A Diagnosis of the Determinants of Dividend Payout Policy in India: A Factor Analytical Approach

A Diagnosis of the Determinants of Dividend Payout Policy in India: A Factor Analytical Approach

Rajesh Kumar (Indian Institute of Technology, Banaras Hindu University, India) and Pawan Kumar Jha (Banaras Hindu University, India)
DOI: 10.4018/978-1-4666-5154-8.ch004
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Dividend decision involves the portion of a firm's net earnings that are paid out to the shareholders, and the remaining is ploughed back in the company for its growth purpose. Despite comprehensive theoretical and empirical explanations, dividend policy and its determinants are a puzzle to be fixed in corporate finance. This chapter is an attempt to assess the dynamics and determinants of dividend-payout policy using a factor analytical tool and a multiple regression analysis as a supportive tool. The authors take into account the sample of ten automobile companies based on Market Capitalization listed on the Bombay Stock Exchange (BSE) for a period of 10 years from 2002-2003 to 2012-2013. The results of the factor analysis show that six factors, current ratio, cash flow, retained earnings per share, earnings per share, equity dividend, and corporate dividend tax, are identified as the most critical factors determining dividend payout in Indian automobile companies. However, regression results depict only three factors (i.e. cash flow, equity dividend, and corporate dividend tax) have been found statistically significant in determining dividend payout policy.
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2. Review Of Literature

Lintner (1956) conducted a classic study on how U.S. managers make dividend decisions, which is focused in the behavioral aspect of dividend policy and concluded that managers only increase dividends when they believe that the level of the firm’s earning has permanently increased.

Miller and Modigliani (1961) argued that in a perfect market dividend policy has no effect on either the price of a firm’s stock or its cost of capital, shareholders wealth is not affected by the dividend decision and therefore, they would be indifferent between dividends and capital gains.

Friend and Puckett (1964) concluded that in growth industries retained earnings are more important than the dividends in determining share price. While, in case of non- growth industries, dividends seem to be more important than retained earnings.

Brittain (1966) indicated that the capacity of a firm to pay dividends has been better explained in terms of cash flows as a variable, i.e., profits after taxes plus depreciation as against the Lintner’s profits net of taxes, as it reflected true earnings.

Farrar and Selwyn (1967) viewed that investors would normally prefer low dividends as the dividends are subject to higher tax rate than that of capital gains resulting out of earnings capitalization.

Fama and Babiak (1968) concluded that net income seems to provide a better measure of dividend than either cash flows or net income and depreciation included as separate variables in the model.

Key Terms in this Chapter

Shareholders’ Wealth: Maximisation of shareholders’ purchasing power. It is any attempt made by a shareholder to accumulate as much wealth as possible, by whatever means possible. Wealth maximisation is a long term objective, although in some instances a short term effort may be carried out to provide shareholders with wealth.

Dividend Puzzle: A concept in finance in which companies that pay dividends are rewarded by investors with higher valuations, even though, according to many economists, it should not matter to investors whether a firm pays dividends or not. The reasoning goes that dividends, from the investor’s point of view, should have no effect on the process of valuing equity because the investor already owns the firm and, thus, he/she should be indifferent to either getting the dividends or having them re-invested in the firm.

Payout Policy: Dividend policy decision is an integral part of a company’s financial decision making, as it is explicitly related to the other two major decisions—investment and financing decision. Management should develop such a dividend policy, which divides the net earnings into dividends and retained earnings in an optimum way to achieve the objective of maximizing the wealth of shareholders.

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