5555 FACTORS AFFECTING DIVIDEND DECISION -...

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FACTORS AFFECTING DIVIDEND DECISIONFACTORS AFFECTING DIVIDEND DECISIONFACTORS AFFECTING DIVIDEND DECISIONFACTORS AFFECTING DIVIDEND DECISION

Dividend is a widely researched arena but still its fathom has to be explored as numerous

questions remains unanswered. The question of “Why do corporations pay dividends?”

has puzzled researchers for many years. Despite the extensive research devoted to solve

the dividend puzzle, a complete understanding of the factors that influence dividend

policy and the manner in which these factors interact is yet to be established. Allen et al.

(2000)1 stated that:

“Although a number of theories have been put forward in the literature

to explain their pervasive presence, dividends remain one of the

thorniest puzzles in corporate finance.”

The dividend decision is taken after due considerations to number of factors like legal as

well as financial. This is so because one set of dividend policy cannot be evolved that can

be applied to all firms rather the dividend decision vary from firm to firm in light of the

firm specific considerations. Lintner (1956)2 suggested that dividend depends in part on

the firm's current earnings and in part on the dividend for the previous year. He found

that major changes in earnings with existing dividend rates were the most important

determinants of the firm's dividend policy. Ramcharran (2001)3 observed that:

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“…dividend policy in the equity emerging markets from a corporate

finance perspective has not been empirically examined to

date…Continuing financial reforms in emerging markets, together with

the validity of more published data, will encourage further research on

other determinants of dividend policy, including the impact of agency

costs, information, and taxes as well as the capital structure of firms”.

This suggested that much more research needed to be undertaken on dividend policy in

developing economies.

5.1 FACTORS AFFECTING DIVIDEND DECISION

Dividend decision, one of the important aspects of company’s financial policy, is not an

independent decision. Rather, it is a decision that is taken after considering the various

related aspects and factors. There are various factors influencing a firm's dividend policy.

For example, some studies suggest that dividend policy plays an important role in

determining firm capital structure and agency costs. Many studies have provided

arguments that link agency costs with the other financial activities of a firm. Easterbrook

(1984)4 argued that firms pay out dividends in order to reduce agency costs. Dividend

payout keeps firms in the capital market, where monitoring of managers is available at

lower cost. If a firm has free cash flows, it is better to share them with shareholders in the

form of dividend in order to reduce the possibility of these funds being wasted on

unprofitable (negative net present value) projects (Jensen, 1986)5.

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Crutchley and Hansen (1989)6 examined the relationship between ownership, dividend

policy, and leverage and concluded that managers make financial policy tradeoffs to

control agency costs in an efficient manner. More recently, researchers have attempted to

establish the link between firm dividend policy and investment decisions. Smith and

Watts (1992)7 investigated the relations among executive compensation, corporate

financing, and dividend policies and concluded that a firm's dividend policy is affected

by its other corporate policy choices. Also, Jensen, Solberg and Zorn (1992)8 linked the

interaction between financial policies and insider ownership to informational

asymmetries between insiders and external investors. Despite this rich literature, most

prior work recognizes differences in determinants of financial decisions between different

firms.

5.1.1 Basic Factors Affecting Dividend Decision

Theoretically, over the past number of years, it has been believed by the academicians

that the dividend decision is influenced by number of factors. Some of the factors that

affect the dividend decision of a firm are listed as follows:

1. Legal Provisions: Indian Companies Act, 1956 has given the guidelines regarding

legal provisions as to dividends. Such guidelines are required to be followed by

the companies whenever the dividend policy is to be formulated. As per the

guidelines, a company is required to transfer a certain percentage of profits to

reserves in case the dividend to be paid is more than 10 percent. Further, a

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company is also required to pay dividend only in cash but only with the exception

of bonus shares.

2. Magnitude of Earnings: Another important aspect of dividend policy is the

extent of company’s earnings. It serves as the introductory point for framing the

dividend policy. This is so because a company can pay dividends either from the

current year’s profit or the past year’s profit. So, if the profits of a company

increase, it will directly influence the dividend declaration as the latter may also

increase. Thus, the dividend is directly linked with the availability of the earnings

with the company.

3. Desire of Shareholders: The decision to declare the dividends is taken by Board

of Directors but they are also required to consider the desire of the shareholders,

which depend on the latter’s economic condition. The shareholders, who are

economically weak, prefer regular dividend policy while the rich shareholders

may prefer capital gains as compared to dividends. However, it is very difficult

for the board to reconcile the conflicting interests of different shareholders yet the

dividend policy has to be framed keeping in view the interest of all the interested

parties.

4. Nature of Industry: The nature of industry in which a company is operating,

influences the dividend decision. Like the industries with stable demand

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throughout the year are in a position to have stable earnings, thus, should have the

stable dividend policy and vice-versa.

5. Age of the Company: A company’s age also determine the quantum of profits to

be declared as dividends. A new company should restrict itself to lower dividend

payment due to saving funds for the expansion and growth as compared to the

already existing companies who can pay more dividends. Grullon et al. (2002)9

suggested that as firms mature, they experience a contraction in their growth

which results in a decline in their capital expenditures. Consequently, these firms

have more free cash flow to pay as dividends. Similarly, Brav et al. (2005)10

suggested that more mature firms are more likely to pay dividends. In contrast,

younger firms need to build up reserves to finance the future growth

opportunities, thus, making them to retain the earnings.

6. Taxation Policy: The tax policy of a country also influences the dividend policy

of a company. The rate of tax directly influences the amount of profits available

to the company for declaring dividends.

7. Control Factor: Yet another factor determining dividend policy is the threat to

loose control. If a company declares high rate of dividend, then there is the

possibility that a company may face liquidity crunch for which it has to issue new

shares, resulting in dilution of control. Keeping this threat in view, a company

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may go for lower level of dividend payments and more ploughing back of profits

in order to avoid any such threat.

8. Liquidity Position: A company’s liquidity position also determines the level of

dividend. If a company does not have sufficient cash resources to make dividend

payment, then it may go for issue of bonus shares.

9. Future Requirements: A company while faming dividend policy should also

consider its future plans. If it foresees some profitable investment opportunities in

near future then it may go for lower dividend and vice-versa.

10. Agency Costs: The separation of ownership and control results in agency

problems. Agency costs can be reduced by distributing dividends (Rozeff, 198211,

Easterbrook, 198412, Jensen et al., 199213). In this stratum, dividends are paid out

to stockholders in order to prevent managers from building unnecessary empires

to be used in their own interest. In addition, dividends reduce the size of internally

generated funds available to managers, forcing them to go to the capital market to

obtain external funds (Easterbrook, 198414). As explained in Rozeff (1982)15,

firms with a larger percentage of outside equity holdings are subject to higher

agency costs. The more widely spread is the ownership structure, the more acute

the free rider problem and the greater the need for outside monitoring. Hence,

these firms should pay more dividends to control the impact of widespread

ownership.

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11. Business Risk: Business risk is a potential factor that may affect dividend policy.

High levels of business risk make the relationship between current and expected

future profitability less certain. Consequently, it is expected that firms with higher

levels of business risk will have lower dividend payments. Many researchers

argued that the uncertainty of a firm’s earnings may lead it to pay lower dividends

because volatile earnings materially increase the risk of default. In addition, field

studies using survey data (e.g., Lintner, 195616) reported compelling evidence that

risk can affect dividend policy. In these surveys, managers explicitly cited risk as

a factor that influences their dividend choice.

5.1.2 Financial Factors Affecting Dividend Decision

The above mentioned factors are not limited and many more can be there that affect the

determination of dividend. Keeping in view the above-mentioned factors and the review

of literature, some variable has been identified within the arena of the theoretical factors.

Those variables include both the dependent and independent variables. However, their

interpretation depends upon their measurement. The present study covers the following

set of variables:

1. DPS to Face Value: This ratio evaluates the relationship between dividend per

share and face value of the share. It is calculated as:

Dividend Yield ratio= Dividend per share/Face value per share

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2. DPS to Market Value (Yield ratio): This ratio evaluates the relationship between

dividend per share and market value of the share. It is calculated as:

Dividend Yield ratio= Dividend per share/Market value per share

3. Dividend Payout Ratio: It indicates the extent to which the earnings per share

have been retained by a company. It enables the company to plough back the

profits which will result in more profits in future and hence, more dividends. It is

calculated as:

Dividend Pay-Out Ratio= Dividend per equity share/Earnings per

share

The higher the ratio, lower is the dividend payment and vice-versa.

4. Current Ratio: It is a measure of firm’s liquidity and is basically used for

measuring the short-term financial position or liquidity of the firm. It indicates the

ability of the firm to meet its current liabilities. It is calculated as:

Current Ratio= Current assets/Current liabilities

A high ratio indicates that firm’s liquidity position is good and it has the ability to

honor its obligations while a low ratio implies that firm’s liquidity position is not

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so good so as to honor all its obligations. However, a ratio of 2:1 is considered

satisfactory. The expected relation between current ratio and dividend payment is

positive.

5. Net Profit Ratio: This ratio establishes the relation between net profits and sales

and indicates the management’s efficiency. It is calculated as:

Net Profit ratio= (Net Profit/Net sales)*100

As dividends are declared from the net profits of a firm, so higher the net profit

ratio, higher will be the expected dividend payment.

6. Net Profit to Net worth: This ratio indicates the relation between net profits earned

by a company and the net worth which is represented by shareholder’s capital. It

is composed of equity share capital, preference share capital, free reserves and

surpluses, if any. It is also referred to as return on investment and is calculated as:

Return on shareholder’s investment= Net Profit/Net Worth

This ratio is an indication of company’s ability to earn profits. If the earning

capacity of the company is more, more dividend payment can be expected and

vice-versa.

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7. Debt Equity Ratio: This ratio measures the claims of outsiders and owners

against the firm’s assets. It indicates the relation between outsider funds and

shareholders funds. It is calculated as:

Debt-equity ratio= Outsiders funds/Shareholders funds

This ratio tells the solvency position of the firm. Higher the ratio, better will be

the solvency as well as the ability of firm to pay dividends. The vice-versa will

hold true in case of low ratio.

8. Lagged Profits: The dividend is not only influenced by the past year’s dividend but

also by the past year’s profits. This is so because a company can follow the stable

dividend policy if it has sufficient current year’s profit or the past year’s profit.

9. Behavior of Share Prices: The prevailing share prices also influence the

dividend payment by a company. If the share prices of a company are

unfavorable, then it may increase the dividend in order to boost up the share

prices. It can be calculated as:

Behavior of share prices= Higher share price - Lower share price

Higher share price + Lower share price

10. Growth in Earnings: If the earnings of a company increase, then the chances of

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increase in dividend payment are also there. Growth is must for the survival of a

company. This ratio can be calculated as:

Growth in Earnings= EPSt- EPSt-1 / EPSt-1

Where, EPSt= Current earnings per share

EPSt-1= Previous earnings per share

12. Growth in Working Capital: This ratio indicates increase in the working capital

of a company.

Growth in Working Capital= WCt- WCt-1 / WCt-1

Where, WCt= Current working capital

WCt-1= Previous working capital

Higher ratio indicates the increase in the capacity of a company to pay dividends

but this is interrelated with other factors also. Like, if a company has increase the

working capital to match the increased level of operations, then this ratio will not

be useful in studying the impact on the dividend payments.

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14. Lagged Dividends: A company may consider the past year’s dividend as a

benchmark. If a company prefers stability of dividend payments, it may consider

the past year’s dividend rate and can act accordingly.

15. Tobin’s Q: This variable represents the investment opportunities for a company.

It is measured as

(MV of equity-BV of equity +Total Assets)/Total Assets

16. Investment Opportunity Set (Market to Book Value): It represents the

availability of investment opportunities to the company and generally is believed

to have negative relationship with dividend payout.

17. Free Cash Flow: This variable is used to measure the availability of cash with the

company. It is calculated as

(Cash flow from Operations-Cash flow from investment activities)/Total assets

18. Cash Holdings: It is another financial variable to analyse the liquidity position of

the firm. It is calculated as

(Cash + Short-term investment)/Total assets

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19. Uncertainty in Earnings: It refers to the variation in the earnings from one year

to another. Some companies might witness irregular earnings and thus, may not

have stable dividend policy. Uncertainty in earnings can be measured as

σ = √ (∑x2/N)

A small value of standard deviation means high degree of uniformity in the

earnings and vice-versa.

20. Solvency Ratio: This ratio is a small variant of equity ratio. It indicates the

relationship between total liabilities to outsiders to total assets of a firm. It can be

calculated as:

Solvency ratio= Total Liabilities to Outsiders/Total Assets

21. Return on Net worth: This ratio is also termed as return on investment. This ratio

indicates the relationship between net profits (after interest and tax) and the

shareholders funds. It can be calculated as

Net profit (after interest and taxes)/Shareholders funds

22. Return on Capital Employed: This ratio establishes the relationship between

profits and capital employed. It can be calculated as

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(Adjusted Net Profits/Gross Capital Employed)*100

or

(Adjusted Net Profits/Net Capital employed)*100

5.2 DATA ANALYSIS AND INTERPRETATIONS

In the present chapter, the Principal Component Analysis approach has been used in order

to obtain a set of variables pertaining to dividends. The major emphasis was in deriving

the exclusive cluster of the aforesaid group of variables for each of the four industrial

groups: Engineering, FMCG, Information Technology and Textiles; and for the combined

group of all the four industries separately for the years 2007and 2008.

For the same purpose, the following financial variables have been used: DPS to Face

Value, DPS to Market Value, Payout Ratio, Lagged Dividend, Lagged Profits, Current

Ratio, Solvency Ratio, Debt-Equity Ratio, Free Cash Flow, Cash Holdings, Share Price

Behavior, Growth in EPS, Growth in Working Capital, Return on Capital Employed,

Return on Net worth, Age of the Company, Net Profit to Net worth, Net Profit ratio,

Market to Book value, Tobin’s Q and Uncertainty in EPS. The analysis has been made

carried out with the help of Factor Analysis. The following steps were followed in order

to extract the factors.

The principal component analysis using VARIMAX rotation of twenty one variables

pertaining to Engineering, FMCG, IT and Textiles industrial sector has led to the

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extraction of numerous factors. After a meaningful set of variables have been obtained,

the next task is to group the variables under particular factor and label them in order to

assign some meaning to the factor loadings. Variables with higher loadings are

considered more important and have greater influence on the label selected to represent

the factor. For this purpose, the sampling adequacy tests have been conducted to know

that whether the sample is adequate or not. KMO recommends accepting value greater

than .5 as barely acceptable (value below this leads either to collect more data or to

rethink which variable should be included or excluded). And Bartlett recommends the

accepting value less than .05. Bartlett’s test finds that the correlations, when taken

collectively are significant at .0001 level whereas measure of sampling adequacy looks at

the patterns between the variables.

Derivation of the factors is based on the perusal of correlation matrix results in retaining

only those components that fulfill the same criteria. The decision to choose the factor

loadings has been based on the criteria of sample size (factor loading between .3-.4 if the

sample ranges between 150 and 350). Since the sample size for the current study is 172,

so only the loadings above .30 have been considered for the study. For obtaining the

rotated factor matrix, Orthogonal rotation method viz. VARIMAX rotation has been used

which shows factor loadings for each variable onto each factor. In this matrix, only the

main factors have been displayed which are reliable & whose value is more than .3 and

the rest have been eliminated. After identifying the significant factor loadings, next step

is to study the communalities of the variables, representing the amount of variance

accounted for by the factor solution for each variable. It is generally assumed that

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variable with communalities> .50 should be retained for the study. In the present analysis,

no variable could be found having communality <.50. Hence, finally, the structure of the

factors for the variables has been well-defined and the significant factors have been

selected and grouped together for labeling.

5.2.1) FACTOR ANALYSIS RESULTS FOR INDIVIDUAL INDUS TRIAL

SECTORS FOR THE YEAR 2007

A) Engineering Industry

For the Engineering industrial sector, the overall MSA value falls in the acceptable range

(above .50) with a value of .656 for KMO and .000 for Bartlett’s test (less than .5), these

measures indicate that the set of variables are appropriate for factor analysis.

Table 5.1: KMO and Bartlett's Test for Engineering Industry

Kaiser-Meyer-Olkin Measure of Sampling Adequacy .656

Approx. Chi-Square 1069.090

df 210 Bartlett's Test of Sphericity

Sig. .000

Factor analysis has yielded eight factors for Engineering Industry which represented

82.815% of the variance, of 21 variables deemed sufficient in terms of total variance

explained (solution should account for >60% variance). Table 5.2 summarises the

orthogonal solution resulting from VARIMAX rotation of the original twenty one

measures for Engineering industrial sector for the year 2007.

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Table 5.2: Factor Analysis for Factors Affecting Dividend in Engineering Industry

for the Year 2007

Factors Factor Loadings

Eigen Value Percentage of Variance Explained

Cumulative Variance

Profitability and Investment Set

5.150 21.110 21.110

Net Profit Ratio .864 Return on Net worth .961 Return on Capital Employed

.871

Market to Book Value .650 Free Cash flow .549 Net Profit to Net worth Ratio

.956

Dividend Rate 3.781 17.862 38.972 Dividend Per Share .952 Dividend Per Share to Market Value

.876

Dividend Per Share to Face value

.930

Dividend Payout .948 Financial Soundness 2.307 12.460 51.431 Current Ratio .828 Debt Equity Ratio .725 Cash Holding .713 Solvency Ratio .858 Liquidity 1.524 7.555 58.986 Growth in Working Capital

.785

Company’s Age 1.306 6.678 65.664 Age .892 Earnings and Share Price Behavior

1.215 6.275 71.939

Share Price Behavior .694 Profit After Tax .569 Growth in EPS .512 Investment Opportunity 1.098 5.521 77.460 Tobin’s Q .893 Risk and Uncertainty 1.009 5.355 82.815 EPS Uncertainty .814

The factor 1 variables: “Net Profit Ratio”, “Return on Net worth”, “Return on Capital

Employed”, “Market to Book Value”, “Free Cash Flow” and “Net profit to Net worth

ratio” are interpreted under the construct “Profitability and Investment Set”. Factor 2 was

named as “Dividend Rate” and includes the variables “Dividend per Share”, “Dividend

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Per share to Market Value”, “Dividend per share to Face Value” and “Dividend Payout”.

Factor 3 was named as “Financial Soundness” and includes variables “Current Ratio”,

“Debt Equity”, “Cash Holding” and “Solvency Ratio”. Factor 4 was named as “Liquidity”

and includes variables “Growth in Working Capital”. Factor 5 was named as “Company’s

Age” and includes variables “Age”. Factor 6 was named as “Earnings and Share Price

Behavior” and includes variables “Share Price Behavior”, “Profit after Tax” and “Growth

in Earnings per Share”. Factor 7 was named as “Investment Opportunity” and includes

variables “Tobin’s Q”. Factor 8 was named as “Risk and Uncertainty” and includes

variables “Earnings per Share Uncertainty”.

B) FMCG Industry

For the FMCG industrial sector, the overall MSA value falls in the acceptable range



Table 5.3: KMO and Bartlett's Test for FMCG Industry




Sig. .000

Factor analysis has yielded seven factors for FMCG sector which represented 75.5% of

the variance, of 21 variables deemed sufficient in terms of total variance explained

(solution should account for >60% variance). Table 5.4 summarises the orthogonal

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solution resulting from VARIMAX rotation of the original twenty one measures for

FMCG industrial sector for the year 2007.

Table 5.4: Factor Analysis for Factors Affecting Dividend in FMCG Industry for

the Year 2007



Cumulative Variance

Profitability and Investment Set

5.336 22.481 22.481

Net Profit Ratio .538 Return on Net worth .944 Return on Capital Employed

.955

Market to Book Value .797 Free Cash flow .688 Net Profit to Net worth Ratio

.939

Dividend Rate 2.732 11.211 33.691 Dividend Per Share .551 Dividend Per Share to Market Value

.536


.911

Dividend Payout .544 Financial Soundness 2.182 11.182 44.874 EPS Uncertainty .855 Age .611 Debt-Equity Ratio .735 Profit After tax .710 Growth in Working Capital .527 Solvency Ratio .718 Investment Opportunity 1.690 8.291 53.164 Tobin’s Q .905 Liquidity 1.548 8.089 61.253 Current Ratio .542 Cash Holdings .836 Growth Rate 1.267 7.375 68.628 Growth in EPS .822 Share Price Movement 1.099 6.872 75.500 Share Price Behavior .525


Employed”, “Market to Book Value”, “Free Cash Flow” and “Net profit to Net worth

Ratio” are interpreted under the construct “Profitability and Investment Set”. Factor 2

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was named as “Dividend Rate” and includes the variables “Dividend per Share”,

“Dividend Per share to Market Value”, “Dividend per share to Face Value” and

“Dividend Payout”. Factor 3 was named as “Financial Soundness” and includes variables

“EPS Uncertainty”, “Age”, “Debt Equity”, “Profit after Tax”, “Growth in Working

Capital” and “Solvency Ratio”. Factor 4 was named as “Investment Opportunity” and

includes variable “Tobin’s Q”. Factor 5 was named as “Liquidity” and includes variables

“Current Ratio” and “Cash Holdings”. Factor 6 was named as “Growth Rate” and

includes variables “Growth in EPS”. Factor 7 was named as “Share Price Movement” and

includes variables “Share Price Behavior”.

C) IT Industry

For the IT industrial sector, the overall MSA value falls in the acceptable range (above

.50) with a value of .554 for KMO and .000 for Bartlett’s test (less than .5), these


Table 5.5: KMO and Bartlett's Test for IT Industry




Sig. .000

Factor analysis has yielded seven factors for IT sector which represented 80.392% of the

variance, of 21 variables deemed sufficient in terms of total variance explained (solution

should account for >60% variance). Table 5.6 summarises the orthogonal solution

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resulting from VARIMAX rotation of the original twenty one measures for IT industrial

sector for the year 2007.

Table 5.6: Factor Analysis for Factors Affecting Dividend in IT Industry for the

Year 2007



Cumulative Variance

Profitability Position 5.475 22.637 22.637 Net Profit Ratio .940 Return on Net worth .629 Return on Capital Employed .670 Free Cash Flow .846 Net Profit to Net worth Ratio .650 Growth in Working Capital .778 Dividend Rate 3.274 11.999 34.636 Dividend Per Share .494 Dividend Per Share to Market Value

.419


.852

Dividend Payout .418 Financial Soundness 2.365 11.179 45.815 Current Ratio .836 Cash Holding .746 Debt Equity .873 Solvency Ratio .593 Company’s Age 1.984 10.036 55.851 Age .764 Investment Opportunity 1.571 9.853 65.704 Market Value to Book Value .846 Tobin’s Q .891 Share Prices and Uncertainty

1.169 7.415 73.119

EPS Uncertainty .505 Share Price Behavior .720 Earnings and Growth Rate 1.044 7.273 80.392 Profit After Tax .864 Growth in EPS .898


Employed”, “Market to Book Value”, “Free Cash Flow” , “Net profit to Net worth ratio”

and “Growth in Working Capital” are interpreted under the construct “Profitability

Position”. Factor 2 was named as “Dividend Rate” and includes the variables “Dividend

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per Share”, “Dividend Per share to Market Value”, “Dividend per share to Face Value”

and “Dividend Payout”. Factor 3 was named as “Financial Soundness” and includes

variables “Current Ratio”, “Cash Holding”, “Debt Equity” and “Solvency Ratio”. Factor

4 was named as “Company’s Age” and includes variables “Age”. Factor 5 was named as

“ Investment Opportunity” and includes variables “Market Value to Book Value” and

“Tobin’s Q”. Factor 6 was named as “Share Prices and Uncertainty” and includes

variables “EPS Uncertainty” and “Share Price Behavior”. Factor 7 was named as

“Earnings and Growth Rate” and includes variables “Profit after Tax” and “Growth in

Earnings per Share”.

D) Textile Industry

For the Textiles industrial sector, the overall MSA value falls in the acceptable range



Table 5.7: KMO and Bartlett's Test for Textiles Industry




Sig. .000

Factor analysis has yielded seven factors for Textiles sector which represented 86.306%

of the variance, of 21 variables deemed sufficient in terms of total variance explained


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solution resulting from VARIMAX rotation of the original twenty one measures for

Textiles industrial sector for the year 2007.

Table 5.8: Factor Analysis for Factors Affecting Dividend in Textiles Industry for

the Year 2007



Cumulative Variance

Profitability Position 5.109 23.449 23.449 Return on Net worth .928 Return on Capital Employed .851 Net Profit to Net worth Ratio .905 Profit After Tax .880 Growth in EPS .666 Financial Soundness 4.103 16.11 39.559 Growth in Working Capital .820 Net Profit Ratio .947 Cash Holdings .826 Solvency ratio .958 Investment and Risk 3.096 13.427 52.986 EPS Uncertainty .886 Tobin’s Q .762 Market Value to Book value .943 Dividend Rate 2.220 11.953 64.938 Dividend Per Share .890 DPS to Market Value .811 DPS to Face Value .713 Dividend Payout .780 Capital Structure and Share Price Behavior

1.317 8.000 72.938

Debt Equity .743 Share Price Behavior .754 Company’s Age 1.262 7.114 80.052 Age .798 Liquidity Position 1.110 6.254 86.306 Current Ratio .732 Free Cash Flow .581

The factor 1 variables “Return on Net worth”, “Return on Capital Employed”, “Net Profit

to Net worth”, “Market to Book Value”, “Profit after Tax” and “Growth in Earnings per

Share” are interpreted under the construct “Profitability Position”. Factor 2 was named as

“Financial Soundness” and includes the variables “Growth in Working Capital”, “Net

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profit Ratio”, “Cash Holdings” and “Solvency Ratio”. Factor 3 was named as “Investment

and Risk” and includes variables “EPS Uncertainty”, “Tobin’s Q” and “Market Value to

Book Value”. Factor 4 was named as “Dividend Rate” and includes variables “Dividend

per Share”, “Dividend to Market Value”, “Dividend to Face Value” and “Dividend

Payout”. Factor 5 was named as “Capital Structure and Share Price Behavior” and

includes variables “Debt Equity Ratio” and “Share Price Behavior”. Factor 6 was named

as “Company’s Age” and includes variables “Age”. Factor 7 was named as “Liquidity

Position” and includes the variables “Current Ratio” and “Free Cash Flow”.

5.2.2) FACTOR ANALYSIS RESULTS FOR GROUPED DATA FOR THE YEAR

2007

The sampling adequacy tests have been conducted to know that whether the sample is

adequate or not. For the grouped data, the overall MSA value falls in the acceptable range



Table 5.9: KMO and Bartlett's Test for Grouped Data




Sig. .000

Factor Analysis has resulted in retaining seven factors for the grouped data which

retained represented 68.771% of the variance, of 21 variables deemed sufficient in terms

of total variance explained (solution should account for >60% variance). Table 5.10

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summarises the orthogonal solution resulting from VARIMAX rotation of the original

twenty one measures for the grouped data for the year 2007.

Table 5.10: Factor Analysis for Factors Affecting Dividend for Grouped Data for

the Year 2007



Cumulative Variance

Profitability and Investment Set 4.037 17.519 17.519 Return on Net worth .956 Return on Capital Employed .887 Market Value to Book Value .644 Net Profit to Net worth Ratio .946 Profit After Tax .356 Dividend Rate 3.018 13.740 31.259 Dividend Per Share .902 Dividend per Share to Market Value

.735

Dividend per Share to Face Value .735 Dividend Payout .916 Financial Soundness 2.403 9.365 40.624 Net Profit Ratio .917 Current Ratio .730 Cash Holdings .622 Free Cash Flow .553 Solvency Ratio .926 Share Price Movement 1.465 8.229 48.853 Share Price Behavior .728 Capital Structure and Investment Opportunity

1.343 6.790 55.642

Debt-Equity Ratio .569 Tobin’s Q .709 Growth Rate 1.126 6.616 62.259 Growth in EPS .829 Growth in Working Capital .414 Company’s Age and Uncertainty 1.049 6.512 68.771 EPS Uncertainty .614 Age .769

The factor 1 variables “Return on Net worth”, “Return on Capital Employed”, “Market to

Book Value”, “Net Profit to Net worth” and “Profit after Tax” are interpreted under the

construct “Profitability and Investment Set”. Factor 2 was named as “Dividend Rate” and

includes variables “Dividend per Share”, “Dividend to Market Value”, “Dividend to Face

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Value” and “Dividend Payout”. Factor 3 was named as “Financial Soundness” and

includes the variables “Net profit Ratio”, “Current Ratio”, “Cash Holdings”, “Free Cash

Flow” and “Solvency Ratio”. Factor 4 was named as “Share Price Movement” and

includes variables “Share Price Behavior”. Factor 5 was named as “Capital Structure

and Investment Opportunity” and includes variables “Debt-Equity Ratio” and “Tobin’s

Q”. Factor 6 was named as “Growth Rate” and includes the variables “Growth Rate in

EPS” and “Growth Rate in Working Capital”. Factor 7 was named as “Company’s Age

and Uncertainty” and includes the variables “EPS Uncertainty” and “Age”.

5.2.3) FACTOR ANALYSIS RESULTS FOR INDIVIDUAL INDUS TRIAL

SECTORS FOR THE YEAR 2008

A) Engineering Industry

For the Engineering industrial sector, the overall MSA value falls in the acceptable range



Table 5.11: KMO and Bartlett's Test for Engineering Industry




Sig. .000

Factor analysis has yielded six factors for Engineering sector which represented 68.679%

of the variance, of 21 variables deemed sufficient in terms of total variance explained


194

solution resulting from VARIMAX rotation of the original twenty one measures for the

Engineering sector for the year 2008.

Table 5.12: Factor Analysis for Factors Affecting Dividend in Engineering Industry

for the Year 2008



Cumulative Variance

Profitability Position 5.209 18.222 18.222 Net Profit Ratio .876 Return on Net worth .873 Return on Capital Employed

.785

Free Cash flow .649 Net Profit to Net worth Ratio

.907

Financial Soundness 3.163 14.316 32.538 Current Ratio .885 Debt Equity Ratio .613 Cash Holding .854 Growth in Working Capital

.582

Solvency Ratio .910 Dividend Rate 1.982 11.825 44.363 Dividend Per Share .818 Dividend Per Share to Market Value

.768


.734

Dividend Payout .462 Company’s Age and Profitability

1.696 10.312 54.675

Age .623 Profit After Tax .488 Investment Opportunity 1.259 8.427 63.102 Market Value to Book Value

.776

Tobin’s Q Earnings and Share Price Behavior

1.114 5.578 68.679

Share Price Behavior .489 Growth in EPS .467


Employed”, “Free Cash Flow” and “Net profit to Net worth ratio” are interpreted under

195

the construct “Profitability Position”. Factor 2 was named as “Financial Soundness” and

includes variables “Current Ratio”, “Debt Equity”, “Cash Holding”, “Growth in Working

Capital” and “Solvency Ratio”. Factor 3 was named as “Dividend Rate” and includes the

variables “Dividend per Share”, “Dividend Per share to Market Value”, “Dividend per

share to Face Value” and “Dividend Payout”. Factor 4 was named as “Company’s Age

and Profitability” and includes variables “Age” and “Profit after Tax”. Factor 5 was

named as “Investment Opportunity” and includes variable “Market Value to Book Value”

and “Tobin’s Q”. Factor 6 was named as “Earnings and Share Price Behavior” and

includes variables “Share Price Behavior”, and “Growth in Earnings per Share”.

B) FMCG Industry

For the FMCG industrial sector, the overall MSA value falls in the acceptable range



Table 5.13: KMO and Bartlett's Test for FMCG Industry




Sig. .000

Factor analysis has yielded eight factors for FMCG sector which represented 80.717% of

the variance, of 21 variables deemed sufficient in terms of total variance explained


196

solution resulting from VARIMAX rotation of the original twenty one measures for the

FMCG sector for the year 2008.

Table 5.14: Factor Analysis for Factors Affecting Dividend in FMCG Industry for

the Year 2008



Cumulative Variance

Profitability and Investment Opportunity

4.723 20.505 20.505

Net Profit Ratio .612 Return on Net worth .947 Return on Capital Employed .950 Market to Book Value .763 Net Profit to Net worth Ratio .951 Capital Structure and Risk 2.830 10.531 31.036 Debt-Equity Ratio .839 Solvency Ratio .771 Liquidity 2.319 10.069 41.105 Current Ratio .710 Cash Holding .758 Growth in Working Capital .850 Dividend Rate 2.027 9.757 50.862 Dividend Per Share .594 Dividend Per Share to Market Value

.698


.911

Dividend Payout .907 Earnings and Uncertainty 1.539 9.205 60.067 EPS Uncertainty .830 Profit After tax .789 Company’s Age and Risk 1.355 8.439 68.506 Age .513 Tobin’s Q .908 Financial Soundness 1.109 6.262 74.768 Free Cash Flow .448 Growth in EPS .862 Share Price Movement 1.048 5.949 80.717 Share Price Behavior .552


Employed”, “Market to Book Value” and “Net profit to Net worth Ratio” are interpreted

under the construct “Profitability and Investment Opportunity”. Factor 2 was named as

197

“Capital Structure and Risk” and includes the variables “Debt-Equity Ratio”, “Solvency

Ratio”, “Dividend per share to Face Value” and “Dividend Payout”. Factor 3 was named

as “Liquidity” and includes variables “Current Ratio”, “Cash Holdings” and “Growth in

Working Capital. Factor 4 was named as “Dividend Rate” and includes the variables

“Dividend per Share”, “Dividend Per share to Market Value”, “Dividend per share to

Face Value” and “Dividend Payout”. Factor 5 was named as “Earnings and Uncertainty”

and includes variables “EPS Uncertainty” and “Profit after Tax”. Factor 6 was named as

“Company’s Age and Risk” and includes variables “Age” and “Tobin’s Q”. Factor 7 was

named as “Financial Soundness” and includes variables “Free Cash Flow” and “Growth

in EPS”. Factor 8 was named as “Share Price Movement” and includes variables “Share

Price Behavior”.

C) IT Industry

For the IT industrial sector, the overall MSA value falls in the acceptable range (above

.50) with a value of .616 for KMO and .000 for Bartlett’s test (less than .5), these


Table 5.15: KMO and Bartlett's Test for IT Industry




Sig. .000

Factor analysis has yielded seven factors for IT sector which represented 75.881% of the

variance in IT sector, of 21 variables deemed sufficient in terms of total variance

198



measures for the IT sector for the year 2008.

Table 5.16: Factor Analysis for Factors Affecting Dividend in IT Industry for the Year 2008

Factors Factor

Loadings Eigen Value Percentage of

Variance Explained Cumulative

Variance Profitability Position 5.249 19.166 19.166 Net Profit Ratio .954 Return on Net worth .912 Return on Capital Employed .729 Free Cash Flow .581 Net Profit to Net worth Ratio .901 Dividend Rate 2.945 11.166 30.332 Dividend Per Share .735 Dividend Per Share to Market Value

.897

Dividend Per Share to Face value .821 Dividend Payout .637 Liquidity 2.135 10.485 40.817 Cash Holding .921 Financial Soundness 1.857 10.456 51.273 Current Ratio .879 Growth in Working Capital .559 Solvency Ratio .518 Leverage and Risk 1.354 9.760 61.033 EPS Uncertainty .921 Debt Equity .572 Earnings and Investment Opportunity

1.264 8.010 69.043

Tobin’s Q .730 Market Value to Book Value .610 Growth in EPS .799 Share Prices and Profits 1.131 6.839 75.881 Share Price Behavior .685 Profit After Tax .778


Employed”, “Free Cash Flow” and “Net profit to Net worth Ratio” are interpreted under

the construct “Profitability Position”. Factor 2 was named as “Dividend Rate” and

includes the variables “Dividend per Share”, “Dividend Per share to Market Value”,

199

“Dividend per share to Face Value” and “Dividend Payout”. Factor 3 was named as

“Liquidity” and includes variable “Cash Holding”. Factor 4 was named as “Financial

Soundness” and includes variables “Current Ratio”, “Growth in Working Capital” and

“Solvency Ratio”. Factor 5 was named as “Leverage and Uncertainty” and includes

variables “Debt-Equity Ratio” and “EPS Uncertainty”. Factor 6 was named as “Earnings

and Investment Opportunity” and includes variables “Tobin’s Q”, “Market Value to Book

Value” and “Growth in Earnings per Share”. Factor 7 was named as “Share Prices and

Profits” and includes variables “Share Price Behavior” and “Profit after Tax”.

D) Textile Industry

For the Textile industrial sector, the overall MSA value falls in the acceptable range



Table 5.17: KMO and Bartlett's Test for Textile Industry




Sig. .000

Factor analysis has yielded seven factors for Textile sector which represented 68

84.604% of the variance, of 21 variables deemed sufficient in terms of total variance



measures for the Textile sector for the year 2008.

200

Table 5.18: Factor Analysis for Factors Affecting Dividend in Textiles Industry for

the Year 2008



Cumulative Variance

Company’s Age and Profitability Position

6.305 26.809 26.809

Net Profit Ratio .956 Return on Net worth .932 Return on Capital Employed .756 Age .810 Net Profit to Net worth Ratio .923 Profit After Tax .911 Financial Soundness 3.289 13.759 40.568 Current Ratio .807 Debt-Equity Ratio .622 Solvency Ratio .882 Dividend Rate 2.346 13.525 54.094 Dividend Per Share .926 DPS to Market Value .590 DPS to Face Value .919 Dividend Payout .593 Liquidity Growth 2.052 8.176 62.269 Growth in Working Capital .854 Earnings and Uncertainty 1.664 8.007 70.276 EPS Uncertainty .809 Growth in EPS .627 Liquidity Position 1.067 7.563 77.838 Cash Holding .645 Free Cash Flow .830 Investment Opportunity and Share Price Movement

1.044 6.766 84.604

Share Price Behavior .908 Market Value to Book Value .651 Tobin’s Q .535

The factor 1 variables “Net Profit Ratio”, “Return on Net worth”, “Return on Capital

Employed”, “Age”, “Net Profit to Net worth” and “Profit after Tax” are interpreted under

the construct “Company’s Age and Profitability Position”. Factor 2 was named as

“Financial Soundness” and includes the variables “Current ratio”, “Debt-Equity Ratio”,

and “Solvency Ratio”. Factor 3 was named as “Dividend Rate” and includes variables

“Dividend per Share”, “Dividend to Market Value”, “Dividend to Face Value” and

201

“Dividend Payout”. Factor 4 was named as “Liquidity Growth” and includes variable

“Growth in Working Capital”. Factor 5 was named as “Earnings and Uncertainty” and

includes variables “EPS Uncertainty” and “Growth in EPS”. Factor 6 was named as

“Liquidity Position” and includes the variables “Cash Position” and “Free Cash Flow”.

Factor 7 was named as “Investment Opportunity and Share Price Movement” and

includes the variables “Share Price Behavior”, “Market Value to Book Value” and

“Tobin’s Q”.

5.2.4) FACTOR ANALYSIS RESULTS FOR GROUPED DATA FOR THE YEAR

2008

The principal component analysis using VARIMAX rotation of twenty one variables

pertaining to the grouped data for the four industrial sectors viz. Engineering, FMCG, IT

and Textiles, has led to the extraction of numerous factors. The tests of sampling

adequacy have been conducted to know that whether the sample is adequate or not. For

the grouped data, the overall MSA value falls in the acceptable range (above .50) with a

value of .703 for KMO and .000 for Bartlett’s test (less than .5), these measures indicate

that the set of variables are appropriate for factor analysis.

Table 5.19: KMO and Bartlett's Test for Grouped Data




Sig. .000

202

Factor Analysis has resulted in retaining seven factors for the grouped data which

represented 64.072% of the variance, of 21 variables deemed sufficient in terms of total

variance explained (solution should account for >60% variance). Table 5.20 summarises

the orthogonal solution resulting from VARIMAX rotation of the original twenty one

measures for the grouped data for the year 2008.

Table 5.20: Factor Analysis for Factors Affecting Dividend for Grouped Data for

the Year 2008



Cumulative Variance

Profitability Position 4.487 18.251 18.251 Net Profit Ratio .656 Return on Net worth .899 Return on Capital Employed .823 Net Profit to Net worth Ratio .909 Financial Soundness 2.465 11.515 29.765 Current Ratio .850 Debt-Equity Ratio .487 Cash Holding .791 Solvency Ratio .808 Dividend Rate and EPS 1.855 9.948 39.713 EPS Uncertainty .689 Dividend Per Share .694 Dividend per Share to Market Value

.790

Dividend per Share to Face Value .546 Dividend Payout .623 Investment Opportunity 1.428 6.758 46.471 Market Value to Book Value .557 Tobin’s Q .724 Liquidity 1.147 6.555 53.025 Free Cash Flow .558 Growth in Working Capital .321 Share Price Movement 1.057 5.645 58.670 Share Price Behavior .750 Growth in EPS .795 Company’s Age and Profitability 1.017 5.401 64.072 Age .511 Profit After Tax .733

203

The factor 1 variables “Return on Net worth”, “Return on Capital Employed”, “Net Profit

to Net worth” and “Profit after Tax” are interpreted under the construct “Profitability

Position”. Factor 2 was named as “Financial Soundness” and includes the variables “Net

profit Ratio”, “Current Ratio”, “Debt-Equity Ratio”, “Cash Holdings” and “Solvency

Ratio”. Factor 3 was named as “Dividend Rate and EPS” and includes variables “EPS

Uncertainty”, “Dividend per Share”, “Dividend to Market Value”, “Dividend to Face

Value” and “Dividend Payout”. Factor 5 was named as “Investment Opportunity” and

includes variables “Market Value to Book Value” and “Tobin’s Q”. Factor 5 was named

as “Liquidity” and includes the variables “Free Cash Flow” and “Growth Rate in

Working Capital”. Factor 6 was named as “Share Price Movement” and includes

variables “Share Price Behavior”. Factor 7 was named as “Company’s Age and

Profitability” and includes the variables “Age” and “Profit after Tax”.

5.3 MAIN FINDINGS

The results of the study presented above show that the determinants of dividend

identified in the literature apply equally to Indian industries under study. More

importantly, the results are an important first step in consolidating our understanding of

the factors affecting dividend decision of industries in India in general. The

“Profitability” factor is related to the extent of profits that accrue to the industry in order

to take a decision on declaration of dividend. Further, it also influences the opportunities

for future investments. The “Dividend Rate” factor is related to the dividend declared by

the companies. The determinants in this group include the dividend per share, dividend

payout, and relationship of dividend with market value and face value of shares. The

204

“Financial Soundness” factor is related with the creditworthiness of the industries which

is influenced by solvency position and cash position. Further “Liquidity” factors are also

one of the major factors affecting dividend in terms of free cash holdings and current

ratio. An important factor “Share Price Movement” also influences the dividend decision

in terms of the relationship of dividend with behavior of the share prices. Further,

“ Investment Opportunity” factor also has emerged as an important factor presenting the

trade-off between the dividend declaration and the future investment opportunities set.

The key implication of these findings is that the Indian industries decision of dividend is

influenced by these factors.

REFERENCES

1 Allen, F., Bernardo, A. and Welch, I., 2000, “A Theory Of Dividends Based On Tax

Clienteles”, Journal of Finance, Vol. 55, pp. 2499-2536

2 Lintner, J., 1956, “Distribution of Income of Corporation among Dividends Retained

Earning and Taxes”, American Economic Review, Vol. 46, pp. 97-133

3 Ramcharran, H., 2001, “An Empirical Model of Dividend Policy in Emerging

Equity Markets”, Emerging Markets Quarterly, Vol. 5, pp. 39-49

4 Easterbrook, F.H., 1984, “Two Agency-Cost Explanations of Dividends”, American

Economic Review, Vol. 74, Issue-4, pp. 650-659

5 Jensen, M., 1986, “Agency Costs of Free Cash Flow, Corporate Finance, and

Takeovers”, American Economic Review, Vol. 76, pp. 323-329

6 Crutchley, C. E. and Hansen, R., 1989, “A Test of Agency Theory of Managerial

Ownership, Corporate Leverage, and Corporate Dividends”, Financial Management,

Vol. 18, No. 4

7 Smith, C. W., and Watts, R., "The Investment Opportunity Set and Corporate

Financing, Dividend, and Compensation," Journal of Financial Economics, Vol. 32,

205

pp. 263-292

8 Jensen, G., Donald, R., Solberg, P., and Zorn, T. S., 1992, “Simultaneous

Determination of Insider Ownership, Debt and Dividend Policies”, Journal of

Financial and Quantitative Analysis, Vol. 27, Issue-2, pp. 247-263

9 Grullon, G., Michaely, R. and Bhaskaran S., 2002, “Are Dividend Changes a Sign of

Firm Maturity?” Journal of Business, Vol. 75, Issue-3, pp. 387-424

10 Brav, A., Graham, J., Harvey, C. and R. Michaely, 2005, “Payout Policy in the 21st

Century”, Journal of Financial Economics, Vol. 77, pp. 483-527

11 Rozeff, M.S., 1982, “Growth, Beta And Agency Costs As Determinants Of

Dividend Payout Ratios”, Journal of Financial Research, Vol. 5, Issue-3, pp. 249-

259

12 Easterbrook, F.H., 1984, op.cit.

13 Jensen, G., Donald R., Solberg, P., and Zorn, T. S., 1992, op.cit.

14 Easterbrook, F.H., 1984, op.cit.

15 Rozeff, M.S., 1982, op.cit.

16 Lintner, J., 1956, op.cit.

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