vafeas, 1998;
Adedeji, 1998) and is likely to be less liquid when
compared with small firms. Shareholders are
likely to expect more dividend on the one hand
and the company is expected to pay principal and
interest to debtholders on the other hand. When
there is inadequate cash flows (when a company
is highly levered), the firm’s ability to change its
dividend policy in response to its performance is
constrained. Therefore cash flows are expected to
play a significant role in setting dividend policies.
This hypothesis is examined by regressing divi-
dend changes on profit after tax (PAT), cash
flows (CF), total distributable earnings (TDE)
and lagged dividends (DVL).
In table 5, hypothesis 3 is investigated by esti-
mating the empirical model separately for each of
the three portfolios, which are partitioned, based
on the magnitude of debt.
The regression result in panel A of table 5
revealed a negative significant relationship
between dividend changes and cash flows of
lowly geared firms (at the 1 per cent level of
significance) and positive significant relation-
ships between cash flows and dividend changes
of highly geared and moderately geared firms at
the 5 per cent level of significance. PAT have
negative coefficients that are not significantly

# Blackwell Publishing Ltd, 2003 R&D Management 15, 1, 2003 45

O.J. Adelegan

Table 5. Cross-sectional OLS regression results for 882 firm-year observations from 1984 to 1997a.

Variable Sub-sample 1 Sub-sample 2 Sub-sample 3

Lowly geared Averagely geared Highly geared

Panel A, Model 1:
DV ¼ b0 þ b1PAT þ b2DVL þ b3CF þ b4TDE

Intercept 0.1409 (0.553) (
0.1872)
PAT 0.9921 0.0189
0.3477
(114.0)*** (
0.1887) (
0.8694)
DVL
8.3842 0.2100 0.8105
(
5.3439) (0.2806) (1.7056)*
CF
4.399 3.302 0.873
(
3.791)*** (2.2166)** (2.0727)**
TDE 0.2983
1.0811 1.8590
(1.2728) (
0.3707) (0.6930)
R2 99.96% 52.69% 51.39%
Adj. R2 99.93% 29.04% 27.08%
F-Stat. 4048.61 2.228 2.1142
Panel B, Model 3:
DV ¼ b0 þ b2DVL þ b3CF
Intercept 8.1145 0.01598 0.1706
(1.7798) (0.05911) (0.5994)
DVL
75.9756 0.5254 0.4045
(
1.3952) (0.9579) (2.558)***
CF
22.3985 3.6026
0.4565
(
0.5453) (2.568)*** (
1.5500)
R2 19.25% 45.44% 41.55%
Adj. R2 1.30% 34.53% 29.86%
F-Stat. 1.0725 4.164 3.5549
a
Firms are partitioned into three according to the firm leverage. t-values are in parentheses. ***, ** and * indicate values are
significant at the 1%, 5% and 10% level. The estimates reported here are obtained by using OLS regression procedure in E-views
(1995 version).

different from zero for moderately and highly
levered firms. The negative coefficient of CF for
dividend changes of lowly geared firms may be
due to the fact that large firms are usually less
levered than small firms. The cost of issuing debt
and equity securities is related to firm size. There-
fore small firms pay more to issue new equities
and long-term debt than large firms do. If large
firms are lowly levered than small firms (Smith,
1977; Titman and Wessel, 1988), then their divi-
dend behaviour is likely to be influenced more by
current earnings (PAT), which gives a significant
positive relationship. Even when cash flow is
reducing, lowly levered firms will be unwilling
to reduce their dividend.
In table 5 panel B, CF was substituted for PAT
in Lintner’s model; the result revealed that cash
flow is only significant for averagely geared firms
and not significantly different from zero for the
extreme portfolios. We therefore reject hypoth-
esis 3, which says that the relationship between
dividend change–cash flow is significantly posi-
tive for highly levered firms.
Hypothesis 4 predicts that operating cash
flows are a better predictor of dividend changes
for small firms. Our reasoning for this hypothesis
is as follows: small firms are more levered than
large firms because the cost of issuing new equi-
ties and long-term debt are higher for small firms
than large firms. They therefore fall back on
short-term debt (Smith, 1977; Titman and
Wessel, 1988). High leverage means high com-
mitment to repayment of principal and interest
and therefore low cash flows. Low size will bring
about low earnings and low cash flows. When
cash flows are low, cash flows (in addition to
earnings) are expected to play a significant role
in setting dividend policy.
In table 6 hypothesis 4 is investigated by esti-
mating empirically the dividend policy equation
separately for each of the three portfolios, which
are partitioned, based on firm growth.
The coefficient of cash flow is significant for
small firms and not significantly different from
zero for average and large sized firms. Large
firms and moderate firms, however, have signifi-
cant positive coefficient for PAT. This reveals
that large firms are lowly levered and their divi-
dend changes is dependent on earnings after tax
(PAT) and lagged dividend (DVL) and total dis-
tributable earnings. This is consistent with
Lintner (1956). Small firms’ dividend change is
determined more by the availability of cash
flows. They are highly geared compared to large

46 R&D Management 15, 1, 2003 # Blackwell Publishing Ltd, 2003

 Cash Flow and Dividend Changes in Nigeria

Table 6. Cross-sectional OLS regression results for 882 firm-year observations from 1984 to 1997a.

Variable Sub-sample 1 Sub-sample 2 Sub-sample 3

Small size Average size Largest size

Panel A, Model 1:
DV ¼ b0 þ b1PAT þ b2DVL þ b3CF þ b4TDE

Intercept 0.0469 0.1792 0.3295
(0.6077) (0.9114) (1.038)
PAT 0.06364 0.9991 0.6039
(0.4745) (108.9)*** (7.644)***
DVL 1.2596
4.9934
4.4349
(2.1676)** (
2.555)** (
1.0922)
CF 0.9072 1.9262
1.6708
(2.5148)** (1.25) (
0.5833)
TDE
0.00586
0.3504
0.7047
(
0.03592) (
1.0716) (
5.348)***
R2 76.71% 99.95% 90.03%
Adj. R2 63.39% 99.92% 84.32%
F-Stat. 5.7617 3626.93 15.7942
Panel B, Model 3:
DV ¼ b0 þ b2DVL þ b3CF
Intercept 0.0722
3.437 0.2809
(2.327) (
0.5558) (0.3208)
DVL 1.518 69.0115 0.08632
(5.122)*** (1.0084) (0.9565)
CF 1.0422 57.3065
0.5888
(4.327)*** (1.0532) (0.0863)
R2 75.64% 13.65% 0.47%
Adj. R2 70.23%
5.50%
21.60%
F-Stat. 13.9755 0.7113 3626.925
a
Firms are partitioned into three according to the firm size. t-values are in parentheses. ***, ** and * indicate values are
significant at the 1%, 5% and 10% level. The estimates reported here are obtained by using OLS regression procedure in E-views
(1995 version).

firms (Smith, 1977; Titman and Wessel, 1988).
They are also less liquid when compared with
large firms; therefore their dividend decision
depends more on the availability of cash flow.
However, this is inconsistent with findings in
Homaifar et al. (1994) where a positive associ-
ation is established between leverage and firm size.
The adjusted R2 is 76.7 per cent for small
firms, 99.9 per cent for moderate firms and 84.3
per cent for large firms. This shows that the
explanatory variables explain 76.7 per cent, 99.9
per cent and 84.3 per cent of variations in the
dividend changes of small-sized, medium-sized
and large-sized firms as shown in table 6, panel
A. In panel B of table 6, we regressed dividend
changes on cash flows and lagged dividend yield,
the adjusted R2 for medium- and large-sized
firms are
5.5 per cent and
21.6 per cent
respectively, and the coefficients of the parameter
estimates are not significantly different from
zero. The parameter estimate of cash flow for
small-sized firms is positively significant at the 5
per cent level of significance with R2 of 70.23 per
cent. This is consistent with findings in hypoth-
esis 2. We therefore accept hypothesis 4.
However, the mitigating role of market-to-
book ratio (MBV), firm size (SZ) and leverage
(LEV) may not be independent as shown in table
1, Sample summary statistics. MBV is highly
positively correlated with SZ and weakly nega-
tively correlated with total debt (LEV). This is
consistent with findings in Myers (1977) and
Chung (1993). Therefore, there is a probability
that the results of partitioning the samples are
associated. However, prior empirical studies have
shown that further sub-partitioning may result
in loss of power in some small sub-samples
(Charitou and Vafeas, 1988).
7. Conclusion
Earnings drive empirical evidence, which sup-
ports the notion that dividend policy, and lagged
dividend yield abounds. However, researchers
have argued that the accrual component of earn-
ings measure firm performance less reliably than
the cash flow component. They argued that
accruals are subject to manipulations by man-
agers and that cash flows are a better measure
of liquidity.

# Blackwell Publishing Ltd, 2003 R&D Management 15, 1, 2003 47

O.J. Adelegan
Our correlation matrix and pooled cross-
sectional time series regression test reveals that
cash flows are a better measure of liquidity that
are highly significant. We also went further to
examine the importance of cash flow in setting
dividend policy.
In particular, we investigate contextual factors
that are potentially important in mitigating the
relationship between cash flows and dividend
changes. This study hypothesized that the homo-
geneity of the dividend policy equation across
firms does not hold due to cross-firm variation
in firm growth, leverage and firm size.
Our results revealed that cash flow is signifi-
cant in determining the dividend changes of
small-sized firms, there is a positive significant
association between cash flows and dividend
changes of averagely geared firms and low and
high growth firms.
In conclusion, there is enough evidence to con-
clude that firm growth potentials, firm size and
the level of leverage affect the association
between changes in dividend and cash flow of
corporate firms in Nigeria.
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