0 có EFFECT OF DIVIDEND ANNOUNCEMENT-Md. Hamid Uddin.pdf

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EFFECT OF DIVIDEND ANNOUNCEMENT ON SHAREHOLDERS VALUE:EVIDENCE FROM DHAKA STOCK EXCHANGE

Md. Hamid Uddin*Golam Mohammed Chowdhury**

ABSTRACT

Academic literature suggests that dividend payments should have no impact onshareholders value in the absence of taxes and market imperfections. Hence,companies should invest excess funds in the positive net present value projectsinstead of paying out them to the shareholders. Literature also suggests that marketvaluation of stocks depends on the expected future dividends. If company pays out all

of the earnings, funds for future investment will decrease and dividend may notincrease in the future. Moreover, when dividend is taxable, paying out more cashwould increase the shareholders tax liability. Despite these theoretical arguments fornot paying dividends, companies often pay cash dividends to their shareholderspossibly to signal information about the future earnings prospects. Our empiricalresults based on 137 samples of dividend paying companies listed on Dhaka StockExchange, showed that investors do not gain value from dividend announcement.Indeed shareholders lost about 20 percent of value over a period of 30 days prior tothe dividend announcement through to 30 days after the announcement. The lostvalue may be partially compensated because of the current dividend yield. Overall,

the evidence tends to support the dividend irrelevancy hypothesis. Evidence alsoindicates that dividend payment does not signal any information to the investors,which needs to be further investigated.

1.0 INTRODUCTION

The goal of corporate entities is to maximize the value of shareholders investment inthe firm. Managers pursue this goal through their investment and financing decisions.Investment decisions involve with selection of positive net present value projectswhile financing decisions involve with selection of a capital structure that wouldminimize the cost of capital of firm. Apart from the investment and financing

decisions, managers need to decide on regular basis whether to payout the earningto shareholders, reducing the agency problem (Jensen and Meckling, 1976).However, the question remains whether paying out of earnings would essentiallycreate value for the shareholders or not. A dividend payment provides cash flow tothe shareholders but reduces firms recourses for investment; this dilemma is a mythin the finance literature.

A great deal of theoretical and empirical research on dividend effects has been doneover the last several decades. Theoretically, cash dividend means giving reward tothe shareholders that is something they already own in the company; hence this will

be offset by the decline in stock value (Porterfield, 1959 and 1965). In an ideal world(without tax and any restrictions) therefore dividend payments would have no impacton the shareholders value (Miller and Modigliani, 1961)[1]. In the real world, howevera change in the dividend policy is often followed by change in the market value ofstocks. The economic argument for investor preference to dividend income was

* Assistant Professor, Institute of Business Administration, University of Dhaka, Dhaka,Bangladesh.

** Professor, Institute of Business Administration, University of Dhaka, Dhaka, Bangladesh.

This article is brought to you by www.bdresearch.org


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Effect of Dividend Announcement on Shareholders Value2

offered by Graham-Dodd (1951). Subsequently, Walter (1956) and Gordon (1959 and1962) forwarded the dividend relevancy idea, which has been formalized into atheory, postulating that current stock price would reflect the present value of allexpected dividend payments in the future.

Other researchers made efforts to further understand the dividend controversy.Among them, Brennan (1970 and 1973), Litzenberger and Ramaswamy (1979 and1980) showed that it is not optimal for the investors to receive dividends if theirmarginal tax rate is greater than zero, and investors after-tax expected rate of return(discount rate) depends on the dividend yield and systematic risk[2]. This leads to anidea that at least dividend might have some tax-induced effect on the share prices.Average investors, subject to their personal tax rates, would prefer to have less cashdividend if it is taxable: size of optimal dividend inversely related to personal incometax rates (Pye, 1972). Hence, stocks prices tend to decline after announcement of

dividend increase.Empirical studies however showed mixed evidence, using the data from US, Japanand Singapore markets. A number of studies found that stock price has a significantpositive relationship with the dividend payment [Gordon (1959), Ogden (1994),Stevens and Jose (1989), Kato and Loewenstein (1995), Ariff and Finn (1986), andLee (1995)], while others found a negative relationship [Loughlin (1989) and Eastonand Sinclair (1989)]. A negative relationship between dividend announcement stockreturns is expected due to tax effect, but researchers tended to relate the positiverelationship between the stock returns and dividend announcement with the

information effect of dividend. The dividend information hypothesis postulates thatcash dividend carries information regarding the future cash flows of firm that is to bereflected in the market price of stock after announcement of dividend, particularlywhen dividend increases [Bhattacharya (1979) Bar-Yosef and Huffman (1986) andYoon and Starks (1995)].

The theoretical literature on dividend effects has been well developed. Researcherslargely accepted that dividendper-sehas no impact on the shareholders value in anideal economy. However, in a real world, dividend announcement is important to theshareholders because of its tax effect and information content. In this study, we have

examined the dividend effect on shareholders value in Dhaka Stock Market with asample of 137 companies who announced dividend over a period from October 2001to September 2002. Our results showed that Cumulative Abnormal Return (CAR) of137 stocks portfolio increased shortly before the announcement of dividends but thisvalue increase did not sustain in the ex-dividend periods. Indeed, the shareholders ofdividend paying companies lost significant amount of value over a period of 30 daysafter the dividend announcement. However, the lost value can be partiallycompensated by the dividend yield.

As CARs are negative in the periods after dividend announcement, evidence suggestsdividend announcements do not carry information about the future earnings and cashflows of the companies. Hence, our findings are not consistent with the dividendinformation hypothesis. The negative CAR in the ex-dividend periods is apparentlyconsistent with the dividend tax-effect hypothesis. This could be possible becausedividend income generally needs to be included in the investors personal income fortax purposes. Since the dividend yield partially compensates the value lost in the ex-dividend periods, investors overall value remains largely unchanged after dividendpayments. Hence, evidence seems to be consistent with Miller and Modiglianihypothesis (1961).


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Journal of Business Research, Vol. 7, June 20053

The rest of the paper is organized as follows: in Section 2, we discuss themethodology. Characteristics of samples are described in Section 3. The empiricalfindings are presented and analyzed in Section 4. Finally, Section 6 concludes thepaper.

2.0 RESEARCH METHODOLOGY

In order to study the impact of dividend announcement on shareholders value weuse two measures: firstly, daily market-adjusted abnormal return (MAAR) andsecondly, daily cumulative abnormal return (CAR). MAAR indicates the relative dailypercentage price change in the dividend paying stocks compared to the change inaverage market price. We use DSE all-share price index as the proxy of averagemarket price. MAAR is calculated as follows:

Where,

The market adjusted abnormal return (MAAR) shows the change in individual stocksvalue due to the dividend announcement. As the percentage change in market index(average market price) is deducted, the remainder gives us the unsystematic portionof the value change, which is specific to that particular stock resulting from itsdividend announcement. MAAR is calculated over a period starting to 30 days to+30 days relative to the dividend announcement day (0-day).

The second measure used is cumulative abnormal returns (CAR), which measures the

investors total return over a period starting from well before the announcement of

dividend to well after the dividend announcement day. We use a 61-day window

period staring from -30-day to +30-day relative to the dividend announcement day

(0-day). CAR is computed as follows:

=

=

=jt

ttt MAARCAR

1

(2)

Where, CARt is cumulative abnormal return, MAARt as defined above, j denotes the

day -30 through day +30. Finally, we used parametric test to determine the statistical

significance of market adjusted average abnormal return of dividend paying stocks

over the window period (-30 day to +30 day relative to dividend announcement). The

t-statistics were calculated cross-sectionally by using the standard deviation of

abnormal returns of the portfolio of 137 dividend-paying stocks. Moreover, t-test

suggested in Brown and Warner (1980, p. 251-252) is also applied to test the

statistical significance of the cumulative abnormal returns.

MAARit is the market adjusted abnormal return for security iover time t

Rit is the time treturn on security i, calculated as (Pit Pit-1)/Pit-1. Where, Pit isthe market closing price of stockion day t. Pit-1 is the market closing priceof stockion day t-1.

Rmt is the time treturn on the DSE all-share price index calculated as (It It-1)/It-

1. Where, I

itis the market index on day t. I

t-1is the market index on day

t-1.


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3.0 SAMPLE DESCRIPTIONS

The sample includes 137 companies listed on the Dhaka Stock Exchange (DSE) who

announced dividends between October 2001 and September 2002. We considered

the sample period as the stable year in recent periods, as this period followedimmediately after the change of political power in the country when political chaos

was generally absent and market run smoothly. A stable market period is essential

for collecting samples. Otherwise, the empirical results may be contaminated by the

other factors such as market volatility. A breakdown of the sample companies

according to industrial sectors is given below in Table 1 and Figure 1.

Table 1 shows that the highest average dividend was paid in the Fuel and Power

sector, followed by that in the investment sector. The highest dividend was

announced in the food sector, and lowest in the Jute and Services sectors. In Jute

sector, only one company announced dividend during the sample period. The

average dividend was 19.5 percent with standard deviation of 12.9 percent. Overall,

the table shows that our sample includes stocks from all sectors, except the paper

sector. The number of samples are also fairly equally distributed with 10 to 20 stocks

from each sector - except Paper, Jute and Services sectors. This is also noted that

out of 137 companies, 34 companies announced dividend in 2001 and 103 in 2003.

Sample also displays that 108 companies belong to A-category, 17 belong to B-

category and 12 belong to Z-category

[3]

. Therefore, the empirical result based thissample is likely to be reliable.

Table 1: Distribution of Sample Companies Listed on DSE

Sector Number ofCompanies

MaximumDividend

MinimumDividend

AverageDividend

Bank 16 50.0% 16.5% 27.0%

Chemical 14 40.0% 5.0% 18.3%

Engineering 15 50.0% 10.0% 19.5%

Food 15 60.0% 8.0% 19.0%Fuel and Power 3 50.0% 5.0% 33.0%

Insurance 17 43.0% 10% 20.1%

Investment 10 50.0% 7.5% 23.7%

Jute 1 - - 10.0%

Paper 1 - - -

Service 3 10.0% - 10.0%

Textile 22 40.0% 5.0% 10.3%

Misc. 20 50.0% 5.0% 21.1%

Total 137


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4.0 EMPIRICAL FINDINGS AND ANALYSES

4.1 Market Adjusted Abnormal Return

Findings reported in Table 2 shows that average market adjusted abnormal return(MAAR) on the day of dividend announcement was only 0.8 percent, which was not

statistically significant. This could be due to the fact that the information of dividendpayment often leaks out to the market a few days before the announcement madeby the company. Hence, the announcement of dividend normally carries no surpriseto the market. Therefore, evidence shows that MAARs of day 4 and 3 are about 2percent and 2.9 percent respectively, which are significant at 5 percent level. Thissuggests that market reacts earlier than the actual announcement of dividend.

Table 2: MAAR of 137 dividend-paying DSE stocks over a window period of day 30to day +30 relative to dividend announcement day (0-day)

Day relative to dividendannouncement

Average MAAR tstatistic

-30 -0.049 -1.091

-29 -0.012 -0.664

-28 -0.002 -1.037

-27 0.004 1.275

-26 -0.001 -0.239

-25 0.006 1.625

-24 0.005 1.451

-23 0.005 2.071

-22 0.002 0.738

-21 0.01 0.579

-20 0.004 -2.031**

-19 0.01 0.497

-18 -0.002 -0.884

-17 0.001 0.268

-16 0.009 1.526

Figure 1: Average dividend in different industrial sectors

0.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

35.00%

Bank

Chem

ical

Engineerin

gFo

od Fuel

Insura

nce

Investm

ent

Jute

Pape

r

Serv

ice

T

extile

Misc

.

Induatrial Sectors

Dividend%


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Day relative to dividendannouncement

Average MAAR tstatistic

-15 0.016 3.877***

-14 0.003 1.155

-13 0.02 0.653

-12 -0.004 -1.951*-11 0.011 1.953*

-10 0.008 1.161

-9 -0.002 -0.958

-8 0.015 0.374

-7 0.004 0.867

-6 -0.005 -1.892*

-5 0.002 0.215

-4 0.020 2.038**

-3 0.029 2.172*

-2 -0.007 -1.064

-1 -0.003 -0.439

0 0.008 0.554

1 -0.004 -0.669

2 -0.007 -0.779

3 0.001 0.386

4 -0.014 -1.635

5 0.004 0.976

6 -0.011 -1.218

7 -0.039 -1.748*

8 -0.029 -1.474

9 -0.008 -0.370

10 0.004 0.458

11 -0.036 -1.590

12 -0.02 -1.086

13 0.001 0.194

14 -0.015 -0.95615 -0.016 -0.892

16 -0.019 -0.915

17 -0.045 -1.569

18 -0.04 -1.342

19 -0.0028 -1.168

20 0.000 0.051

21 0.001 0.122

22 -0.010 -0.958

23 -0.001 -1.707*24 -0.005 -0.534

25 0.005 0.660

26 0.0012 0.695

27 0.004 0.634

28 -0.0046 -2.052**

29 -0.003 -0.196

30 0.008 1.093


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Note: Asterisks in the last column denotes that the corresponding MAAR is statisticallysignificant. The asterisks ***, **, and * indicate the level of significance (based on the tvalues) at respectively the 1, 5 and 10 percent level.

Prior to dividend announcement, MAAR also found significant on the days 6, -11, -12, and 20. However, the percentage returns on these days are less than that on the day4. On otherdays, MAAR is insignificant. Therefore, evidence tends to confirm that market reacts a fewdays before the announcement of dividend is made. During the post-announcement periods(day +1 to +30), all MAARs are insignificant except those on day +7, +23, and +28. Overall,MAAR results suggest that the effect of dividend announcement is not strong in Dhaka StockExchange. Shareholders gain only about 4 percent value about three/four days before theannouncement of dividend but no significant value gain on the announcement day.

4.2 Cumulative Abnormal Return

Results in Table 3 shows that investors do not gain value from dividend

announcement. Evidence depicts that CAR had risen from -4.9 percent on day -30 toa level of 10.5 percent on the day of dividend announcement. But the gained valuewas lost over the next 30 days after dividend announcement, as CAR dropped to 19.52 percent on the day 30. Although results tends to suggest that investors mayhave overreacted to the dividend announcement, the evidence generally consistentwith the dividend irrelevance hypothesis of Miller and Modigliani (1961). This isbecause investors seemed to gain no value from the dividend announcements.

Findings also show that investors lost more value in the ex-dividend period than thevalue gained in the pre-dividend period. This finding tends to suggest that dividendannouncement does not carry information about the future earnings and cash flow ofthe companies. In Bangladesh, DSE and Security and Exchange Commissions (SEC)generally rate the performance of the listed companies based on their regulardividend payments. Hence, companies may like to retain their good standing bypaying regular dividends[4]. In the presence of a kind of indirect pressures from theregulatory authorities, the companies may not be able to effectively signal the futureearning prospects through their dividend announcement.

Table 3: CAR of 137 dividend-paying DSE stocks over a window period of day 30to day +30 relative to dividend announcement day (0-day)

Days relative to dividend announcement CAR t-values

-30 -0.049 -1.091

-29-0.061

-1.571

-28-0.063

-1.141

-27-0.059

-1.271

-26-0.060

-1.091

-25-0.054

-1.781

-24-0.049

-2.052

-23-0.044

-1.781

-22-0.042

-1.111

-21-0.032

-0.890

-20-0.028

-0.111

-19-0.018

-1.194

-18-0.02

-1.123

-17-0.019

-1.178

-16-0.010

-1.152

-150.006

3.125

-140.009

1.962


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Days relative to dividend announcement CAR t-values

-130.029

1.561

-120.025

1.333

-110.036

3.152

-100.044

2.150

-9 0.042 2.111-8

0.0574.591

-70.061

4.781

-60.056

3.589

-50.058

3.456

-40.078

7.985

-30.107

8.978

-20.100

9.781

-10.097

5.891

0 0.105 6.888

10.101

5.578

20.094

4.595

30.095

4.258

40.081

8.654

50.085

4.568

60.074

3.245

70.035

1.589

80.006

0.015

9-0.002

1.065

100.002

0.860

11-0.034

-3.656

12-0.054

-7.891

13-0.053

-2.456

14-0.068

-5.892

15-0.084

-5.654

16-0.103

-4.444

17

-0.148

-10.652

18-0.188

-5.456

19-0.1908

-4.658

20-0.1908

-3.222

21-0.1898

-4.658

22-0.1998

-7.698

23-0.2008

-4.587

24-0.2058

-7.159

25-0.2008

-9.346

26-0.1996

-11.986

27-0.1956

-12.654

28-0.2002

-10.258

29-0.2032

-8.348

30-0.1952

-8.147

Our results reported above support the dividend irrelevance proposition in the DhakaStock Market. It is however important to examine further whether dividend carriesany information, e.g., future earnings. We leave it for future research because the


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earning data for the year following the current dividend payment is not yetavailable[5] Hopefully, future findings on the dividend information hypothesis wouldvalidate the current evidence from DSE, which supports the dividend irrelevancyproposition in Bangladesh.

Figure 2: Cumulative abnormal return (CAR) of 137

DSE listed companies over period from day -30 to day

+30 relative to dividend anncouncement

-27

-23

-19

-15

-11 -7 -3 1 5 9 1

317

21

25

29

Event days relative to dividend anncouncementCumu

lativea

bnorma

l

return

5.0 CONCLUSION

In academic literature, it was suggested that dividend payments have no impact onthe shareholders value (Miller and Modigliani, 1961) in the absence of taxes andother market imperfections. A dividend payment provides cash flow to theshareholders but it reduces firms recourses for investment. Hence, firms should notpay dividend if they have any positive net present value project in hand. However,Walter (1956) and Gordon (1959 and 1962) showed that valuation of stock dependson the expected future dividends. If company pays out all the earnings toshareholders, funds for future investment will decrease and dividend may not

increase in the future. Therefore, theoretical literature suggested that dividendspayout should not be desirable provided that companies can better invest their funds.Moreover, cash dividend is not desirable if investors need to pay taxes on theirdividend income. Given the valid reasons for not paying dividends, an announcementof dividend payments may carry some information for the market and stock pricesmay be adjusted accordingly.

Based on the 137 DSE listed companies declaring dividends during October 2001 andSeptember 2002, we found that investors do not benefit from dividendannouncement. Over the period starting from 30 days prior to dividend

announcement to 30 days after the announcement of dividend payment, investorsincurred losses upto 19.52 percent of stock value. Although this loss of value ispartially compensated by the current dividend yield, investors in Bangladesh seemedto have no net gain due to dividend payments. The evidence from DSE tends tosupport Miller and Modigliani (1961) hypothesis of dividend irrelevancy. Apart fromthe academic significance of our findings, the regulatory authorities (DSE and SEC)may wish to review their policy of company evaluation, which emphasizes ondividend payments by the listed companies, in the context of empirical evidence onthe dividend effects.


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NOTES

1. It was further showed that the irrelevancy of dividend policy holds even after dropping theassumption of ideal economy.

2. Black and Scholes (1974) argued however that tax effect is not uniform for all investors,because different investors are subject to different tax rates depending on the level oftheir wealth and income.

3. DSE classify the listed companies into A, B and Z categories. A category companies aregood stocks as their operating performance are assessed to be good and pay regulardividends, B-category companies are moderate companies whose operating performanceare satisfactory and pay some dividends from time to time, and Z-category companies arethose whose operating performance are not good and normally pay no dividend.

4. Payment of dividend is purely a corporate financial decision of a firm. Dividend per seshould not have any impact on the shareholders value but companies may like to pay

dividend due to tax effect or information effect. Since dividend income was tax free inBangladesh, tax effect should not be found at DSE. If companies pay dividend that shouldbe for signaling any information to the investors, but when regulatory authorities rate thecompanies based on their regular dividend payments, investors may become confusedabout the purpose of dividend announcement by the companies.

5. We have collected the dividend announcement data from October 2001 to September2002, which have been analyzed in this paper. Currently, we are keeping the track ofinformation on earning announcements by the same companies from October 2002onward. Hopefully, we will get most of the earning announcements by the end of year2003, which will be analyzed in next paper on dividend information hypothesis.

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