THE IMPACT OF DIVIDEND POLICY ON INVESTMENT
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THE IMPACT
OF DIVIDEND POLICY ON INVESTMENT
CHAPTER ONE
Introduction
1.0 Background to the study
For firms to
remain in business and pursue their set goals and objectives, they need to
adhere to certain financial management principles and policies that can enhance
their overall performance. These policies have impact on the bearing of the
organization. There are so many financial policies open to firm’s management;
and one of such policy is dividend policy. Dividend is the return that accrues
to shareholders as a result of the money invested in acquiring the stock of a
given company (Eriki and Okafor 2002). While dividend policy on the other hand
is concerned with division of net profit after taxes between payments to
shareholders (ordinary shareholders) and retention for reinvestment on behalf
of the shareholders (Kempner 1980).
Dividend policy serves as a mechanism for
control of a managerial opportunism. Empirical studies show that firms in developing
Countries (e.g. Nigeria) smooth on their income and therefore, their dividends.
The pattern of corporate dividend policies not only varies over time but also
across countries, especially between developed, developing and emerging Capital
markets. If the value of a company is the function of its dividend payments,
dividend policy will affect directly the firm’s cost of capital. But is there
any significant relationship between dividend policy and corporate performance
in form of profitability investment and Earning per Share? What are the factors
affecting dividend policy in Nigerian firms? This topic continues as one of the
most challenging and controversial issues in corporate finance and financial
economies. Research into dividend policy has shown not only that a general
theory of dividend policy remains elusive, but also that corporate dividend
varies over time between firms. For a firm, which encounters financial
difficulties, reliance is placed on retained earnings and accordingly results
in lower payout ratios.
However,
shareholders have keen enthusiastic interest in the outcome of their
investments. These outcomes are expressed in terms of earnings and capital
gains. These two ingredients are in turn affected by the quality of policies
made by the management team of the enterprises. Among the most important
decisions that management of an enterprise must take which has direct bearing
on firms’ continuity, earning potentials, investors’ satisfaction and share
price gain is the decision to withhold or distribute net earnings as retained
profit or dividends.
Pandey
(1999), stated firmly that "Dividend policy is a decision by the financial
manager whether the firm should distribute all profit or retain them or to
distribute a portion and retain the balance. Dividend policy is an important
aspect of corporate finance and dividends are major cash outlays for many
corporations.
Garrison
(1999) defined dividend policy as payments made to stockholders from a firm's
earnings, whether those earnings were generated in the current period or in the
previous period. Dividend could also be referred to as that part of the
enterprise earning that is given to shareholders as interest on their
investment. Also, it represents the return to investors who put their money at
risk in the company. Company pays dividend to reward existing shareholders and
encourage others that are prospective shareholders to buy new issues of the
common stock at high price.
However,
many seem obvious that a firm would always want to give as much as possible to
its shareholders by paying dividends. It might seem equally obvious that a firm
can always invest the money for its shareholders instead of paying it out. The
heart of dividend policy question is should the firm payout money to its shareholders
or should the firm take the money and invest it for shareholders into the
enterprise business.
Moreover, it
has been discovered that the dividend policy of a firm always have short term
or long term effect on the market price of its shares.
It is quite
difficult to clearly identify the effects of payout on firm's valuation. The
valuation of a firm is a reflection of so many factors that the long run effect
of payout is quite difficult to separate.
Kehinde and
Abiola (2001) viewed dividend policy as "the dividend policy of a firm
accounts for how a firm divides its income between retained earnings and
dividends. It states the policy measure of how much dividend to be declared, in
what form should the dividend be declared- either as a cash dividend or as
stock dividends. By dividend policy the corporate organization, strike a
balance between current income to the shareholders and a future income. Income
can be retained and reinvested into available profitable investment
opportunities. The retained earnings provide the cheapest source of financing.
This research is to examine empirically the factors that affect dividend policy
of some listed quoted companies. In addition, it tends to identify the impact
of dividend policy on examine the factors that impact on dividend policy in
respect to investment; and determine if there is any significant relationship
between dividend policy and earning per share of companies.
1.1 Overview of the Nigeria Economy
and Stock Market
Nigerian is
a West African Economy with a long coast line in the gulf of guinea which is
the part of the Atlantic Ocean. The country shares international borders with
Chad, Cameroon Benin and Niger. Nigeria ranks 32 in the world in terms of total
area. The terrain of the country consists of southern lowlands and plateaus in
the central region. The south east region has a mountainous surface, while the
north consists of plains. Nigeria is the federal constitutional republic, with
36 states and 1 federal capital territory (FCT). Nigeria is recognized as the
most populated nation in Africa. According to the 2009 estimates, the country
has a total population in excess of 154 million, of which almost 70% live below
the international poverty line.
Nigeria‟s
economy is overly dependent on the petroleum sector; it is the largest oil
producer in Africa. The petroleum industry is central to the Nigerian economic
profile; it is the 12th largest producer of petroleum products in the world.
The industry accounts for almost 80% of the GDP share and above 90% of the
total exports. It is blessed with the high quantities of tin, iron ore, zinc,
coal and some uranium. Nigeria is highly rich in terms of coal and natural gas
which are untapped. Half of the population is earning their livelihood from the
agriculture and allied activities and is producing rice, maize, groundnuts,
rubber etc.
Nigeria is a
middle-income nation with developed financial, communication and manufacturing
sectors. Nigeria’s manufacturing sector
includes areas like vehicle production, textiles, pharmaceuticals, paper,
cement etc. It is recognized as the eminent member of the OPEC. Nigeria is also
one of the fastest growing economies in the international arena as the
International Monetary Fund has projected its growth to be 9 per cent in 2008
and 8.3 per cent in 2009. It has the second largest stock exchange in the
continent.
1.1.1 The Nigerian Economy
Nigeria's
economy depended more on petroleum in the 1980s compared to the 1970s. The
Nigeria's economy dependence on petroleum accounted for 77 percent of the
federal government's current revenue and 87 percent of export receipts in 1988.
In the 1980s declining oil production and prices contributed to another facet
of the economy. The decline in per capita real gross national product (GNP)
persisted until oil prices began to rise in 1990. GNP per capita per year
decreased 4.8 percent from 1980 to 1987, which led to Nigeria's classification
by the World Bank as a low-income country in 1989 (based on 1987 data) for the
first time since the annual World Development Report was instituted in 1978. In
1989 the World Bank also affirmed that, Nigeria is poor enough to be eligible
(along with countries such as Bangladesh, Ethiopia, Chad, and Mali) for
concessional aid from the International Development Association (IDA).
The Nigerian
economy had a chain of rapid changes in the government's share of expenditures.
As a percentage of gross domestic products (GDP), national government
expenditures rose from 9 percent in 1962 to 44 percent in 1979, but fell to 17
percent in 1988. Nigeria's government became more centralized as a result of
the 1967-70 civil wars. This oil boom in the 1970s provided the tax revenue
with the 35 ability to strengthen the central government further. With
Expansion of the government's share of the economy, the government did small to
enhance its political and administrative capacity, but did raise incomes and
the number of jobs that the governing elites could distribute to their clients.
The economic
crumpled in the late 1970s and early 1980s contributed to substantial
disgruntlement and disagreement between ethnic communities and nationalities,
which added to the political pressure to drive out more than 2 million illegal
workers (mostly from Ghana, Niger, Cameroon, and Chad) in early 1983 and May
1985. The lower spending of the 1980s to a certain extent resulted in the
structural adjustment program (SAP) which upshot from 1986 to 1990, first
founded by the International Monetary Fund (IMF) and carried out under the
patronage of the World Bank, which emphasized privatization, market prices, and
reduced government expenditures. This program was based on the principle that,
as GDP per capita falls; people would demand relatively fewer social goods
(produced in the government sector) and relatively more private goods, which
tend to be essential items such as food, clothing, and shelter. Widespread
poverty and lack of industrial resources are the biggest challenges for
Nigeria. The country ranks 151 out of 177 on the UN Development Index. During
2003-07, the government initiated strategic economic reforms to eradicate
poverty and bring economic equality. However, corruption has been the main
barrier to the success of any such effort.
1.1.2 History of Nigeria Stock Exchange
The Nigeria
Stock Exchange is the second largest equities marketplace in Africa and the
largest in West Africa. The Nigerian Stock Exchange was established in 1960 as
the Lagos Stock Exchange and In December 1977 it became The Nigerian Stock
Exchange, with branches established in some of the major commercial cities of
the country. At present, there are eight branches of The Nigerian Stock
Exchange. Each branch has a trading floor. The branch in Lagos was opened in
1961; Kaduna, 1978; Port Harcourt, 1980; Kano, 1989; Onitsha, February 1990;
and Ibadan August 1990; Abuja, October 1999 and Yola, April 2002. Lagos is the
Head Office of The Exchange. An office has just been opened in Abuja. The
Exchange started operations in 1961 with 19 securities listed for trading.
Today there are 262 securities listed on The Exchange, made up of 11 Government
Stocks, 49 Industrial Loan (Debenture/Preference) Stocks and 195 Equity or Ordinary
Shares of Companies or private holdings, all summing to a total market
capitalization of well above N875.2billion. The year 2007 was quite outstanding
for the Nigerian Stock Exchange as it experienced tremendous growth with a
74.7% return on index and market turnover of over 4 times the previous year. It
is expected that with a hypothetical forecast of 100% ratio by 2012, that the
Nigerian Stock Market would achieve a market capitalization of 29 Trillion
Naira. The transactions in The Market are regulated by The Nigerian Stock
Exchange which is an autonomous and self-regulatory organization (SRO), and the
Securities and Exchange Commission (SEC) on the other hand is vested with the
power to administer Investments and Securities according to the investment
ruling of 1999. After the deregulation of the capital market in 1993 by the
Federal Government, The Nigerian Stock Market was internationalized in 1995.The
capital market was internationalized with the removal of laws that constrained
foreign participation in the Nigerian capital market. Due to this removal of
the Exchange Control Act of 1962 and the Nigerian Enterprise Promotion Decree
of 1989, foreigners can now participate in the Nigerian capital market both as
operators and investors. Currently there are no limits any more to the
percentage of foreign holding in any company registered in Nigeria. Pricing and
other direct controls have given way to indirect controls by the regulatory
bodies, which are the Securities and Exchange Commission of Nigeria and The
Nigerian Stock Exchange. Basically on the overall, the competitiveness of the
Nigerian market has improved and in addition is more investor-friendly.
1.1.3 Structure of the Nigerian Stock Exchange
(NSE)
The market
broadly speaking is the arm of the financial market which trades in medium to
long term financial instruments such as Loan Stocks, Government bonds and
Equity or Ordinary Shares with maturity in excess of usually one year; without
this markets investors would not be able to liquidate their investments or
adjust their portfolio whenever they aspire to do so and there would be no
motivation to invest in securities. Major Companies listed in Nigeria Stock
Exchange are:
A.A.A. Stockbrokers Limited
AIL Securities Limited
Alliance Capital Management Company Limited
BFCL Assets & Securities Limited,
BGL Securities Limited,
Calyx Securities Limited
Capital Assets Limited
Dakal Services Limited
Davandy Finance & Securities Limited
EMI Capital Resources Limited
The stock
market is segmented in two units, the primary market and secondary market. In
the primary market where stock shares are first sold, Companies raise money for
investment projects. Investment bankers specialize in arranging financing for
companies in the primary market. Investment bankers often act as underwriters,
buying newly issued stock from the company and then reselling the stock to the
public. The primary market is best known as the market for initial public
offerings (IPOs). The secondary market is where investors trade securities
among themselves; the secondary market enhances the supply of funds to the
primary market. If there were no secondary market where investors could cash
their investment in listed securities they choose, many investors may not be
able to buy new shares in the first place. Secondary market transactions are
directed through three channels; directly with other investors and with a
dealer or indirectly through a broker. Most common stock trading is aimed at an
organized stock exchange. The most organized stock exchange is the New York
Stock Exchange (NYSE), in the United State which is known as the Big Board,
NYSE is owned by its members also partly by the government. From the
perspective of the overall economy, the secondary market is particularly
important, as it makes it possible for the economy to ensure long-term
commitments in real capital. The Nigerian stock exchange has over two million
individual investors and above three hundred institutional investors including
NSITF, insurance companies and government parastatals, using the facilities of
the stock exchange. In the last frothy years, the NSE has been free from any
major fraud, shocks and scandals with the exception of the witnessed fraudulent
sale of share certificates relating to Nestle Foods Nigeria Plc that took place
recently. In this regard, the listing requirements and code of conduct of
members and staff of the NSE have helped to ensure: Disciplined public
accountability; persistent survival and improved performance of the quoted
companies; Disciplined management of listed companies and market operators; an
increasing pool of ingestible funds for economic development. The implementation
of the Automated Trading System has significantly enhanced the trading process
and made it easier for ordinary people who struggle with trading
technicalities.
1.1.4 Efficiency of Nigerian Stock Exchange
Nigerian
Stock Exchange can be mentioned as a recent establishment leading to very few
studies investigating the efficiency of this emerging market.
According to
Fama (1965) an efficient capital market is a market that is efficient in
processing information. The prices of securities at any time are based on
correct evaluation of all information available at that time. In an efficient
capital market, prices fully reflect available information. In other words, the
theory assumes that such information will be properly interpreted by the
investors in their investment decisions. Given this fact, it is therefore
expected that in an efficient market, information will be quickly and widely
distributed and reasonably available to all investors. Price change as a matter
of fact will only occur at the break of new information to the market which
could affect future profitability of the company and consequently future
dividends.
Samuel and
Yacout (1981) used serial correlation test to observe weekly price series of 21
companies in Nigerian from July 1977 to July 1979. The results show that the
stock price changes are not serially correlated but follow an unsystematic
walk, thus accepting the notion of Weak-Form market efficiency.
In 1984,
Ayadi tested the price behaviour of 30 securities quoted on the NSE between
1977 and 1980. The Monday closing prices of these shares where used, after
adjusting for cash dividends and script issues. The result from these test
showed that the share price movements on the NSE followed a random pace.
Anyanwu
(1998) investigates the efficiency of the NSE from the perspective of the
markets relationship to economic growth of the nation. He used indices of stock
market development liquidity, capitalization, market size, among others to
create an aggregate index of stock market development and associated it to the
long-run economic growth index, emphasizing the GDP growth rate. At the end,
results showed a positive relationship between the two indices and as a result
concluded that NSE is efficient to the extent that it affects the economic
development of the country. Olowe (1999) examined evidence of Weak-Form
efficiency of the NSE using correlation analysis on monthly returns data of 59
individual stocks listed on the NSE over the period January 1981 to December
1992. The results provide support for the work of Samuels and Yacout (1981) and
Ayadi (1984), that is, the NSE is efficiency in the Weak-Form.
Akpan (1995)
studied the informational efficiency of the NSE including the risk implications
of investing in the market, using time series data of stock market price
indices covering the period 1989 to 1992. The results show evidence to reject
the hypothesis of Weak-Form efficiency of the NSE.
1.2 Statement of problem
The dividend
policy of a firm accounts for how a firm divides its income between retained
earnings and dividends. It states the policy measure of how much dividend to be
declared, in what form should the dividend be declared- either as a cash
dividend or as stock dividends. Through dividend policy an organization, strike
a balance between current income to the shareholders and a future income.
Income can be retained and reinvested into available profitable investment
opportunities. But, what factors affect dividend policies of organizations?
Again, should the firm payout money to its shareholders or should the firm take
the money and invest it for shareholders into the enterprise business.
Consequently, the problem of this study resulted from the desire of the
researcher to examine the factors that impact on dividend policy in respect to
investment; and determine if there is any significant relationship between
dividend policy and earning per share of companies?
1.3 Objective of the study
The
objective of the study is to:
Examine the factors that affect dividend
policy in an organization.
Determine the impact of dividend policy on
Investment.
To determine if there is any significant
relationship between dividend policy and Earning per Share of Companies.
1.4 Research questions
Is there any significant relationship
between dividend policy and corporate profitability?
Is there any significant relationship
between dividend policy and investment?
Is there any significant relationship
between dividend policy and earning per share of companies?
1.5 Research hypotheses
The research
hypotheses are stated below;
Hypotheses 1
Ho: There is no significant relationship
between dividend policy and corporate profitability.
Hi: There is a significant relationship
between dividend policy and corporate profitability
Hypotheses 2
Ho: There is no significant relationship
between dividend policy and investment.
Hi: There is a significant relationship
between dividend policy and investment
Hypotheses 3
Ho: There is no significant relationship
between Earning per Share and Dividend policy.
Hi: There is a significant relationship
between Earning per Share and Dividend policy.
1.6 Scope and Limitation of the study
The scope of
this study is limited to the topic on discuss viz; Factors that determine
dividend policies of some selected listed companies in Nigeria. Data for the
study were extracted from annual report and accounts of twenty five (25) quoted
companies in Nigeria. These data were subjected to regression analysis, using
e-view software to find out if there is a significant positive relationship
between dividend policies of organizations and profitability; and if there is a
significant positive relationship between dividend policy and investments and
if there is a significant positive relationship between dividend policy and
Earnings Per. Share.
1.7 Significance of the study
There have
been many empirical investigations, analyses and studies in relation to what determines
dividend policy of firms. This study will equally examine the factors that
determine dividend policies. It will examine the variables and analyze its
impact on the profitability, investment and the possible relationship between
earnings per share and dividend policy.
The
unpredictability of trends in the Nigerian Stock Market are unprecedented,
hence the researchers’ compelling interest to fully investigate, document and
explain the factors that causes these trends, while underlining the opportunities
apparent in the reordering of economic priorities and the opportunities for the
investors in the market to learn how to make intelligent investment engagements
and decisions.
At the end
of the study Organizations would see the need to ensure that they have a good
and robust dividend policy in place because it will enhance their profitability
and attract investments to the organizations.
1.8 Definition of terms
Capital
Market: Capital markets are markets for trading in long-term finance (long tem
financial instruments like equities and debentures).
Nigeria
Stock Exchange: Is the primary operator in the Nigerian capital market in which
companies and other institutions can raise funds by issuing shares or loan
stock but it is more important as a secondary market for buying and selling
existing securities.
Mechanism:
This includes the operative issue and transfer procedure.
Institutions:
These include regulatory agencies, issuing houses, the stock-broking firms etc.
Ordinary
share: These are the real owners of company, because they bear the greatest
risk in the company and also benefit from its success. They represent permanent
capital of a company.
Preference
shares: The holders are entitled to a fixed percentage of dividends before
ordinary shareholders are paid any dividend.
Bonds: State
and local governments go to raise funds on the floor of the NSE using bonds.
Debenture/loans
stock: These are instrument used to raise corporate funds for financing
long-term capital needs.
NSE: This is
an acronym for Nigerian Stock Exchange
Dividend:
Dividend is a distribution of profits earned by a joint stock company, among
its shareholders.
Liquidity:
if the dividends are to be paid by cash, of course, cash must be available to
pay the dividend declared.
Stability of
earnings: earnings are subject to varying degrees of risk and the greater the
variability, the greater the likelihood of reduced dividend due to sudden drop
in earnings.
Taxation:
income distribution and capital gain have different tax implications for
investors. This will affect the relative desirability of dividend and retained
earnings. Hence the marginal rate of tax of the dormant shareholder can be an
important consideration in determining dividend policy.
Investment:
As used in the study refers to committing something into a means to generate
revenue or interest in return. It could either be long term or short term
investment.
Return on Investment:
The yield accruing from committing something into another i.e. dividends to
shareholders, accruals from lease etc.
Return on
Capital Employed (ROCE): This is a summary measure of operating efficiency and
management performance.
Fixed Asset
(FIXA): These are assets purchased for a long-term use and are not likely to be
converted quickly into cash.
Earnings per
Share (EPS): This is the portion of a company’s profit allocated to each
outstanding share of common stock.
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