THE EFFECT OF SCRIP DIVIDEND ON THE RETURNS OF SECURITIES
LISTED AT THE NAIROBI SECURITIES EXCHANGE
ADOW ABDI IBRAHIM
D61/60842/2011
A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFULMENT OF THE
REQUIREMENTS FOR THE AWARD OF MASTER IN BUSINESS
ADMINISTRATION, UNIVERSITY OF NAIROBI
OCTOBER, 2013
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DECLARATION
This research project is my original work and has not been presented for a degree or any
other examination to any other university.
Signature ……………………… Date………………………………………..
Adow Abdi Ibrahim. D61/60842/2011
This research project has been submitted for examination with my approval as the University
Supervisor,
Signature………………………………………. Date…………………………………
Mr. Herick Ondigo,
Lecturer, Department of Finance and Accounting
School of Business, University of Nairobi
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DEDICATION
I would like to dedicate my research project to my family for their love and support during
this study.
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ACKNOWLDGEMENT
I want to thank almighty Allah (SWT) most gracious, most merciful for enabling me to
complete my studies successfully. My sincere appreciation goes to my parent who stood
beside me all through my studies.
Many thanks go to my supervisor Mr. Herick Ondigo for giving me the required guidelines
all the way till I was through. My fellow classmates especially Gideon Kipchumba and
Keziah Njuguna who assisted me in various ways cannot be forgotten since their contribution
had a positive impact.
I can‘t also forget the entire management of University of Nairobi for their cooperation
towards providing library facilities where I accessed much information concerning this
research study.
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ABSTRACT
Dividends are payments made by a company to its shareholders. Dividend policies are
influenced by many factors. Scrip dividends are relevant because they have informational
value. Financial signaling theory implies that dividends may be used to convey information.
Information, rather than dividends itself, affects returns of securities. Stock dividends
supplement, rather than take place of cash dividends. Some scholars argue that Scrip
dividend is irrelevant whereas others view it otherwise. There are also those that argued that
the effect of a change in dividends has on the price of a firm‘s stock is related primarily to
information about expected future earnings conveyed by a change in dividends. Thus, the
study sets to determine whether there exists a causal relationship between scrip dividend and
the returns of securities of a firm. An event study research design was used in the study. The
research depended on secondary data from companies‘ published financial statements. This
research was based on all the 60 companies that are listed at the NSE, as at 31st December
2012. The firms were selected consisting of all the firms quoted consistently at N.S.E for a
period of 10 years from 2003 – 2012. Dividend data on was extracted from published reports
of quoted companies. This information was obtained at the N.S.E library and from the
company libraries. Data on the market returns of securities was obtained from the returns of
securities as reported by N.S.E. Event study was used in data analysis. From the findings
the study concludes that the Kenyan market reacts positively to scrip dividend issue
announcements. There was an increase in volumes of shares traded after scrip dividend issue
as compared to those before the scrip dividend issue. The study also concludes that managers
of the companies sought issues scrip dividend to encourage investors to purchase their stock
which appeared cheaper. This study showed that there were positive mean returns with
respect to scrip dividend, this was in agreement with the signaling hypothesis which stated
that managers of companies‘ issues scrip dividend to act as a means of passing information to
stock holders and potential investors.
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TABLE OF CONTENT
DECLARATION..................................................................................................................... ii
DEDICATION........................................................................................................................ iii
ACKNOWLDGEMENT ....................................................................................................... iv
ABSTRACT ............................................................................................................................. v
TABLE OF CONTENT ......................................................................................................... vi
LIST OF TABLES ................................................................................................................. ix
LIST OF FIGURES ................................................................................................................ x
LIST OF ABBREVIATIONS ............................................................................................... xi
CHAPTER ONE: .................................................................................................................... 1
INTRODUCTION................................................................................................................... 1
1.1 Background of the Study ................................................................................................ 1
1.1.1 Scrip Dividend ......................................................................................................... 2
1.1.2 Returns of Securities ................................................................................................ 5
1.1.3 Effects of Scrip Dividends on Returns of Securities ............................................... 6
1.1.4 The Nairobi Securities Exchange ............................................................................. 8
1.2 Research Problem ........................................................................................................... 9
1.3 Objective of the Study .................................................................................................. 11
1.4 Value of the Study ........................................................................................................ 11
CHAPTER TWO .................................................................................................................. 13
LITERATURE REVIEW .................................................................................................... 13
2.1 Introduction ................................................................................................................... 13
2.2 Theoretical Review ....................................................................................................... 13
2.2.1 Dividend Irrelevance Proposition: Modigliani & Miller Approach (1961) ........... 13
2.2.2 Dividend Policy and Asymmetric Information ...................................................... 14
2. 3 Types of Dividends ...................................................................................................... 15
2. 3.1 Cash Dividend ....................................................................................................... 16
2.3.2 Stock Dividend....................................................................................................... 16
2.3.3 Property Dividend .................................................................................................. 16
2.3.4 Scrip Dividend ....................................................................................................... 17
2.3.5 Liquidating Dividend ............................................................................................. 17
2.4 Managerial Considerations in Determining a Scrip Dividend ...................................... 17
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2.4.1 Fund Needs of the Firm ......................................................................................... 17
2.4.2 Liquidity ................................................................................................................. 18
2.4.3 Ability to Borrow ................................................................................................... 18
2.4.4 Assessment of Any Valuation Information............................................................ 19
2.4.5 Control ................................................................................................................... 19
2.4.6 Nature of Stockholders .......................................................................................... 20
2.4.7 Restrictions in Bond Indenture or Loan agreement ............................................... 20
2.4.8 Inflation .................................................................................................................. 20
2.5 Empirical Studies .......................................................................................................... 21
2.6 Summary of Literature Review ..................................................................................... 30
CHAPTER THREE: ............................................................................................................. 31
RESEARCH METHODOLOGY ........................................................................................ 31
3.1 Introduction ................................................................................................................... 31
3.2 Research Design............................................................................................................ 31
3.3 Population ..................................................................................................................... 31
3.4 Sample........................................................................................................................... 31
3.5 Data Collection ............................................................................................................. 32
3.6 Data Analysis ................................................................................................................ 32
CHAPTER FOUR: ............................................................................................................... 34
DATA ANALYSIS AND INTERPRETATION ................................................................. 34
4.1 Introduction ................................................................................................................... 34
4.2 Findings......................................................................................................................... 34
4.2.1 Abnormality of Returns Following Scrip Dividend Announcement ..................... 34
4.2.2 Security Returns Variability (SRV) ....................................................................... 35
4.3 Interpretation of Findings ............................................................................................. 39
CHAPTER FIVE: ................................................................................................................. 41
SUMMARY, CONCLUSION AND RECOMMENDATIONS ........................................ 41
5.1 Introduction ................................................................................................................... 41
5.2 Summary ....................................................................................................................... 41
5.3 Conclusion .................................................................................................................... 43
5.4 Recommendation for policy .......................................................................................... 43
5.5 Limitation of the study .................................................................................................. 44
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5.6 Suggestion for Further Research ................................................................................... 44
REFERENCES ...................................................................................................................... 45
APPENDICES ....................................................................................................................... 50
Appendix I: Companies Listed at Nairobi Securities Exchange as at 31st Dec, 2012. ....... 50
Appendix II: Average Abnormal Returns (AAR) ............................................................... 53
Appendix IV: Summary of Data ......................................................................................... 57
Appendix V: Data Collection Sheet .................................................................................... 58
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LIST OF TABLES
Table 4.1: Average Value of ASRV for dividend issue scrip dividend issue Announcement 36
Table 4.2: CAR Across the Event Windows .......................................................................... 36
Table 4.3: One-Sample Statistics ............................................................................................ 38
Table 4.4: Average Value of ASRV for scrip dividend issues ............................................... 39
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LIST OF FIGURES
Figure 4.1: Average CAAR for all the companies .................................................................. 37
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LIST OF ABBREVIATIONS
AR - Abnormal Returns
CAPM – Capital Asset Pricing Model
CAR - Cumulative Abnormal Returns
C.F.O - Chief Finance Officer
CRSP – Center for Research in Security Prices
E.A.B.L- East African Breweries Limited
M&M - Miller & Modigliani
NSE - Nairobi Securities Exchange
NYSE - New York Stock Exchange
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CHAPTER ONE:
INTRODUCTION
1.1 Background of the Study
Dividends are payments made by a company to its shareholders. When a company earns a
profit, that money can be put to two uses. Either the funds could be held by the firm for
reinvestment or distributed to members as dividends. Bitok et al (2010) defined; dividends
refer to the distribution of earnings. The common ways of distributing part of firms‘ value to
its owners include payment of cash dividends, repurchasing of stock and payment of stock
dividends. Quoted companies usually pay dividends on a fixed schedule, commonly
annually, bi-annually or quarterly, however they may declare a dividend any time. Cash
dividend is used more often while repurchasing of stocks is not possible in all countries.
Stock dividends do not have real values and when paid after cash dividends they are
perceived to convey positive information about future cash flows. Dividend policies are
influenced by many factors. The legal rules provide that dividends be paid from earnings.
Contractual constraints could restrict payment of dividends.
Other factors considered include cash needed to repay debt, stability of earnings and growth
prospects. Market considerations with respect to access to capital markets are also important.
John Lintner (1956) observes that corporate managers are averse to changing the dollar
amount of dividends in response to changes in earnings, particularly when earnings decline.
Three of the more commonly used dividends policies are constant payout ratio, regular
dividend policy, and low-regular and extra dividend policy. The dividend policy of the firm
is irrelevant in a perfect capital market because the shareholders can effectively undo the
firm‘s dividend strategy. If a shareholder received a greater dividend than desired, he or she
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can reinvest the excess funds. Conversely, if the shareholder received a smaller dividend than
desired, he or she can sell off extra shares of stock, Miller and Modigliani‘s (1958,
1961).While increased dividends generally increase common stock value, sometimes this is
not always the case. If a company‘s overall performance is questionable, then raising
dividends may not encourage investors (Gitman, 2008).
Therefore, dividends are per-share payments designed by company‘s board of directors to be
distributed among shareholders. For preferred shares, it is generally a fixed amount. For
ordinary shares, the dividend varies with the earnings of the company and the amount of cash
on hand. It may be omitted if the business is poor or the directors withhold earnings to invest
in plant and equipment.
The factors that determine dividend paying capacity are; capital needs, expansion plans, debt
repayment, operation cushion, contractual requirements, past dividend paying history of a
business and dividends of a comparable company should be investigated. After analyzing
these factors, percentage of the net income of average cash flow that can be used for the
payment of dividend can be estimated. What also must be determined is the dividend yield,
which can best be determined by analyzing comparable companies. Brealeys and Myers
(2002) list dividends as one of the ten important unresolved problems in finance reinforcing
the conclusion that much more empirical and theoretical research on the subject of dividend
is required before a conclusion is reached.
1.1.1 Scrip Dividend
Scrip Dividend refers to new shares, which a shareholder elects to receive in lieu of cash
dividend where the shareholder is given the right to make such an election. (Nairobi
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Securities exchange; Listing Manual, 2009). Stock dividends/ Bonus issue involves
capitalization of retained earnings and does not increase the wealth of shareholders. This is
because retained earnings are converted to shares (Pandey, 1991). Scrip Dividend is treated
as a normal dividend followed by the purchase of shares equal to the dividend amount.
Companies can decide whether or not they want to pay dividends, how much to pay, and
when to pay them. Shareholders have absolutely no say in the payment of dividends.
However, companies are not prone to changing their dividend policies very often, since
cutting out dividends or decreasing the amount of a dividend, particularly cash dividends, is
generally a sign that the company is in trouble. Boards of directors will only increase
dividends if they are absolutely certain that the company is doing well enough that it can
handle the increase. Typically, companies pay dividends in two ways (though there are
others, such as property). The most popular and common way to pay dividends to
shareholders is with cash. This money comes from either current earnings, from accumulated
profits, or from the earnings made by reinvesting money into the company. Cash dividends
are taxable and count as investment interest/income. The issuance of scrip dividends will
make the price of the stocks fall. They probably won't fall very much, but the price will fall
on the ex-dividend date, or the day four days before the record date. So if you know that a
company is going to pay its dividends in stock, and you want to buy stock at a lower price,
then you will probably want to buy just before or on the ex-dividend date. However, the drop
will be low enough that it will probably be equaled out by transaction costs and taxes.
Scrip dividends are relevant because they have informational value. Financial signaling
theory implies that dividends may be used to convey information. Information, rather than
dividends itself, affects returns of securities (Brigham and Gapenski, 2004).
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Stock dividends supplement, rather than take place of cash dividends. As long as the cash
dividend per share remains unchanged, the effect of stock dividends is to raise the cash
dividend (when adjusted back to the old shares) in the ratio of stock dividends to shares
outstanding. The device of the stock dividends thus adds appreciably to the continuity of
changes to annual cash dividends. The stock dividend will capitalize a portion of these
undistributed earnings, which the board of directors considers should be retained in the
business. At the same time, the stock dividend will provide common stockholders with
tangible evidence of this investment by issuing additional shares to them and by placing this
investment on a dividend-paying basis. It should be stressed that, apart from the effect upon
cash dividends, a policy of stock dividends has inherent value of in its own right. Since
neither the anticipated earnings- risk profile nor the allocation thereof to existing
shareholders is affected; the value of each stockholder‘s holdings is presumably unaffected.
Associated with increase in shares, therefore is a proportional decrease in value per share
(Ross, Westerfield, Jaffe, 1993).
The payment of dividends conveys to shareholders that the company is profitable and
financially strong. This in turn causes an upsurge in demand for the firm‘s shares causing a
rise in their market prices. When a firm changes its dividends policy, investors assume that it
is in response to an expected change in the firm‘s profitability which will last long. An
increase in payout ratio signals to shareholders a permanent or long term increase in firm‘s
expected earnings. Accordingly, the prices of shares are affected by changes in dividends
policy. This, therefore call for studies to be conducted in the area of scrip dividend and how
this policy affects market prices of shares.
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1.1.2 Returns of Securities
Returns are gains or losses of securities in a particular period. The return consists of the
income and the capital gains relative on an investment. It is usually quoted as a percentage.
In standard asset pricing theory, expected returns on securities are related cross-sectionally to
returns' sensitivities to state variables with pervasive effects on investors' overall welfare.
Security whose lowest returns tend to accompany unfavorable shifts in that welfare must
offer additional compensation to investors for holding the security. Liquidity appears to be a
good candidate for a priced state variable. It is often viewed as an important feature of the
investment environment and macro-economy, and recent studies and that fluctuation in
various measures of liquidity are correlated across assets. This empirical study investigates
whether market-wide liquidity is indeed priced. That is, we ask whether cross-sectional
differences in expected returns on securities are related to the sensitivities of returns to
fluctuations in aggregate liquidity (Gibbons).
It seems reasonable that many investors might require higher expected returns on assets
whose returns have higher sensitivities to aggregate liquidity. Consider, for example, any
investor who employs some form of leverage and faces a margin or solvency constraint, in
that if his overall wealth drops sufficiently he must liquidate some assets to raise cash. If he
holds assets with higher sensitivities to liquidity, then such liquidations are more likely to
occur when liquidity is low, since drops in his overall wealth are then more likely to
accompany drops in liquidity. Liquidation is costlier when liquidity is lower, and those
greater costs are especially unwelcome to an investor whose wealth has already dropped and
who thus has higher marginal utility of wealth. Unless the investor expects higher returns
from holding these assets, he would prefer assets less likely to require liquidation when
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liquidity is low, even if the latter assets are just as likely to require liquidation on average
(Grinblatt,)
1.1.3 Effects of Scrip Dividends on Returns of Securities
It is clear enough that in a perfect capital market in which external financing is freely
available, rational investors would be indifferent between components of their returns: Scrip
dividends and Capital gains. However, it is equally clear that in an imperfect market the firm
should consider the possible impact of the differential tax brackets of its shareholders,
dilution of control, floatation and transaction costs the stability of earning etc, when reaching
its scrip dividend decision. Under these circumstances, it is not clear if scrip dividends
would be preferred to capital gains or vice versa (Levy and Sarnat, 2000).
A regularly paid scrip dividend well covered over the long run by the earnings of a company,
will tend to boost the value of the common stock in the market compared with the common
stock of a similar company with similar earnings that pays only occasional scrip dividends or
no scrip dividends are declared even though company earnings have not risen in proportion
or not at all. Even though earnings are the prime economic force behind the value of a share
of equity, the actual distribution equity, the actual distribution of such earnings has been
looked upon by many analysts as an almost separate contribution to value. Other analysts
and scholars have argued that increased scrip dividends are interpreted by the market as an
announcement of a permanent or expected increase in earnings. The apparent collective
market judgment about the desirability of scrip dividends does not take into account the
opportunities for profitable reinvestment of such funds within the company, in the so-called
―growth companies‖ (Helfert, 1966).
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Ross (2007) argued that in an inefficient market, management can use scrip dividend policy
to signal important information to the market, which is only known to them. For example, if
management pays high scrip dividends, it signals high expected profits in future to maintain
the high scrip dividend level. This would increase the share price/value of the firm and vice-
versa. MM (1961) attached this proposition and suggests that the change in share/value
following the change in scrip dividend amount is due to informational content of scrip
dividend policy rather than scrip dividend policy itself. Therefore, scrip dividends are
irrelevant if information can be given to the market to all players. Scrip dividend decisions
are therefore relevant in an inefficient market and the higher the scrip dividends, the higher
the value of the firm as indicated by its returns of securities. The theory is based on the
assumptions that: the sending of signals by management should be cost effective, the signal
should be correlated observable events no company can imitate its competitors in sending the
signals. Managers can only send true signals even if they are bad signals. Sending untrue
signals is financially disastrous to the survival of the firm (Pandey, 2001).
Offer and Siegel (1997) examined the relationship between scrip dividend changes and
subsequent earnings by considering the properties of analysts‘ forecasts errors before and
after the announcements of a scrip dividend change. They found that the security analysts
revise their price forecasts following unexpected scrip dividend changes and that the greater
the unexpected scrip dividend change, the greater is the forecast revision. Also Carroll (2005)
examines the same relation but for quarterly announcements and provide evidence that
analysts revise their quarterly share price forecasts subsequent to scrip dividend changes.
Carroll also provides evidence that earnings increases are more likely to follow scrip
dividend increases than flat or scrip dividend decreases.
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Benartzi, Michaely, and Thaler (2007) implemented two types of analyses (discrete
categorization analysis and linear regression analysis) to test whether or not scrip dividend
changes convey any information about subsequent earnings changes. They found that, at
best, scrip dividend changes are not related, and, at worst, are negatively related to future
changes in earnings. Furthermore, they found no relation between future earnings and the
size of scrip dividend increases in prior years, although they did find some evidence that
scrip dividend increases signal that recent earnings jumps are permanent. However, because
many scrip dividend – signaling models predict a relation between profits and lagged scrip
dividends, Benartzi, Michaely, and Thaler‘s results seriously challenge signaling as an
important component of scrip dividend policy.
1.1.4 The Nairobi Securities Exchange
A stock market is a place where securities are traded. These securities are issued by listed
companies and by the government, with the aim of raising funds for different purposes such
as to fund expansion for the former, and development and finance budget deficits for the
latter. Common securities traded on a stock exchange include company shares, corporate
bonds, and government debt in the form of treasury bonds. (The NSE Hand book 2011)
The Nairobi Securities Exchange which was formed in 1954 as a voluntary organization of
stock brokers is now one of the most active capital markets in Africa. Nairobi. As a capital
market institution, the Securities Exchange plays an important role in the process of
economic development. It helps mobilize domestic savings thereby bringing about the
reallocation of financial resources from dormant to active agents. Long-term investments are
made liquid, as the transfer of securities between shareholders is facilitated. The Exchange
has also enabled companies to engage local participation in their equity, thereby giving
9
Kenyans a chance to own shares. (www.nse.co.ke). Companies can also raise extra finance
essential for expansion and development. To raise funds, a new issuer publishes a prospectus
which gives all pertinent particulars about the operations and future prospects and states the
price of the issue. A stock market also enhances the inflow of international capital. They can
also be useful tools for privatization programmes. Here are some of the companies that have
issued scrip dividends at the NSE: Access Kenya, Bamburi, Barclays, C.F.C, Car and
General, Carbacid, Centum, City Trust, CMC Holdings, Cooperative Bank, Crown Burger,
Diamond Bank, Dunlop, East African Cables, E.A.B.L among others.
1.2 Research Problem
Dividend Irrelevance Proposition according to Modigliani and Miller (1961) show that under
certain simplifying assumptions, a firms‘ dividend policy does not affect its value. The
researcher will want to find out whether those conditions apply in the Nairobi Securities
Exchange by conducting a study on the same area. Scrip Dividends are new shares which a
shareholder elects to receive in lieu of cash dividend where the shareholder is given the right
to make such an election. It is normally assumed that these dividends should have an effect
on the returns of securities.
Companies use these dividends to convey information about the company but in return affect
the returns of the securities. In the last 20 years, companies listed on the Nairobi Securities
Exchange have been using Scrip dividend as a mode of paying dividends. This growing trend
may be attributed to the liquidity problems, political stability, economic growth in the
country, higher investors‘ awareness because of the advent of information technology and the
appealing phenomenon amongst the investors.
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Edwin and Martin (1982) utilized the monthly data on dividends, prices and returns for New
York Stock Exchange securities available on the University of Chicago's CRSP tape. Elton
and Gruber (1970) conducted a study about the relationship between dividends and returns.
They found out that dividends have been postulated as affecting stock returns because of tax
effects.
Aharony and Swary (1980) also conducted a study on how dividends and returns relate and
found out that agency costs affect dividend and returns. Black (1976) argues that firms
should distribute little or no cash to stockholders once payout taxes are introduced to an
otherwise frictionless model, a prediction strongly contradicted by the substantial taxable
distributions actually made by firms. Black‘s ‗‗dividend puzzle‘‘ relies on his interpretation
of MM (1961) as showing that low payouts are optimal, albeit not uniquely so, absent taxes.
Thus, he reasons, zero or near-zero payouts should be strictly preferable once payouts are
taxed.
Gichema (2007) conducted a study on the effects of bonus shares on the market share prices
on all the companies quoted at Nairobi Stock Exchange. The study found out that there are
abnormal returns surrounding the bonus issues announcement had a positive direction and
magnitude of the stock price adjustment on announcement of bonus issue. Muasya (2010)
also conducted a study on all the companies quoted at Nairobi Stock Exchange and looked at
the impact of bonus issues on stock liquidity. He looked at the relationship between bonus
issue and the stock liquidity of firms quoted at the Nairobi Stock Exchange for the period
between 2003 and 2009. Kennedy (2010) did a study about investigation of the information
content of bonus share announcements for companies quoted at the Nairobi Securities
Exchange.
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It has however remained a puzzle whether a company‘s scrip dividend really affect the firm‘s
returns in terms of market price and volumes traded. Some scholars argue that Scrip dividend
is irrelevant (Miller and Modigliani, 1961) whereas others view it otherwise. Weston and
Brigham, (1981) argue that the effect that a change in dividends has on the price of a firm‘s
stock is related primarily to information about expected future earnings conveyed by a
change in dividends. Thus, the study sets to determine whether there exists a causal
relationship between scrip dividend and the returns of securities of a firm.
1.3 Objective of the Study
To determine the effects of scrip dividend on returns of Companies listed at the Nairobi
Securities Exchange
1.4 Value of the Study
The findings of this study will be of interest to the following:
The management of publicly quoted companies will be able to determine the effects of scrip
dividends on the value of their firms so that they can make an informed and timely dividend
decisions when they are issuing scrip dividends.
The study will help the government of Kenya in establishing proper policies relating to
dividends and taxes. The study of the impact of Scrip dividends on the value of the firms will
assist in ascertaining the appropriate tax amount to be charged on dividend payments without
decreasing the investors ‗confidence at the stock exchange.
The findings will enable the financial Analysts and consultants to offer proper services to
their clients when deciding on issuance of Scrip dividends or the time of issuance. This
relates to optimal scrip dividend where the values of their firms can be maximized.
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Scholars and academicians who may wish to use the findings of this study as a basis for
further research on this subject, hence acts as a springboard to further their research.
Investors who may need to know the relationship between dividends policy and value of the
firm for them to choose which firm to invest their funds in. Therefore, they can monitor the
announcements made by different firms, thus making informed decisions.
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CHAPTER TWO
LITERATURE REVIEW
2.1 Introduction
This chapter presents literatures, theories and empirical studies that have been done on the
effect of Scrip Dividend on the Returns of securities
2.2 Theoretical Review
During the last fifty years there are several theoretical and empirical studies that were done
leading to the mainly three outcomes: the increase (decrease) in dividend payout affects the
market value of the firm or the dividend policy of the firm does not affect the firm value at
all. However, we can say that empirical evidence on the determinants of dividend policy is
unfortunately very mixed. The shareholders are indifferent between the different types of
dividends. All they want are high returns either in the form of dividends or in the form of re-
investment of retained earnings by the firm. This study is based on two theories discussed in
relation to this approach
2.2.1 Dividend Irrelevance Proposition: Modigliani & Miller Approach (1961)
In 1961, Merton Miller and Franco Modigliani (M&M) showed that under certain
simplifying assumptions, a firms‘ dividend policy does not affect its value. The basic premise
of their argument is that firm value is determined by choosing optimal investments. The net
payout is the difference between earnings and investments, and simply a residual. Because
the net payout comprises dividends and share repurchases, a firm can adjust its dividends to
any level with an offsetting change in share outstanding. From the perspective of investors,
dividends policy is irrelevant, because any desired stream of payments can be replicated by
14
appropriate purchases and sales of equity. Thus, investors will not pay a premium for any
particular dividend policy.
M&M concluded that given firms optimal investment policy, the firm‘s choice of dividend
policy has no impact on shareholders wealth. In other words, all dividend policies are
equivalent. The most important insight of Miller and Modigliani‘s analysis is that it identifies
the situations in which dividend policy can affect the firm value. It could matter, not because
dividends are ―safer‖ than capital gains, as was traditionally argued, but because one of the
assumptions underlying the result is violated. The propositions rest on the following
assumptions namely: Information is costless and available to everyone equally, no distorting
taxes exist, floatation and transportation costs are non- existent and non-contracting or
agency cost exists
2.2.2 Dividend Policy and Asymmetric Information
In a symmetrically informed market, all interested participants have the same information
about a firm, including mangers, bankers, shareholders, and others. However, if one group
has superior information about the firm‘s current situation and future prospects, an
informational asymmetry exists. Most academics and financial practitioners believe that
managers possess superior information about their firms relative to other interested parties.
Dividend changes (increases and decreases), dividend initiations (first time dividends or
resumption of dividends), and elimination of dividend payments are announced regularly in
the financial media. In response to such announcements, returns of securities usually increase
following dividend increases and dividend initiations, and returns of securities usually
decline following dividend cuts and dividend eliminations. The idea that dividend payouts
can signal a firm‘s prospects seems to be well accepted among the CFOs of large US
15
corporations. In a survey of these executives conducted by Abrutyn and Turner (1990), 63%
of the respondents ranked signaling explanation as the first reason for dividend payouts.
Information about the prospects of a firm may include the firm's current projects and its
future investment opportunities. The firm's dividend policy, either exclusively or in
combination with other signals, such as capital expenditure announcements or trading by
insiders, may communicate this information to a less informed market. Empirical studies in
this area include Akerlof‘s (1970) Bhattacharya model (1979), John and Williams model
(1985) Miller and Rock model (1985) Constantinides and Grundy (1989) John and Nachman
(1986) Kale and Noe (1990), Allen. Bernado and Welch (2000) Pettit (1972) documented
that announcement of dividend increases are followed by significant price increases and that
announcements of dividend decreases are followed by significant price drops. Three studies
of large changes in dividend policy—Asquith and Mullins (1983) (dividend initiations),
Healy and Palepu (1988), and Michaely, Thaler, and Womack (1995) (dividend omissions)—
showed that the market reacts dramatically to such announcements. Other research studies
which tested the dividend announcement effects include Aharony and Swary (1980) Ofer and
Siegel (1987),Dyl and Weigand (1998)
2. 3 Types of Dividends
A dividend is generally considered to be a cash payment to the holders of company stock.
However, there are several types of dividends, several of which do not involve the payment
of cash to shareholders. These dividend types are: According to (Van Horne, 1993)
16
2. 3.1 Cash Dividend
The cash dividend is by far the most common of the dividend types used. On the date of
declaration, the board of directors resolves to pay a certain dividend amount in cash to those
investors holding the company's stock on a specific date. The date of record is the date on
which dividends are assigned to the holders of the company's stock. On the date of payment,
the company issues dividend payments.
2.3.2 Stock Dividend
A stock dividend is the issuance by a company of its common stock to its common
shareholders without any consideration. If the company issues less than 25 percent of the
total number of previously outstanding shares, you treat the transaction as a stock dividend. If
the transaction is for a greater proportion of the previously outstanding shares, then treat the
transaction as a stock split. To record a stock dividend, transfer from retained earnings to the
capital stock and additional paid-in capital accounts an amount equal to the fair value of the
additional shares issued. The fair value of the additional shares issued is based on their fair
market value when the dividend is declared.
2.3.3 Property Dividend
A company may issue a non-monetary dividend to investors, rather than making a cash or
stock payment. You record this distribution at the fair market value of the assets distributed.
Since the fair market value is likely to vary somewhat from the book value of the assets, the
company will likely record the variance as a gain or loss.
17
2.3.4 Scrip Dividend
A company may not have sufficient funds to issue dividends in the near future, so instead it
issues a scrip dividend, which is essentially a promissory note (which may or may not
include interest) to pay shareholders at a later date. This dividend creates a note payable.
2.3.5 Liquidating Dividend
When the board of directors wishes to return the capital originally contributed by
shareholders as a dividend, it is called a liquidating dividend, and may be a precursor to
shutting down the business. The accounting for a liquidating dividend is similar to the
entries for a cash dividend, except that the funds are considered to come from the additional
paid-in capital account.
2.4 Managerial Considerations in Determining a Scrip Dividend
These are the various factors that firms in practice can and should analyze when approaching
a scrip dividend decision.
2.4.1 Fund Needs of the Firm
The expected operating cash flows of the firm, expected future capital expenditures, any
likely build-ups in receivables and inventories, scheduled reduction in debt, and anything that
affects the cash position of the firm should be taken into account. The key is to determine
the likely cash flows and cash position of a change in dividend. In addition to looking at
expected outcomes, we should factor in business risk so that we may obtain a range of
possible cash-flow outcomes.
The firm wishes to determine if anything is left over after servicing its fund needs, including
profitable investment projects. In this regard, the firm should look at its situation over a
18
reasonable number of future years, to iron out fluctuations. The likely ability of the firm to
sustain dividends should be analyzed relative to the probability of distributions of possible
future cash flow and cash position. On the basis of this analysis, the firm can determine its
likely future residual funds (Van Horne, 1993).
2.4.2 Liquidity
The liquidity of company is a prime consideration in many dividend decisions. As dividends
represent cash outflow, the greater the cash position and overall liquidity of a company, the
greater its ability to pay a dividend. A company that is growing and profitable may not be
liquid, for its funds may go into fixed assets and permanent current assets. Because
management of such a company usually desires to maintain some liquidity cushion to give it
flexibility and protection against uncertainty, it may be reluctant to jeopardize this position in
order to pay a large dividend. The investment decision determines the rate of asset expansion
and the firm‘s need for funds, and the financing decision determines the way in which, this
need will be financed (Weston & Brigham, 1991).
2.4.3 Ability to Borrow
A liquid position is not the only way to provide for flexibility and protect against uncertainty.
If a firm thereby has the ability to borrow on a comparatively short notice, it may be
relatively flexible. The ability to borrow can be in the form of a line of credit or a revolving
credit from a bank or simply the informal willing of a financial institution to extend credit. In
addition, flexibility can come from the ability of a firm to go to the capital markets with a
bond issue. The larger and more established a company, the better its access to capital
markets. The greater the ability to borrow, the greater is its ability to pay a cash dividend.
19
With ready access to debt funds, management should be less concerned with the effect that
the cash dividend has upon its liquidity (Van Horne, 1993).
2.4.4 Assessment of Any Valuation Information
Regression analysis involving similar companies may give some indication, even though
studies on this line have statistical problems in addition to the troublesome job of trying to
hold all else constant. As a result, it usually is difficult to make company-specific
generalizations concerning the impact of script dividends on stock market prices. Most
companies look at the dividend payout ratios of other companies in the industry, particularly
those having about the same growth. It may not matter that a company is out of line with
similar companies but it will be conspicuous; and unusually a company should judge the
informational effect of a dividend. What do investors expect? Here security analysts and
security reports are useful. The company should ask itself what information it is conveying
with its present dividend and what it should convey with a possible change in dividend
(Helfert, 1966).
2.4.5 Control
If a company pays substantial dividends it may need to raise capital at a later time through
sale of stock in order to finance profitable investment opportunities. Under such
circumstances, the controlling interest of the company may be diluted if controlling
stockholders do not or cannot subscribe for additional shares. These stockholders may prefer
low dividends payout and the financing of the investment needs with retained earnings.
Control can work two ways, however. When a company is being sought by another company
or individuals, a low dividend payout may work to the advantage of the ―outsiders‖ seeking
control. The outsiders may be able to convince stockholders that the company is not
20
maximizing shareholder wealth and that they (the outsiders) can do a better job.
Consequently, companies in danger of being acquired may establish a high dividend payout
in order to please stockholders (Weston & Brigham, 1991).
2.4.6 Nature of Stockholders
When a firm closely held, management usually knows the dividend desires of its
stockholders and may act accordingly. If most stockholders are in high tax brackets and
prefer capital gains to dividends, current income the firm can establish a low dividend
payout. The low payout, of course, would be predicated upon having profitable investment
opportunities for the retained earnings. The corporation with a large number of stockholders
can judge their desires for dividends only in a market.
2.4.7 Restrictions in Bond Indenture or Loan agreement
The protective covenants in a bond indenture or loan agreement often include a restriction on
payment dividends. The restriction is employed by the lenders to preserve the company‘s
ability to service debt. Usually, it is expressed as a maximum percentage of cumulative
earnings. When such a restriction is in force, it naturally influences the dividend policy of
the firm. Sometimes the management of a company welcomes a dividend restriction
imposed by lenders because it does not then have to justify stockholders the retention of
earnings. It need only point to the restriction (Kolb & Demong, 1998).
2.4.8 Inflation
Inflation also may have an influence upon dividend policy. With rising prices, funds
generated from depreciation are not sufficient to replace or restore existing assets as they
wear out or become obsolete. Consequently, a case can be made for retaining earnings
21
simply to preserve the earning power of the firm. The decision must base upon investment
policy and valuation (Seitz, 2000).
2.5 Empirical Studies
Early studies lend support to the signaling rationale that the information content of dividends
is reflected in the movement of stock price, as the announcements of dividend increases
precede significant price increases and that announcements of dividend decreases precede
significant price decreases. For example, Pettit (1972) shows that the price shifts are
observed prior to the announcements of dividends, which was a result of market imperfection
regarding insiders‘ action. Charest (1978) finds that the announcement of a dividend increase
generates excess returns of about 1%. But his study does not necessarily suggest what the
information content of dividends is, since it does not preclude the effect of contemporaneous
earnings announcements. Aharony and Swary (1980) overcome this shortcoming; they find
that in cases where earnings announcements follow dividend announcements, the average
abnormal return is 0.36% for announcements of dividend increases and -1.13% for dividend
decreases. Stock prices are positively related to dividend announcements after controlling for
contemporaneous earnings announcements, indicating that dividend payment conveys
information that is not entirely contained in published earning information. In addition, their
study supports the efficient market hypothesis; that dividends provide information to stock
market and affect stock price. Grullon, Michaely, and Swaminathan (2002) investigate a
sample that consists of large dividend changes of more than 10% and provide supportive
results for the dividend signaling model that the average abnormal return to dividend
increases is 1.34% and the average abnormal market reaction to dividend decreases is 3.71%.
Using the Fama-French three-factor model Grullon,Michaely and Swaminathan (2002) report
22
three-year significant abnormal returns of 8.3% for dividend increases. They did not detect
any abnormal performance for dividend decreasing firms.
Not surprisingly, the post-dividend abnormal performance is even more pronounced for
initiations and omissions. Michaely, Thaler and Womack (1995) reported a market-adjusted
return of almost 25% in the three years after initiations and a negative abnormal return of
15% in the three years after omissions. Assuming that both dividend initiations and dividend
omissions represent extreme changes in dividend policy, stock markets should have more
dramatic responses to announcements of dividend initiations and dividend omissions than to
announcements of dividend increases and dividend decreases.
Asquith and Mullins (1983) argue that dividends ‗effects should be most visible at initiation
since initial dividends are more likely to be unexpected than normal dividend changes. If this
is the case, the market reaction on announcement day of dividend initiation should fully
reflect the effect. Their sample consists of firms that did not pay dividends for at least 10
years. The majority of firms exhibit a positive market reaction to the announcement of initial
dividend. The 2-day excess return is +3.7% and t-statistic is 6.59. This result is comparable
to the returns reported by other studies that focus on dividend initiations. For example, Healy
and Palepu (1988) report two-day excess returns of 3.9 percent, and Michaely, Thaler, and
Womack (1995) find three-day excess returns of 3.4 percent. The market apparently views
the announcement of an initial dividend as good news regarding firms‘ future prospects.
Their study was done to investigate whether dividend policy of the U.S. equity market
portfolio, forecasts future earnings growth. The study comprised companies in the S&P 500
23
which tend to be large and well established firms in advanced economies (Zhou and Ruland,
2006).
The positive relationship is also driven by sticky dividends combined with mean reversion in
more volatile earnings (Arnott and Asness, 2003). The temporary increases and decreases in
earnings subsequently reversed cause the payout ratio to be positively correlated with future
earnings growth. Their robustness check for the mean reversion of earnings suggested that
earnings seem to revert to the mean but may revert most strongly in terms of their ratio to
dividends. However, Farsio et al. (2004) argue that no significant relationship between
dividends and earnings hold in the long run and studies that support this relationship are
based on short periods and therefore misleading to investors. They proposed three scenarios
that would render the long-term relationship of dividends and future earnings insignificant.
First, they point out that an increase in dividends may lead to a decline in funds that are to be
reinvested by the firm. Firms that pay high dividends without considering investment needs
may therefore experience lower future earnings (Farsio et al., 2004). There is thus a negative
relationship between dividend payout and future earnings.
Secondly, an increase in dividends in a quarter may be the result of the management‘s policy
to keep investors satisfied and prevent them from selling the stock at times when future
earnings are expected to decline or current losses are expected to continue (Farsio et al.,
2004). This is a case of rising dividends followed by declining earnings. An increase in
dividends may be the result of good performance in previous periods which may continue
into the future (Farsio et al., 2004). This supports the view of a positive causal relationship
between current dividends and future earnings. From these scenarios, they argue that the
overall long-term relationship is insignificant since there is a positive relationship between
24
dividends and future earnings in some periods and a negative relationship in other periods.
Nissim and Ziv(2001) showed that dividend increases were directly related to future
increases in earnings in each of the two years after the dividend change. What therefore
happens when there is a steady increase in dividends for a given number of years? Nissim
and Ziv (2001) found that dividend increases and decreases are not symmetric. Dividend
increases are associated with future profitability for at least two years after the dividend
change, whereas dividend decreases are not related to future profitability after controlling for
current and expected profitability. They propose that this lack of association can be explained
by accounting conservatism. They therefore conclude that there is a positive relationship
between dividend payout and future earnings but the relationship is stronger for future
abnormal earnings.
In a study that examines whether dividend policy influences firm performance in the Ghana
Stock Exchange, Amidu (2007) found that dividend policy affects firm performance
especially the profitability measured by the return on assets. The results showed a positive
and significant relationship between return on assets, return on equity, growth in sales and
dividend policy. This showed that when a firm has a policy to pay dividends, its profitability
is influenced. The results also showed a statistically significant relationship between
profitability and dividend payout ratio. Astudy by Howatt et al. (2009) also concluded that
positive changes in dividends are associated with positive future changes in mean real
earnings per share.
Adelegan (2003) evaluated the incremental information content of cash flows in explaining
dividend changes, given earnings in Nigeria. She carried out an 882 firm–year study by
analyzing the dividend changes–cash flow relationship on a sample of 63 quoted firms in
25
Nigeria over a wider testing period from 1984 to 1997. She found a significant relationship
between dividend changes and cash flow, unlike previous studies. The empirical results
reveal that the relationship between cash flows and dividend changes depend substantially on
the level of growth, the capital structure choice, the size of each firm and economic policy
changes.
The information content of scrip dividends hypothesis formulated by Miller and Modigliani
(1961) has been the subject of numerous studies in the last few decades. The validity of this
hypothesis hinges on the belief that a firm‘s managers shape the scrip dividend policy in a
manner that is consistent with their appraisal of the firm‘s future prospects in an environment
characterized by asymmetric information. Two of the early extensive empirical studies that
attempted testing this hypothesis and measuring the impact of scrip dividends on stock prices
were Pettit (1997), and Watts (1997).
Pettit (1972) found that market participants make considerable use of the information implicit
in announcements of changes in scrip dividend payments. However, Watts (2007) regressed
year t+1‘s earnings on year it‘s scrip dividends and concluded that examining the relationship
between unexpected scrip dividend changes and stock prices indicates that these changes
communicate no information beyond that reflected in other contemporaneous variables (for
example, earnings). The dramatically opposed conclusions of these two studies, and because
of the importance of understanding the impact of script scrip dividends on prices and future
earnings, several researchers tried to follow up on these issues. A summary of the major
studies is as follows:-
26
Gonedes (2000) provides evidence that is inconsistently with the view that the annual scrip
dividend signals reflect information beyond that reflected in contemporaneous annual income
signals. Thus, he rejects the scrip dividend information content hypothesis. Although
Charaset (1978) found that announcing a scrip dividend increase generates an excess return
of about 1%, he concluded that his evidence does not necessarily reveal the presence of
information in scrip dividend announcements since he made no efforts to isolate the effect of
contemporaneous earnings announcements.
On the other hand, Aharony and Swary (1990), Kwan (1991) Eades (1992) and Woolridge
(1992), using scrip dividends announcements made apart from other firm news reports, found
a significantly positive association between scrip dividend changes and announcement day
stock returns. In each case, these results were attributed to the information content of scrip
dividends.
The two most frequently cited studies in this area are Aharony and Swary (1990), Asquith
and Mullings (1993). Both of these studies used a naïve scrip dividend forecasting model
(that is, next quarter‘s scrip dividend is expected to be the same with last quarter‘s scrip
dividends). Aharony and Swary (1990) examined the impact of script scrip dividends
announcements which were made at different dates than earnings announcements, and found
them to have the same effects on stock prices as the entire sample of announcements. Thus,
the impact of earnings announcement cannot explain the observed stock price behaviour
around scrip dividends announcements.
Following similar lines of investigation, Asquith and Mullings (1993) tried to refine the
credibility of Watts‘s results by re-examining the stock price reaction to scrip dividend
27
announcement, using daily stock data to control for other contemporaneous information
announcements. Their results show significant positive abnormal returns at scrip dividends
initiation announcements. Healy and Palepu (1998) focus on scrip dividend initiations and
omissions, the two scrip dividend policy changes that have been documented in the literature
as having the largest average announcement returns. Consistent with the scrip dividend
information hypothesis, their findings indicate that the information conveyed by scrip
dividend initiation and omissions are related to earnings changes following the
announcements of these scrip dividend policy changes. Investors therefore interpret scrip
dividend initiations and omissions as changes in management‘s earnings forecasts.
A study conducted by Gichema (2007) found that in the recent past companies quoted on the
Nairobi Stock Exchange have been using stock dividend as a mode of paying dividends. This
emerging trend may be attributed to the pecking order theory, economic growth in the
country and the appealing phenomenon amongst the investors. This study focused on the
effect of bonus share issues on stock prices of companies quoted at the Nairobi Stock
Exchange. The objectives of this study were to determine whether there are abnormal returns
surrounding the bonus issues announcement and to establish the direction and magnitude of
the stock price adjustment on announcement of bonus issue. The sample consisted of all the
companies quoted at NSE which declared bonus issues between the periods of interest, I
January 2004 to 31 July 2007, and were drawn from all the segments of the Nairobi stock
exchange. In order to achieve this objectives secondary data obtained from the NSE
Secretariat informational database and the companies‘ financial statements were used.
Further, the study entailed the determination of the precise day of the bonus share issue
announcement and this day was made to be day zero; definition of the period to be studied; in
28
this study the study period was 101 days surrounding the announcement date. The magnitude
of bonus issue announcement was expected to vary across the firms because the
announcements were made by companies in different industries and at different times. It was
hence useful to examine the behavior of each company independently. Data was presented
using tables and graphs. Descriptive statistics i.e. mean and standard deviation and t-tests
were used to analyze data. The findings of this study were such that bonus issues typically
generate positive stock prices reactions in the short run but produce no lasting gains in the
market price for widely held stocks in the Nairobi Stock Exchange. The limitations
encountered included heavy reliance on secondary data, reliance on research studies
conducted in the developed countries for literature review and due to unavailability of data
this study was restricted to companies quoted in the Nairobi Stock Exchange.
Muasya (2010) conducted a study on the impact of bonus issues on stock liquidity has been a
subject of study in various markets with varying results. This study examined the relationship
between bonus issue and the stock liquidity of firms quoted at the Nairobi Stock Exchange
for the period between 2003 and 2009. The study used the multi-dimensional measures of
liquidity to avoid the shortcomings of the one-dimensional measures. The study adopted a
causal research design in establishing the relationship between stock liquidity and bonus
issues on a sample size of 20 companies that had issued bonuses between 2003 and 2009.
Secondary data from Nairobi Stock Exchange was used. The study collected the daily share
prices, trading volumes and number of transactions from which weekly averages were used
to compute the three liquidity measures-Liquidity ratio liquidity ratio 3 and Flow ratio. The
study then used descriptive statistics (mean, standard deviations, minimum and maximum
values), measures of association (correlations and ANOVA) and regression analysis in
29
establishing the relationship between stock liquidity and bonus issues. The study established
the regression model to be significant at (p<0.039). A further Analysis of Variance by sector
segments showed a significant relationship between bonus issue and stock liquidity (flow
ratio) for Financial Sector (p=0.003) and Industrial and Allied Sectors (p = 0.004) while for
Commercial Sectors liquidity ratio 3 was the most significant measure of liquidity (p =
0.023). The study concludes that the stock liquidity reaction to the information content of the
bonus issues in Kenya is positive, in line with evidence from semi strong efficient markets.
Odumbe (2010) also conducted a study in NSE and found that there is a theory that bonus
shares can signal management's view of the condition of a firm and that firm managers use
bonus shares announcement to signal a firm's quality. The information content of events and
its dissemination determine the security prices in the capital market. This study was to test
the semi-strong form of market efficiency on the Kenyan Capital Market. The study
investigated to information content of bonus issue announcements by companies quoted at
the Nairobi Stock Exchange. This study was an event study, evaluative research design was
used. Analysis of Average Stock Returns Variability (ASRV) and Abnormal Returns (AAR)
were used. ASRV analysis is used if announcement contained information relevant for
valuation companies' stocks and the announcement effect exists only if abnormal returns are
significant. The study empirically examined the information content of corporate event of
stocks with regard to 38 bonus issue announcements released by the 26 companies over the
period January 2000 and September 2010. The results of the study showed that the stock
prices reacted to the announcement of bonus issue. Therefore, the he concluded that bonus
announcement contained information useful for valuing the stocks. Thus information of
bonus announcement can be used by the investors for making abnormal returns at any point
30
of the announcement period, through the strategy of short selling. Further, the results show
that market positively received the bonus announcement information before the
announcement came up. However, the analysis depicts the fact that the market gained
significant reactions in the stock prices during the pre and post announcement periods. Thus
one can conclude from the foregoing discussions that the capital markets in general are not
perfectly efficient, to the announcement of bonus issue. This informational inefficiency can
be used by the investors for making abnormal returns at any point of the announcement
period. The study recommended that stock market may use that information to revise the
prices of securities and the investors are advised that when the company comes up with the
bonus issue, the investor should take immediate investment decision (buy or sell) in order to
benefit from the bonus issue announcement.
2.6 Summary of Literature Review
From the literature review, the effect of script dividend on return of securities has been
discussed. From the discussion, the empirical theory has been seen basing its ground on the
platform of inefficiency of the market and asymmetry of information. Some studies and
empirical evidences also contradicted the information signalling hypothesis. The consistency
of information signal of dividend is still unresolved more so when dividends are reduced. An
increase in subsequent earnings after dividend cut which is not in line with the contention
that a dividend omission indicates less-than-anticipated earnings in the future. The aim was
to point out crucial issues and pave way for further research in identifying the impact of
script dividend on return of securities in Nairobi Stock Exchange.
31
CHAPTER THREE:
RESEARCH METHODOLOGY
3.1 Introduction
This chapter presents the research methodology employed in this study. It included the
research design, population and sampling criteria, data collection and data analysis tools.
3.2 Research Design
An event study research design was used in the study. An empirical study performed on a
security that has experienced a significant catalyst occurrence, and has subsequently changed
dramatically in value as a result of that catalyst. The event can have either a positive or
negative effect on the value of the security. Event studies can reveal important information
about how a security is likely to react to a given event, and can help predict how other
securities are likely to react to different events. This is the most appropriate since there were
sufficient secondary data available in the market for analysis to establish the facts. The
research depended on secondary data from companies‘ published financial statements.
3.3 Population
This research was based on all the 60 companies that are listed at the NSE, as at 31st
December 2012. (Appendix 1)
3.4 Sample
The population of interest in this study consisted of all the firms quoted at the Nairobi Stock
Exchange (N.S.E). This study used census because the population is not large. The firms
was selected consisting of all the firms quoted consistently at N.S.E for a period of 10 years
from 2003 – 2012. A period of 10 years is chosen because the researcher considers the
32
period to be adequate for establishing any relationship between dividend payout ratio and the
value of the firm as reflected in the returns of securities.
3.5 Data Collection
This study was facilitated by the use of secondary data. Dividend data on was extracted from
published reports of quoted companies. This information was obtained at the N.S.E library
and from the company libraries. Data on the market returns of securities was obtained from
the returns of securities as reported by N.S.E.
3.6 Data Analysis
Event study was used in data analysis. Event study is an empirical analysis that is normally
used to measure the effect of an event on stock prices (returns). The basic idea is to find the
abnormal return attributable to the event being studied by adjusting for the return that stems
from the price fluctuation of the market as a whole (Ronald and Bernard, 1995).The
researcher will use event study methodology under the following steps.
i) Normal
The expected return, E(R), is used as the benchmark return in the normal situation to
compare with the actual return during the event window(s). Normal return is the return that
would be expected if the event did not take place. The benchmark return represents the return
that is not related to the event of interest.
RRRR tftmitfjiE
,,,,
33
ii) Abnormal Return
Abnormal return was used to appraise the event‘s impact. It is the difference between the
actual return on time (t) in the event window and the expected return of the firm.
RRAR tititiE
,,,
iii) Cumulative Abnormal Return (CAR)
In this stage, the abnormal return of each stock is aggregated over the event window. The
researcher used the CAR to determine the aggregate over the event window.
ARCAR tii
T
TtTT ,,
3
2
32
iv) Testing the Significance of CAR
To test the significance, the researcher used parametric test of t-statistics. Non-parametric
tests will be applied to test the results. For an individual firm, t-test was calculated using the
formula below.
SARt teitiAR ,,/
Across firms, the following formulae will give parametric test statistics, which was used to
investigate if the average cumulative or buy-and-hold abnormal returns are equal to zero.
nCARCAR titiCARt // ,,
n is the number of events in the study. in this study, n was the number of companies in NSE.
34
CHAPTER FOUR:
DATA ANALYSIS AND INTERPRETATION
4.1 Introduction
This chapter presents the data findings on effects of scrip dividend on returns of Companies
listed at the Nairobi Securities Exchange. These data were collected from the NSE offices.
Analysis involved evaluation of abnormal return and security variability around dividend
issue. The study covered a period of 2003 to 2012; the study sampled 10 year period, 10
years is chosen because the researcher considers the period to be adequate for establishing
any relationship between dividend payout ratio and the value of the firm as reflected in the
returns of securities.
4.2 Findings
4.2.1 Abnormality of Returns Following Scrip Dividend Announcement
The study analysed the returns of the shares and compared the same with the market returns
so as to establish the abnormality of returns following scrip dividend announcement. The
analysed data was presented in Appendix II , which shows the abnormal returns for the
entire market following the scrip dividend announcement shows that t-2 to t1 had a positive
abnormal returns of values greater than 1; 1.0894, 2.3329, 4.5166 and 3.2317 respectively.
The period between t2 to t10 had average abnormal return of less than 1 which means that no
investor benefitted from above normal returns pointing at market adjusting to the scrip
dividend issues. This implies that the market do not react fast to scrip dividend issue which
could point to efficiency, but not perfectly efficient. However, period between between t-15
to t1 had above normal returns meaning that the investors enjoyed above normal returns. This
35
could point at insider trading just before the scrip dividend issues anouncement or
management using scrip dividend issues to adjust stock price to a more marketable range.
4.2.2 Security Returns Variability (SRV)
The study sought to establish the variability of the stock return following scrip dividend
issues thus determine the market reaction to scrip dividend issues announcement. The
information presented in Appendix IV shows that that the variability in stock prices does
decrease erratically with time though there is more variability in the days preceding and after
scrip dividend issues announcmnet. Between t-3 to t9, the securities return variability was
found to be negative an indication that the market was negatively reacting to scrip dividend
issues announcment. However, the t-significance shows 11 of the statistics were significant
as their significance value was less that 0.05; 6 of which were in the post-announcement
period. 6 out of the 10 were between t0 and t15. The announcement day had an average
ASRV of -6.2265 at 95% confidence level. Apart from day t-30, t-29, t-28, t-5, t10, t15, t12,
t13, t16, t19 and t29, other periods had ASVR of less than 1. Results support the semi-strong
form efficient market hypothesis since stock prices adjust so fast to public information that
no investor can earn an above normal return by trading on the announcement day and period
thereafter.
36
Table 4.1: Average Value of ASRV for dividend issue scrip dividend issue
Announcement
Estimation Period Security Return Variability
From day -15 to day +15 4.3362
From day -15 to day -1 1.0607
From day 0 to day +15 3.4875
From day 0 to day +1 3.8742
From day -1 to day 1 3.3604
Form day -3 to day +3 1.8787
From day -7 to day +7 1.0753
Source: Research Findings
To analyze the speed at which the stock market absorbs the scrip dividend issues
announcement in its prices, the study presented the average security return variability across
the announcement periods. As indicated by the table, stock variability was more in post
announcement period than pre-announcement period; while t-15 to t-1 had ASRV of 1.0607,
t0 to t15 had ASRV of 3.4875. Between t0 and t1 the ASRV was 3.8742, t-1 to t1 had a
variability of 3.3604. Day t-3 to t3 had ASRV of 1.8787 and t-7 to t7 had ASRV of 1.0753.
Therefore, the stock market positively absorbed scrip dividend issues contained information
positively.
Table 4.2: CAR Across the Event Windows
Days Mean of CAR Variance
t-30 to t-21 3.200135 2.698851
t-20 to t-1 11.606 54.117
t0 to t1 30.50557 16.91172
t-1 to t1 29.065 26.12547
t+2 to t+20 22.383 1.745567
t+20 to t+30 29.035 57.56523
t-30 to t+30 16.28562 98.38799
Source: Research Findings
37
To track abnormal returns over a number of trading days, cumulative abnormal return (CAR)
is computed through out the event period for the scrip dividend issues announcement as
presented in table above . From the table, it can be noted that CAAR for the sampled stocks
are positive during entire event window.
Figure 4.1: Average CAAR for all the companies
Source: Research Findings
Figure above shows a plotted graph trading volume activity ratio against days around scrip
dividend issues announcement for the sampled companies listed in NSE that had issued scrip
dividend. It shows how the market reacted on days before and after scrip dividend issues.
The graph shows that there was generally an increase in shares traded when scrip dividend
issues was announced. This can be shown by the increase in trading activity before and after
scrip dividend issues. Trading activity after the scrip dividend issues date was however found
to be more than that before scrip dividend issues. The trading activity was found to be
especially high from day 2 to day 15 after scrip dividend issues announcement.
38
Table 4.3: One-Sample Statistics
Days T Mean CAAR Sig. (2-tailed)
15 -.008 -.0375 .994
14 .128 .5876 .901
13 .126 .5119 .902
12 .158 .5993 .878
11 -.092 -.2818 .929
10 -.157 -.4655 .879
9 -.195 -.5942 .850
8 -.212 -.6714 .837
7 -.277 -.8767 .787
6 -.674 -1.8009 .516
5 -.653 -1.6090 .528
4 2.023 -2.2557 .330
3 2.495 -.9429 .631
2 2.461 -.7805 .655
1 1.277 .3476 .787
0 1.985 .9602 .348
1 2.150 .9728 .277
2 .845 .9259 .418
3 2.953 2.8412 .079
4 2.660 2.4830 .128
5 .995 1.7084 .343
6 .931 1.7262 .374
7 .684 1.3705 .510
8 1.122 2.4945 .288
9 1.119 2.6855 .289
10 1.127 3.0673 .286
11 .938 3.0849 .370
12 .841 3.1002 .420
13 1.093 4.4908 .300
14 1.068 4.6181 .311
15 .776 3.8150 .456
Source: Research Findings
From the results shown in table above the mean CAAR was found to be positive in the period
after scrip dividend issues an indication that the trading volume reacted positively towards
the scrip dividend issues announcement, in the period before scrip dividend issues the mean
CAAR was found to have both negative value and indication the market was not sensitive to
scrip dividend issues, in the results on t- value the study found that period surrounding the
39
event date the value of t was close to 2 an indication that trade volume were very sensitive to
scrip dividend issues by the companies.
Table 4.4: Average Value of ASRV for scrip dividend issues
Estimation Period Security Return Variability
From day -15 to day +15 4.3532
From day -15 to day -1 1.1278
From day 0 to day +15 3.1148
From day 0 to day +1 3.1769
From day -1 to day 1 3.1439
Form day -3 to day +3 1.9787
From day -7 to day +7 1.2353
Source: Research Findings
To analyze the speed at which the stock market absorbs scrip dividend issues announcement
in its prices, the study presented the average trade volumes return variability across the
announcement periods. From the results in the table above, trade variability was more in post
announcement period than pre-announcement period; while t-15 to t-1 had ASRV of 1.1278,
t0 to t15 had ASRV of 3.1148. Between t0 and t1 the ASRV was 3.1769, t-1 to t1 had a
variability of 3.1439. Day t-3 to t3 had ASRV of 1.9787 and t-7 to t7 had ASRV of 1.2353.
Therefore, the trade volumes in the stock market positively absorbed scrip dividend issues
contained information positively.
4.3 Interpretation of Findings
The study found that no investor benefitted from above normal returns pointing at market
adjusting to scrip dividend issues as the abonormal return around t2 to t10 had average
abnormal return of less than 1, the study also found that the market do not react fast to scrip
40
dividend issues which could point to efficiency, but not perfectly efficient, in some day
surrounding the scrip dividend issues the abonromal return were above normal return,
meaning that the investors enjoyed above normal returns which could be attributed to insider
trading just before scrip dividend issues anouncement or management using scrip dividend
issue to adjust stock price to a more marketable range.
41
CHAPTER FIVE:
SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 Introduction
The chapter provides the summary of the findings from chapter four. The objective of this
study was to establish the effects of scrip dividend on returns of Companies listed at the
Nairobi Securities Exchange.
5.2 Summary
This chapter presents discussions of the summary of key findings presented in chapter four,
conclusions drawn based on such findings and recommendations there-to. This chapter will
thus be structured into summary, conclusion, recommendations and areas for further
research. From the findings on the abnormal returns for the entire market following the scrip
dividend issue announcements shows that t-2 to t1 had a positive abnormal returns of values
greater than 1; 1.0894, 2.3329, 4.5166 and 3.2317 respectively. The period between t2 to t10
had average abnormal return of less than 1 which means that no investor benefitted from
above normal returns pointing at market adjusting to scrip dividend issue. This implies that
the market do not react fast to scrip dividend issue which could point to efficiency, but not
perfectly efficient. In the period between between t-15 to t1 had above normal returns
meaning that the investors enjoyed above normal returns. This could point at insider trading
just before scrip dividend issue anouncement or management using scrip dividend issue to
adjust stock price to a more marketable range.
42
The study establishes the variability of the stock return following scrip dividend issue
announcements thus determine the market reaction to scrip dividend issue. In 2006, the
security return variability rose to 11.1829, in 2004 the SVR rose to 6.0276 while in 2010 the
SRV was 0. The t-significance shows 15 of the statistics were significant; 10 of which were
in the post-announcement period. 6 out of the 10 were between t0 and t15. The
announcement day had an average ASRV of 3.9164 at 95% confidence level. Apart from day
t1, t11, t15, t12, t15, t16, t22, t24, t26, t28 and t29, other periods had ASVR of less than 1.
Results support the semi-strong form efficient market hypothesis since stock prices adjust so
fast to public information that no investor can earn an above normal return by trading on the
announcement day and period thereafter.
From the findings, the results indicated that generally, there was an increase in the volumes
of shares traded when scrip dividend issue were announced. This was especially so in the
days around the scrip dividend issue. Trading activity was also seen to generally increase
after scrip dividend issue as compared to that before scrip dividend issue. The disparity in
trading activity before and after scrip dividend issue was found not to be very big except. All
the companies showed increases in trading activities but not with disparities. The results
showed there was a positive announcement effect on shares traded as a result of scrip
dividend issue. On the issue date, there was a positive average abnormal return which was
very significant at 0.05% level. To track abnormal returns over a number of trading days, the
cumulative abnormal return was computed throughout the event period.
43
5.3 Conclusion
From the findings the study concludes that the Kenyan market reacts positively to scrip
dividend issue announcements. There was an increase in volumes of shares traded after scrip
dividend issue as compared to those before the scrip dividend issue. The study also concludes
that managers of the companies sought issues scrip dividend to encourage investors to
purchase their stock which appeared cheaper. This study showed that there were positive
mean returns with respect to scrip dividend, this was in agreement with the signaling
hypothesis which stated that managers of companies‘ issues scrip dividend to act as a means
of passing information to stock holders and potential investors.
5.4 Recommendation for policy
The key assumption of the event study method was the ability to identify the event date. In
this case of scrip dividend issue, two key event dates did occur; the announcement date and
the effective date. The data of announcement date was not complete so the effective scrip
dividend issue date was defined as the event date. Although scrip dividend issue
announcement already contained information regarding future earnings and dividends
expectations by management, the inclusion of these firms could have resulted in an
overstatement of the effect of the scrip dividend issue announcement on stock prices. The
comparisons done were based purely on price trends and did not account for changes in the
overall market conditions. Other market conditions could have arisen, which had effects on
the general activity of shares in the market and on the returns, hence there was need to make
use of the market model.
44
5.5 Limitation of the study
In attaining its objective the study was limited to 31 firms listed companies in the NSE that
had issued scrip dividend in the between the year 2002 to year 2012. The study could not
therefore incorporate the impact of other companies that had issues scrip dividend in the
same period.
Secondary data was collected from the NSE reports. The study was also limited to the degree
of precision of the data obtained from the secondary source. While the data was verifiable
since it came from the Nairobi Securities Exchange publications, it nonetheless could still be
prone to these shortcomings.
The study was limited to investigate effects of scrip dividend on returns of Companies listed
at the Nairobi Securities Exchange. Secondary data was collected from the Nairobi security
exchange publications.
5.6 Suggestion for Further Research
Scrip dividends were found to be relatively new in the Nairobi Securities Exchange.
However, many companies intending to distribute their earnings do so by use of scrip
dividend. Scrip dividends are not so different from the bonus issue. This study made use of a
simple methodology based on the market model to determine abnormal returns. There is need
for further study in this area and a need to include more independent variables such as those
relating to firm size, growth and profitability of the firms so as to determine whether when
other factors are considered there market would still react positively to scrip dividend
announcements
45
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50
APPENDICES
Appendix I: Companies Listed at Nairobi Securities Exchange as at 31st Dec, 2012.
NAIROBI SECURITIES EXCHANGE LISTED COMPANIES
AGRICULTURAL
1 Eaagads Ltd Ord
2 Kapchorua Tea Co. Ltd OrdOrd
3 Kakuzi Ord.
4 Limuru Tea Co. Ltd Ord
5 Rea Vipingo Plantations Ltd Ord
6 Sasini Ltd Ord
7 Williamson Tea Kenya Ltd Ord
COMMERCIAL AND SERVICES
8 Express Ltd
9 Kenya Airways Ltd
10 Nation Media Group
11 Standard Group Ltd
12 TPS Eastern Africa (Serena) Ltd
13 Scangroup Ltd
14 Uchumi Supermarket Ltd
15 Hutchings Biemer Ltd
16 Longhorn Kenya Ltd
TELECOMMUNICATION AND TECHNOLOGY
17 AccessKenya Group Ltd
18 Safaricom Ltd
AUTOMOBILES AND ACCESSORIES
19 Car and General (K) Ltd
20 CMC Holdings Ltd
21 Sameer Africa Ltd
22 Marshalls (E.A.) Ltd
51
BANKING
23 Barclays Bank Ltd
24 CFC Stanbic Holdings Ltd
25 I&M Holdings Ltd
26 Diamond Trust Bank Kenya Ltd
27 Housing Finance Co Ltd
28 Kenya Commercial Bank Ltd
29 National Bank of Kenya Ltd
30 NIC Bank Ltd
31 Standard Chartered Bank Ltd
32 Equity Bank Ltd
33 The Co-operative Bank of Kenya Ltd
INSURANCE
34 Jubilee Holdings Ltd
35 Pan Africa Insurance Holdings Ltd
36 Kenya Re-Insurance Corporation Ltd
37 CFC Insurance Holdings
38 British-American Investments Company ( Kenya) Ltd
39 CIC Insurance Group Ltd
INVESTMENT
40 Olympia Capital Holdings ltd
41 Centum Investment Co Ltd
42 Trans-Century Ltd
43 MANUFACTURING AND ALLIED
B.O.C Kenya Ltd
44 British American Tobacco Kenya Ltd
45 Carbacid Investments Ltd
46 East African Breweries Ltd
47 Mumias Sugar Co. Ltd
48 Unga Group Ltd
52
49 Eveready East Africa Ltd
50 Kenya Orchards Ltd
51 MANUFACTURING AND ALLIED
A.Baumann CO Ltd
52 CONSTRUCTION AND ALLIED
Athi River Mining
53 Bamburi Cement Ltd
54 Crown Berger Ltd
55 E.A.Cables Ltd
56 E.A.Portland Cement Ltd
57 ENERGY AND PETROLEUM
KenolKobil Ltd
58 Total Kenya Ltd
59 KenGen Ltd
60 Kenya Power & Lighting Co Ltd
53
Appendix II: Average Abnormal Returns (AAR)
Days AAR T Sig. (2-tailed)
-30 .4375 .816 .451
-29 1.3938 2.180 .081
-28 .5875 1.342 .237
-27 .7102 -1.000 .363
-26 1.0529 -.267 .800
-25 .3839 .951 .385
-24 .2612 1.410 .218
-23 .4774 .866 .426
-22 .3698 -.635 .554
-21 .3845 -1.230 .273
-20 .6196 .361 .733
-19 .4158 -.523 .623
-18 .3621 2.191 .080
-17 .4290 1.210 .280
-16 .2057 .735 .495
-15 .1673 .261 .805
-14 1.0176 .565 .596
-13 1.7646 1.066 .335
-12 1.2849 4.912 .004
-11 .3819 2.378 .063
-10 2.6129 2.938 .032
-9 .5799 3.022 .029
-8 1.4308 1.120 .314
-7 .5264 2.515 .053
-6 1.2743 .059 .955
-5 .3490 .262 .804
-4 .2696 1.926 .112
-3 .8296 1.390 .223
-2 1.0894 2.629 .047
-1 2.3329 1.967 .106
0 4.5166 1.834 .126
1 3.2317 -1.841 .125
2 .8559 -2.758 .040
3 .2945 -1.660 .158
4 .2251 -1.346 .236
5 .1447 .656 .541
6 .0607 -1.318 .245
7 .1299 .365 .730
8 .0411 -1.637 .163
9 .0692 -1.380 .226
10 .1885 -.131 .901
11 3.0224 .993 .366
54
12 1.5179 .171 .871
13 .1160 .974 .375
14 .2478 -.869 .424
15 1.1385 -1.404 .219
16 2.3328 -.104 .921
17 .7888 -1.196 .285
18 .2792 -.537 .614
19 .2432 .756 .483
20 .3464 1.020 .355
21 .2046 .438 .680
22 .7916 -1.897 .116
23 .1092 -1.144 .304
24 .8801 .081 .939
25 .0676 -.167 .874
26 .9100 -.024 .981
27 .4095 -.217 .837
28 1.2688 1.869 .121
29 17.2388 .716 .506
30 .2198 -.280 .790
Source: Research Findings
55
Appendix III: Average Security Returns Variability
Day Mean (ASRV) STDEV T-stat Sig
-30 0.4375 0.5234 2.047 0.096
-29 1.3938 1.8582 1.837 0.126
-28 0.5875 0.6349 2.267 0.073
-27 0.7102 0.5702 3.051 0.028
-26 1.0529 1.1117 2.320 0.068
-25 0.3839 0.4850 1.939 0.110
-24 0.2612 0.2629 2.434 0.059
-23 0.4774 0.4699 2.488 0.055
-22 0.3698 0.3010 3.009 0.030
-21 0.3845 0.5874 1.603 0.170
-20 0.6196 0.7380 2.057 0.095
-19 0.4158 0.5269 1.933 0.111
-18 0.3621 0.5936 1.494 0.195
-17 0.4290 0.5200 2.021 0.099
-16 0.2057 0.1282 3.932 0.011
-15 0.1673 0.1663 2.465 0.057
-14 1.0176 1.2111 2.058 0.095
-13 1.7646 3.4017 1.271 0.260
-12 1.2849 2.0187 1.559 0.180
-11 0.3819 0.6810 1.374 0.228
-10 2.6129 3.4394 1.861 0.122
-9 0.5799 0.5939 2.392 0.062
-8 1.4308 1.4331 2.446 0.058
-7 0.5264 0.5191 2.484 0.056
-6 1.2743 1.7801 1.754 0.140
-5 0.3490 0.3457 2.473 0.056
-4 0.2696 0.4164 1.586 0.174
-3 0.8296 0.7799 2.605 0.048
-2 1.0894 0.8281 3.222 0.023
-1 2.3329 2.7111 2.108 0.089
0 4.5166 3.9164 2.825 0.037
1 3.2318 4.1131 1.925 0.112
2 0.8559 0.5396 3.886 0.012
3 0.2945 0.1820 3.962 0.011
4 0.2251 0.2760 1.997 0.102
5 0.1447 0.2029 1.747 0.141
6 0.0607 0.0271 5.491 0.003
7 0.1299 0.0981 3.244 0.023
8 0.0411 0.0397 2.540 0.052
9 0.0692 0.1027 1.651 0.160
10 0.1885 0.1639 2.817 0.037
11 43.0224 85.8135 1.228 0.274
56
12 1.5179 2.3342 1.593 0.172
13 0.1160 0.1066 2.666 0.045
14 0.2478 0.3888 1.561 0.179
15 1.1385 1.5994 1.744 0.142
16 2.3328 4.4154 1.294 0.252
17 0.7888 0.6696 2.886 0.034
18 0.2792 0.3248 2.105 0.089
19 0.2432 0.2181 2.732 0.041
20 0.3464 0.5638 1.505 0.193
21 0.2046 0.0673 7.444 0.001
22 0.7916 1.0715 1.810 0.130
23 0.1092 0.0663 4.038 0.010
24 0.8801 1.5974 1.350 0.235
25 0.0676 0.0470 3.521 0.017
26 0.9100 1.5537 1.435 0.211
27 0.4095 0.4468 2.245 0.075
28 1.2688 1.3201 2.354 0.065
29 17.2388 33.5374 1.259 0.264
30 0.2198 0.2115 2.546 0.052
Source: Research Findings
57
Appendix IV: Summary of Data
β0 β1
Access Kenya 0.050 -0.021
Barclays 0.025 0.004
C.F.C Bank 0.024 -0.007
Car & General 0.016 0.002
Carbacid 0.018 -0.014
Centum Investment 0.033 0.013
City Trust 0.052 0.001
Cmc Holdings 0.037 -0.003
Co-Operative Bank -0.050 -0.018
Crown Berger -0.040 0.003
Diamond Trust -0.012 -0.008
Ea Breweries 0.022 -0.007
Ea Breweries 0.008 0.002
Ea Cables 0.022 0.002
Eaagads 0.023 0.015
Equity Bank 0.011 0.014
Express Kenya 0.034 0.013
Jubilee Holdings 0.026 -0.007
Kenya Reinsurance 0.021 0.032
Kplc -0.001 -0.030
Limuru Tea 0.021 0.000
Mumias Sugar 0.016 0.017
Nation Media Group -0.007 0.027
National Bank 0.014 0.017
Nic Bank -0.015 0.031
Nic Bank 0.001 0.026
Pan Africa Ins. -0.015 0.016
Sasini 0.052 0.020
Scangroup 0.071 0.076
Scbk 0.228 0.054
Standard Group -0.006 0.036
Standard Group -0.073 -0.164
Tps Serena -0.073 -0.029
Unga Group -0.026 -0.025
Source: Research Findings
58
Appendix V: Data Collection Sheet
Company Name
Date Share prices Market return
1.
2.
3.
4.
5.
6.
7.
8.
9.
10.
11.
12.
13.
14.
15.
16.
17.
18.
19.
20.
21.
22.
23.
24.
25.
26.
27.
28.
29.
30.
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