Determinants of Dividend Payout Ratio of Selected Bangladeshi Listed Companies

Sheikh Quaniz Fatema

Mohammad Abu Sayeed*

Tasnima Aziza*

Shahriar Kabir*

Abstract

The study applied Least Square Regression for balanced panel data to explore the

determinants of dividend payout ratios (DPR) of Bangladeshi listed firms in the food and

textile sectors. Data from 46 listed firms from these sectors are analyzed. It is observed

from previous studies on dividend policy that earning of firms, free cash flow, effective

tax rate, growth of firms and future growth opportunities are important determinants of

DPR. From regression results it has been found that only one determinant, effective tax

rate is a significant determinant of DPR for selected Bangladeshi companies. The result

is similar to a study on Indian market. Therefore, we can conclude that DPR in

developing countries is not determined by the factors that have implications on DPR on

firms of developed or emerging countries.

Key words: Dividend payout ratio, agency cost, free cash-flow, effective interest rate

*Assistant Professor, Institute of Business Administration, Jahangirnagar

University

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1.0 Introduction

Dividend is one of the most vital and contentious decisions for finance managers.

Deservedly, it is one of the prevalent topics of debate in the finance literature. A number

of studies have been conducted to reveal the puzzle of dividend policy resulting in a large

number of conflicting explanations of the factors that affect dividend decisions. However,

it is the developed economies which got the primary attention of those researches.

Whereas, Al-Kuwari (2009, p. 38) observes “dividend policy in emerging markets is

often different in its nature, characteristics, and efficiency, from that of developed

markets”. As a result, study on dividend policy in context of Bangladesh as a developing

economy has been aimed in this research to enrich the relevant field of literature. Purpose

of this study is to explore the impact of different factors of the dividend payout ratios in

Bangladesh. Two of the biggest industrial sectors, food and textile, have been chosen for

this study.

By dividend policy we mean the size and pattern of cash distribution to shareholders from

the earnings of the company for a given time period. The work of Miller and Modigliani

(1961) first brought the attention of academicians to dividend policy. They argued that

dividend decision is irrelevant as this decision does not affect the firm value in a perfect

capital market. A plethora of studies have focused dividend policy since then. Many of

them have concentrated on exploring determinants that affect dividend payout ratios

(DPR) of firms. Nonetheless, no consensus has been established yet among the

researchers on those determining factors of dividend decisions.

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2.0 Justification of the study

The dividend payout ratio (DPR) is one of the indicators of financial health of a firm.

Investors can judge the performance of the firm by looking at this information. It is also

used in asset valuation methods. Investors who need current income from their

investments look for firms that offer high DPR. The life cycle of a firm is reflected in the

dividend payout ratio which is an important component of dividend policy.

Thus, it is important to know the factors that affect the dividend payout ratio. Though a

number of factors has been discussed in literature but little has been known about the

DPR of Bangladeshi firms. Hence studying the determinants of DPR of Bangladeshi

firms commands justification. This research certainly enriches & broadens the knowledge

base on dividend payout ratio in context of Bangladesh by providing spotlight on food &

textile industry.

3.0 Literature review

As mentioned before, a number of studies has been conducted to explore different aspects

of dividend policy and its determinants. This section gives a brief review of those

research studies along with relevant definitions and ideas.

Dividend payout ratio is the percentage of earnings that is paid out as dividends (Allen

and Michaely, 1995). The dividend yield is one of the two components of the return on

investment for a stock, whereas, the other component is capital gain1.

1 Capital gain is the return on investment derived from the price increase of assets.

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Though Miller and Modigliani (1961) illustrated dividends as irrelevant in the

determination firm’s share price, financial researchers and practitioners have disagreed

with Miller and Modigliani’s proposition. They argued that Miller and Modigliani (1961)

based their proposition on the assumption of perfect capital market, which in reality does

not exist. A number of studies has shown the rationale behind the existence of dividends.

These studies showed dividends as a mechanism to reduce information asymmetry about

company earnings between insiders and outsiders (Agarwal and Jayaraman, 1994). Some

other studies such as Jensen and Meckling, (1976) and Easterbrook (1984) demonstrated

that dividends can be used to reduce agency cost between outside shareholders and

managers. Since dividends or dividend policy has different implications researchers have

been studying the determinants of dividend payout ratio resulting in various theories and

propositions.

One of the determinants of dividend payout ratio is the profitability of firms. As observed

by Anil & Kapoor (2008, p. 65) “profits have long been regarded as the primary indicator

of the firm’s capacity to pay dividends”. Linter (1956) conducted a classic study on

determinants of dividend decisions based on survey of 28 well established industrial U.S.

firms. His findings show that the dividend payout ratio changes for a change in the

current year earnings and previous year dividends of a firm. Aivazian and Booth (2003)

explained DPR as a function of firm profitability. Anil and Kapoor (2008) and Kumar

(2006) also argued that firms with higher earnings should be able to pay high dividends

and their findings in the context of Indian market have conformed to their argument. In

another study on Gulf Cooperation Council (GCC) countries Al-Kuwari (2009) showed

similar findings.

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Free cash flow of firms is another determinant of DPR and has long been examined in the

literature. The basic argument here is derived from the model that dividends are used to

reduce agency cost. If free cash flows are available in a firm after meeting all operational

and investment needs, managers may be tempted to use that cash flow for betterment of

themselves than that of shareholders. Using these free cash flows in paying dividends

can be a mechanism to reduce this kind of agency cost. Thus the more free cash flow a

firm has the more dividends are likely to be paid to the shareholders (Gul, 1999, Porta et

al. 2000, Brav et al. 2005). Barclay et al. (1995) tested free cash flows as a determinant of

DPR and found a significant and positive relationship between these two variables.

Kumar (2006) and Al –Kuwari (2009) showed similar impact of free cash flows on DPR.

An alternative method of reducing agency cost of free cash flows is to repurchase a

firm’s shares from the existing shareholders. Burnheim (1991) observed that dividends

and repurchases have identical impacts on shareholders. Thus firms can choose to

repurchase their shares with the free cash flow rather than to pay dividends. However,

Allen and Michaely (1995) argued that because of the rise of repurchases of firms, payout

of dividends is increasing along with firms’ financial flexibility.

Another way to control agency cost as suggested by Agarwal and Jayaraman (1994) is to

increase the managerial holding of ownership in a firm. Firms with greater managerial

holding should face less agency problem and thus the requirement of paying dividends to

reduce agency cost will be decreased. An opposite view is that managers and directors

will be tempted to pay high dividends when they have a relatively high stock ownership

in the firm. On the other hand, managers with high holdings of stock options will be

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inclined to decrease dividends as low dividend payout ratio will more likely to increase

the value of stock options (Brown et al. 2007). A similar model proposed by Chang

(2003) also suggests that managers will be willing to pay higher dividends if their

compensation can be linked with it.

A set of dividend studies has examined the use of dividends as a signal of firm’s financial

strength. Bhattacharya (1979) argues that managers use high DPR as a signal of expected

cash flows. Following dividend signaling model Barclay et al. (1995) suggested that

managers who think that their firm is undervalued will pay higher dividends and

managers who feel that their firm is overvalued will do the opposite. Nonetheless, Brav

(2005) in a survey of 384 managers showed only a moderate support for signaling model

of dividends.

The association between firms’ growth opportunities and DPR is well documented in the

literature. But there is a disagreement on the direction of association among different

authors. The signaling model suggests that firms with high quality or growth opportunity

may increase dividends to show their high quality to the market (Easterbrook, 1984 and

Bhattacharya, 1979). On the contrary, higher dividends reduce free cash flows of firm

thus reducing scopes of investment which is essential for future growth. For this reason,

companies with high growth opportunities will use their cash flows in funding positive

net present value (NPV) projects rather than in paying dividends. The empirical studies

support the latter view of negative relationship between growth opportunities and DPR

(Gul, 1999, Kumar, 2006, Barclay et al. (1995).

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Tax consideration is another issue that may have impact on dividend policy of firms.

Barclay et al. (1995) suggested that taxes paid by individuals should have a negative

impact on DPR. Investors who receive dividends are subject to pay tax on the same year.

By contrast, investors do not pay any tax on undistributed profits, which increase the

share price, until the share is sold at a profit. Anil and Kapoor (2008) argued that

corporate tax rate is also a determinant of DPR. This association should be negative with

the view that firms with higher effective tax rate will reduce free cash flows of the firm

which, in turn, will reduce dividends. On the contrary, companies with high tax rate will

have less incentive to retain current earning in order to increase profitability in future. In

that case, managers will make higher dividend payouts.

The other notable determinants of dividends examined in the literature are leverage,

ownership and corporate governance. Gugler (2003) showed that dividend policy varies

across different ownership of firms. State owned firms try to smooth out dividends while

family owned firms tend to pay low dividends. Grinstein & Michaely (2005) argued that

firms with high institutional holdings should be well-monitored and managed resulting in

payment of higher dividends. John & Knyazeva (2006) argued that DPR decreases as

corporate governance quality increases as good corporate government practices mitigate

agency cost. Leverage is another way to decrease agency cost of free cash flows by

requiring higher cash flows to repay debt payments. Consequently, highly levered firms

can afford paying lower dividends (Aivazian and Booth, 2003).

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4.0 The food and Textile sector of Bangladesh

In terms of number of companies listed in the Dhaka stock Exchange textile and Food

industries are the biggest two non-banking sectors. Textile which includes knitwear,

ready-made garments and specialized textile products accounts for around 80% of

Bangladesh’s total merchandise export in 2009. Bangladesh was the 3 rd largest textile

exporter in 2009 behind Turkey and China.

After the slump of jute and tea export, the garments industry became the main export

sector in Bangladesh after 1980s. The industry now provides employment to nearly 3.5

million workers, almost double to the number in 2004. Low wage rate is the driving force

behind the high the growth rate of this sector in Bangladesh.

Food industry also experienced a rapid growth in last few years in Bangladesh. The

biggest conglomerates are investing in this sector along with small and medium

enterprises. The fast growing urban population, increasing participation of women in the

workforce are contributing to the rise of this sector. At present the number of food

companies listed in Dhaka Stock Exchange (DSE) is 35. This is the second largest non-

financial sector in DSE.

5.0 Research methodology

This section gives a detailed idea on how the research has been conducted starting from

data collection procedure to data analysis.

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5.1 Sample and Data

In this research, all information is taken from Dhaka Stock Exchange (DSE). Data are

collected from the annual reports of different companies. Only listed companies of DSE

have been selected since these companies generally publish annual reports containing the

financial reports. Only non-financial sectors are selected as banks and other financial

institutions have specific regulatory requirements that are not applicable for other sectors.

Among the other sectors textile and food sectors have been chosen hence these are

biggest two non-financial sectors in DSE. Since industry characteristic is one of the

independent variables to test, it is essential to choose industries which have sufficient

number of companies to get a meaningful result. Only few companies from other sectors

are listed in DSE at present. 40 textile companies and 35 food companies are listed in

DSE at present. To increase number of observations and to avail the advantages of panel

data regression 6 years data ranging from 2000 to 2005 has been used in this study. Based

on availability of annual reports from DSE 46 companies (23 from each sector) are

included in the sample here. As DSE has stopped reserving soft copies of annual reports

for the use of researchers it was not possible to extend the research period beyond 2005.

Total number of observations here is (46X6) 276.

All data used in the research are manually excerpted from the relevant audited financial

reports of the respective companies (collected from DSE) by the researchers. To derive

the indicators, the researcher did necessary calculation using formulas shown in the

subsection “Variable and model used in the Study” and also performed different

statistical tests and analysis using MS Excel 2003, SPSS 12 & Eviews 6.

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5.3 Variable and model used in the Study

The statistical techniques of Least Square Regression with fixed effect model for panel

data were used to explore the relationship between these variables. For the analysis of

panel data for six years i.e. 2000 to 2005 correlation matrix was also constructed. A

multiple regression equation has been modeled identifying the key determinants of

dividend payout ratio (DPR). For obvious reason, the dividend payout (Y) was used as

dependent variable and other variables, (X1, X2, X3, X4, and X5) were used as independent

variables. On this basis under-mentioned multiple linear regression equation was

developed.

Y= a+b1X1+b2X2+b3X3+b4X4+b5X5+b6X6+e

Where, a is the regression constant and b1, b2, b3, b4, b5 and b6 are regression coefficients

respectively.

Y= dividend payout ratio

X1=earnings before interest and taxes /total assets = profitability of the firm

X2= cash from operations (Tk. crore) = proxy for free cash flow

X3=corporate tax /profit before tax = effective corporate tax rate

X4=annual sales growth = growth of the company

X5= Market to book value ratio = growth opportunities

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X6 = Industry difference

e = the error term

Panel data analysis has become a popular data analysis technique in longitudinal studies.

A balanced panel data comprising of same time span of all cross sections has been

analyzed here. There are mainly two types of panel data analytic models which are

random & fixed model. Based on the study nature researcher used fixed panel option as

the companies are likely to have unique characteristics that have fixed effect on the

dividend payout policy.

6.0 Findings of the study

The results of the regression analysis are presented in this section with necessary

explanations.

6.1 Correlation Analysis

Correlation Analysis measures the closeness of the linear relationship between two or

more variables. Strong correlation between independent variables may bias the regression

results. It is thus essential to check correlations among the independent variable before

using in the regression equation. The study result of correlation is given below:

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Table 1: Correlation matrix between variables used in the model. A strong

correlation indicates the existence of multi-collinearity problem in the model.

X1 X2 X3 X4 X5 X6

X1

Pearson

Correlation1 .136(*) .027 .083 .073 -.061

X2

Pearson

Correlation.136(*) 1 .004 .027 .050 .021

X3

Pearson

Correlation.027 .004 1 -.004 .049 -.062

X4

Pearson

Correlation.083 .027 -.004 1 -.003 -.019

X5

Pearson

Correlation.073 .050 .049 -.003 1 -.128

The correlation matrix highlighted that none of correlation is very strong considering that

correlation can vary with in a range of +1 to -1. Therefore we can conclude that

multicollinearity problem is nonexistent in the dataset and all the independent variable

can be used in the regression.

6.2 Regression Analysis

The regression results are shown in Table 2.

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Table 2: Regression Coefficients and their Significance. Dependent variable is dividend

payout ratio. Number of observation is 276.

Coefficient t-Statistic Prob.

a 12.08150 13.58291 0.0000***

X1 -0.318564 -0.156076 0.8761

X2 1.45E-10 0.344319 0.7309

X3 0.092519 8.989314 0.0000***

X4 -0.004627 -1.638806 0.1027

X5 0.010476 1.378185 0.1695

X6 0.733004 0.421671 0.6737

R-squared 0.321741

Adjusted R-squared 0.164508

S.E. of regression 71.44613

F-statistic 2.046272

Prob(F-statistic) 0.000209

Durbin-Watson stat 1.736228

*** Significant at the 0.01 level

As per table 2, only X3 (corporate tax/profit before tax) & a (constant) are significant

with dividend payout ratio (DPR). That means X3 (corporate tax /profit before tax) is the

most important factor for the DPR among the entire factors examined in the study. The

significance of ‘a’ indicates that other factors of dividend payout ratio which are not

considered here may have more significance than the given factors. This clearly indicates

that the variables which are selected as determinant of DPR are not important factors that

influence the dividend payment behavior of firms included in food & textile sector.

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On the other hand, the results shown in table 2 do not match with the theoretical

explanations of the relationship with DPR. Here, X1 & X4 have negative relationship with

DPR. Others are shown to have positive relationship with DPR. According to the theory,

X3 should be negative & X1 should be positive relation with DPR. But in this calculation

the relation is inversed with these two variables. That means the theoretical aspect does

not properly match with Bangladeshi market or does not appropriate for Bangladeshi

industry perspective.

In case of Indian IT sector, the result of the study (Anil and Kapoor, 2008) also does not

match with the theoretical aspect of dividend payout ratio. In Indian IT sector, X3 has also

the positive relationship with DPR.

That indicates the results of such study may provide the similar outcome for most of the

developing countries.

The strength of association in multiple regression is measured by the adjusted R- squared,

which is also called the coefficient of multiple regression. It varies between 0 & 1 and

signifies the proportion of the total variation in Y that is accounted for by the variation in

X. (Malhotra , 2008, p. 553)

In this study, Adjusted R- squared is 0.164508. The value indicates that the independent

variables could explain only 16% of the variability of dividend payment pattern of

Bangladeshi listed companies included in food and textile sectors.. The F value of the

study is 2.046272 which is significant at 5 % level of significance suggesting overall

applicability of the existing model.

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The Durbin- Watson statistics estimated the auto- correlation of the model. The value is

1.736228 which is close to the value of 2 thus does not indicate existence of auto

correlation in the error term.

Anil and Kapoor (2008) showed an adjusted R- squared of 23.6% which is little over

than the current study. That indicates again applicability of the model in the context of

developing economies with strong political and social instability.

7.0 Conclusion

Dividend payout ratio is an important financial tool used for explore organization’s

dividend pattern & other important decisions. It is a crucial element of dividend policy.

There are many theories & studies are available if this topic. Almost every study

background was developed country. Such research is not available publicly in

Bangladesh yet. So this research has tried to identify the determinants which are

influence on DPR based on financial theories & prove the relation mathematically.

This study examines the determinants of dividend payout ratios of food and textile

companies of Bangladesh. It can be concluded that existing variables as per available

literature do not explain the dividend payment pattern of companies included in these

sectors (textile & food industry). Only X3 (corporate tax /profit before tax) is found to be

a significant determinant. Food & textile industries are two of the largest sectors of

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Bangladesh. Bangladesh market is a rising market which is not properly structured yet.

So the factors of dividend payout ratio are not acting as per theory. So the result is not

properly fitted as per expectation.

Since the existing variables explain only 16.45% of Bangladeshi textile and food

industries dividend behavior future research can be focused on discovering variables that

explain the behavior more properly. Survey based research such as shareholder/ executive

opinion based study may provide better insight of the determinants of DPR. Examining

the influence of price earning ratio, debt equity ratio on dividend payout policy would be

interesting exercises.

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