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Factors affecting Dividend Policy of listed Companies in Nepal

A MBS Thesis Proposal

Submitted to:

Research Department

Faculty of Management

Bishwa Adarsha College

Itahari, Sunsari, Nepal

Submitted by:

Shishir Chapagain

Course: MBS

Exam Roll Number: 4650009

TU Registration Number: 7-2-39-1119-2011

In partial fulfillment of the requirement for the degree of

Master of Business Studies (MBS)

Itahari, Sunsari

March, 2019
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TABLE OF CONTENTS

Table of Contents

Abbreviation

1.1 Background of the Study 1

1.2 Statement of the Problem 3

1.3 Objectives of the Study 6

1.4 Significance of the Study 6

1.5 Literature Review 7

1.5.1 Introduction 7

1.5.2 Theoretical Framework 10

1.6 Research Methodology 12

1.6.1 Introduction 12

1.6.2 Research Design 12

1.6.3 Research Methodology 13

1.6.4 Description of Sample 13

1.6.5 Nature and Sources of Data 19

1.6.6 Data Collection Procedure 13

1.6.7 Validity and Reliability 14

1.7 Limitations of the Study 14

1.8 Organization of the Study 15

References 16
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ABBREVIATIONS

CR Current Ratio

df Degree of Freedom

DPR Dividend Payout Ratio

DPRL Dividend Payout Ratio of Previous Year

ECM Emerging Capital Market

FS Firm Size

GRP Graduate Research Project

LEV Leverage

MBS Master of Business Studies

NEPSE Nepal Stock Exchange

PE Price Earning Ratio

ROA Return on Assets

ROE Return on Equity

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1.1 Background of the study

Every firm operates to generate profit in a capital market. Profit is the return from

investment which is the fund collected from various sources. Companies raise funds in

various ways but one of the major source of raising fund is equity capital which is raised

from its shareholders. Shareholders invest in the company expecting return. Dividend

policy is the major policy which helps to address the issue of the shareholders.

Despite extensive research into dividend policy, a full understanding of the

factors that influence dividend policy and how these factors interact has not yet

been established. The dividend decision is taken after careful consideration of a number

of factors, such as legal and financial. This is because it is impossible to develop a

dividend policy set that applies to all companies. The decision about dividends differs

from company to company in the light of company considerations (Marsy, Sakr & Amer,

2018).

Companies finance either by using internal or external sources of funds. The

internal sources include retained earnings and depreciation, while external sources can be

new borrowings or the issue of stock. The decision of whether to use part of the profit

(retained earnings) in financing investment is dividend decision. The decision that

determines the proportion of external finance to be borrowed and the proportion to be

raised in the form of new equity is capital structure decision. The managers of the

companies are usually free to determine the level of dividend they wish to pay to holders

of ordinary shares, although factors such as legal requirements, debt covenants and the

availability of cash resources impose limitations on this decision. This is why many
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empirical studies will record variations in dividend behavior across companies, countries,

time and type of dividend.

Generally, investors are aiming to earn income in the form of dividends and the

difference between the selling prices of the share purchase price (capital gain). Investors

as shareholders expect a big gain or a minimum dividend relatively stable every year.

The dividend is expected to improve the welfare of shareholders (Ritha & Koestiyanto,

2013).

Dividend policy of a firm is an effect of dividing its net earning into two parts: the

retained earnings and dividend payment. Brealey and Myers (2005) described dividend

policy as one of the top ten most difficult unsolved problems in financial economics. The

retained earning is used by the company for long term growth; we call it as an internal

source also. Dividend is the portion of earning, which is paid to the stockholders, in

return of their investment. Dividend policy is the decision to pay out earnings versus

retaining and reinvesting. A decision regarding dividend distribution is affected by

various financial considerations which present a difficult situation to the management for

such decision.

Dividend is the reward that a company gives to its shareholders. In other word,

dividend is the parts of earning which is distributed among shareholders. Dividend

decision is one of the important decisions for any profit making firm. In the theoretical

context, dividends have been both a core topic and a controversial area of finance since

the dividend irrelevance theory proposed by Miller and Modigliani (1961). Dividend

payout is the portion of net income which is paid to the shareholders of the firm.
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Dividend policy is the entire managerial policy to determine how much net

income will be paid out as dividends and how much net profit can be maintained for

company. This led to a number of conflicting theories. Among the dividend irrelevance

theory stated by Miller and Modigliani (1961) that the dividend decision doesn’t

affect the value of the company and don’t affect the stock price of a company, in other

words the actual dividend policy is irrelevant for the question. Bird in the hand theory

stated by Gordon and Lintner (1962) that investors are more confident about the receipt

and distribution of dividends rather than capital appreciation. Signaling theory which

states that the dividend changes is a signal to investors about the company's future

(Alzomaia & Al Khadiri, 2013).

1.2. Statement of Problem

The dividend policy is one of the most debated topics within corporate finance and many

academics have been trying to find the missing pieces in the dividend puzzle for more

than a half century. But dividends is not a new phenomenon, payouts to shareholders

have been a standard procedure for most companies in hundreds of years (Baker, 2009).

But there are many cases where companies are successful without paying dividend to its

stockholders.

The debate over the importance of dividend policy first appeared in Miller and

Modigliani (1961), who concluded that in a world of perfect capital markets, the payment

of dividends does not affect the value of the firm and is therefore irrelevant. But, the

market is not perfect therefore, to accommodate the world in which market imperfections

exist, academicians have developed many theories to explain reasons for a firm to pay
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dividends. Baker and Powell (2000) has presented example where mature companies with

highly stable cash flows, paying too little in dividend could lead managers to investing

excess cash flow in projects or acquisitions with insufficient net present value. Yet, for

high growth firms, paying out too much in cash dividends may reduce the firm’s financial

flexibility and force it to pass up valuable investment opportunities. In this both

situations, firm will be negatively affected. Although there are many research found to

resolve the dividend puzzle.

Despite extensive research into dividend policy, a full understanding of factors

that influence dividend policy and how these factors interact has not yet been established.

While the argument for the irrelevance of corporate dividend policy in perfect capital

markets has been very important in financial theory, dividend policy in the real world,

where the shortcomings of the market exist, also raises many controversies. The presence

of asymmetric information, agency problems, taxes and transaction costs all seem to

make dividend policy a substantial issue. A large amount of theoretical and empirical

research has tried to identify the determinants of corporate dividend policy. To date,

however, there is no consensus on the factors that influence the business distribution

policy. The problem becomes even more complicated when it comes to emerging capital

markets (Marsy, Sakr & Amer, 2018).

Fitri et al. (2016) noted that the dividend policy in ECMs from the point of view

of corporate finance has not yet been empirically investigated. Continued financial

reforms in emerging markets, as well as the validity of published data, will further

encourage research into other determinants of dividend policy, including the impact of

agency cost, information and investments, taxes and the capital structure of companies.
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This shows much more research needed to be done regarding the dividend policy

in ECMs. This study tries to give an overview of the dividend policy in an ECM, namely

the Nepal Stock Exchange (NEPSE), where there is no evidence about the determinants

of decisions about the dividend of companies. The purpose of the study is to define the

factors that influence the dividend policy in the financial sector and non-financial sector

listed on the Nepal Stock Exchange.

Despite the fact that many studies have been conducted on the financial markets

of developed countries, very little has been done in the case of emerging capital market.

Emerging Capital Market is different in many aspects from those in developed countries.

They are often of more recent origin, have less information efficiency, and are smaller

and more volatile. ECMs also differ from these developed markets due to other

characteristics, such as corporate governance, taxation of capital gains, unsystematic risk

and dividends, and ownership structure (Marsy & Heba, 2018).

There are large number of studies found to describe the relationship between a

number of factors and the company’s dividend payouts to shareholders. But even though

many studies have been conducted, the results indicate that there are some differences

between countries regarding which factors that have an impact on dividend payouts. For

example Rozeff (1982) conducted an investigation regarding the determinants of

dividends in United States and he found a strong negative relationship between the

riskiness and the dividend payouts. These results are contrary to the study made by Al

Shabibi and Ramesh (2011) in the United Kingdom. The study revealed a positive

relationship between the dividend payouts and the riskiness of the company. It becomes
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even more important in the country like Nepal where the capital market is just starting to

grow and where only few studies have been done.

1.3 Objectives of the study

The main objective of this research is to investigate the relationship between the dividend

policy and company’s selected factors. However, specific objectives are as follows:

i. To examine the impact of liquidity, profitability, risk, firm size, leverage and dividend

payout of previous year on dividend policy of firms.

ii. To identify the most influencing factor determining dividend policy.

iii. To compare the factors affecting dividend policy of financial and non-financial

companies listed in Nepal Stock Exchange.

1.4 Significance of the study

This study opens up an opportunity to contribute to the understanding of the determinants

of dividend policy of the listed corporations in the Nepal Stock Exchange, aiming

permeates greater scientific knowledge in the context of understanding the determinants

of dividend puzzle policy and the existing divergences of several previous empirical

studies. This study helps to identify the principal determinants of the dividend policy of

the companies listed on the Nepalese capital markets. It also allows sustaining and

improving the corporations and investors’ decisions.

This study will helps in providing various insights to the managers for deciding

dividend policy and investors and shareholders for deciding on investing decision and/or

reinvesting decision. Dividend policy is the controversial topic of financial management.

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It may affect value of the firm. Moreover, most common objective of the firm is

to maximize shareholder's wealth. Shareholders are more concerned with the amount of

dividend paid by firm. So, they have more curiosity on the dividend policy adopted by

their concerned firms. With this study they can make their mind more comparable in

terms of dividend pattern and value of the firm. Generally, most of the investors prefer to

invest in profitable firm and expect high return. Corporate sector is expanding but there is

information gap between the management of Nepalese companies and Nepalese investors

who are eager to invest in shares. They are just investing in the shares in trial and error

methods. So, the dividend behavior should be effective to attract new investors keeping

the previous investors satisfied and should maintain the reputation of the firm. It also

helps other researchers for the further study in dividend policy.

At last, this study is relevant to identify the factors affecting dividend policy in

context of Nepalese companies and also helps to determine the critical factors affecting

dividend policy. It helps stakeholders of the company to take relevant decision. Dividend

policy decision is one of the most important decisions in every organization. This study is

expected to fill the research gap and add to the inputs to financial literatures relating to

the dividend policy.

1.5 Literature Review

1.5.1 Introduction.

Dividend decision is one of the important aspects of a company’s financial policy. At the

same time it is not an independent decision. Rather, it is a decision that is taken after

considering the various related aspects and factors. The objective of this section is to

identify the factors that influence the dividend policy decisions. There are various ways
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through which companies can generate income and can put to use. Based on the residual

theory of dividend, there is the tendency for companies to reinvest such profit in the

business. Because of clientele effect there has been increasing pressure on companies to

pay dividends. Dividends are referred to as reward for providing finance (Kumar, 2003).

The question is should all income be paid out as dividends or part? What percentage

should be retained and what percentage to be paid? The dividends and dividend policy

were the subject of many studies for many years from past to present (Lintner, 1956;

Miller and Modigliani, 1961; Amiduand Abor, 2006). Dividend payout policy has been

the primary puzzle in the economics of corporate finance since the work of Black (1976).

Profit is the main economic purpose for companies, being that there can be two

destinations attributed to it: the profit can be held in the company and used in its

activities, or it can be distributed to shareholders. As for its distribution, it can be done in

two ways either in the form of dividends or through the repurchasing of circulating

shares.

Every firm operates to generate profit in a capital market. Profit is the return from

investment which is the fund collected from various sources. Companies raise funds in

various ways but one of the major source of raising fund is equity capital which is raised

from its shareholders. Shareholders invest in the company expecting return. Dividend

policy is the major policy which helps to address the issue of the shareholders.

Over the past several decades, researchers have directed much attention toward

identifying the determinants of corporate dividend policy. Finance scholars have engaged

in extensive theorizing about factors that may be important in determining a firm’s

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dividend policy. For example, some of these theories involve tax preference, signaling,

and agency explanations. Other researchers have developed and empirically tested

various models to explain dividend behavior. Some conducted surveys of corporate

managers to learn the most important determinants of corporate dividend activity.

Because of the considerable volume of both theoretical and empirical work on dividends,

the following discussion focuses on a few behavioral models and surveys on corporate

dividend policy.

Dividend Policy decides to distribute the enterprise’s profit in which business

makes the choice whether use earning after tax to reinvest or pay out dividends to

shareholders. In term of corporate, profit after tax, considered as the lowest cost of

funding source, is kept to support capital for company in reinvesting, expanding scale,

and approaching to a larger project for development of business networks. However,

companies maintaining a major portion as retained earnings will make company’s shares

less attractive. Shareholders always desire a significant dividend payout ratio because it is

the income from the capital gains of the stock. It is complicated task especially in country

like Nepal where capital market has just started growing to decide the dividend policy or

to decide the dividend payout ratio.

The term dividend policy can be described as the policy a company uses to decide

how much it will pay to shareholders such as managers, lenders, and investors. It is one

of the most debated topics and a core theory of corporate finance which still keeps its

prominent place. Debate about what drive companies to pay dividends has continued over

the years. The earliest research was undertaken by Linter (1956) on American companies

in the mid of 1950s. The finding of this study shows that dividend decisions made by
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companies are based on the current profitability and in part on the dividends of the

previous year. However, since then, there have been a plethora of on-going debate on

dividend policy and the results are mixed.

There are varied results about dividend policy in developing markets or emerging

markets. Nizar and Al-Malkawi (2008) researching on the dividend payment policy of

the Jordian companies pointed out four factors affecting this policy, including: the

profitability of the business, the financial leverage, the number of operating years, and the

internal holding rate of managers. Twaijry (2007) studied about Malaysia emerging

markets and indicated that dividend policy in the past and future. Dividends was also

influenced by profit which the greater company size, the higher the dividend payment.

1.5.2 Theoretical Framework.

Theoretical framework is a group of related ideas that provides guidance to a research

project or business endeavor. It is the structure that can hold or support a theory of a

research study. Theoretical framework is shown below:

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Figure 1.1: Theoretical Framework of the Study

Independent Variables Dependent Variable

Liquidity
Dividend Payout Ratio of
Previous Year
Dividend Policy
Leverage
Firm Size
Risk
Profitability

Types of Firm

 Financial

 Non-Financial

(Source: Theoretical Framework by Al Khadiri, 2013)

Figure 2.1 shows the conceptual framework of the research study where dividend policy

is the dependent variable whereas liquidity, dividend payout ratio of previous year,

leverage, firm size, risk and profitability are the independent variables. This study is

based on the firms listed in the NEPSE. These firms are divided into financial firms and

non-financial firms based on their nature. Financial firms include bank, insurance

companies and other financial institutions whereas non-financial firms include

hydropower, manufacturing firms and others. This study had also analyzed the result as a

whole which include all the listed firms of NEPSE.

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1.6 Research Methodology

1.6.1 Introduction

This chapter focuses on the methodology and procedures used in the study as well as how

questionnaire of the survey were administered. This chapter begins to present the research

strategy along with the research plan and design, sampling technique as well as the

instrumentation used for the research. It presents the systematic way of solving research

problems. It also describes the methods and processes applied in the entire aspects of the

study and explain the reliability and validity test as well as statistical treatments of data.

Furthermore, it refers to the various sequential steps adopted by the researcher in

studying and analyzing the research problem with research objectives in view.

1.6.2 Research Design.

This research is quantitative in nature as financial statements of listed firms of NEPSE

are interpreted using financial and statistical tools to fulfill the research objectives.

Descriptive research design was used to accomplish the study. Descriptive research

design involves observing and describing the subject without influencing it in any way.

Descriptive statistics were calculated to understand the key characteristics of the

dependent and independent variables while hypothesis testing was performed to draw

conclusion from the study. Correlation was calculated to determine the association

between variables. Fixed effect panel regression model was found appropriate for the

hypotheses testing.

1.6.3 Research Methodology.

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Every study follows certain research design and methodology In order to achieve the

objective mentioned above. In this study the procedure concerning the research includes

research design, nature and source of data and collection procedure, tools used for

analysis.

1.6.4 Description of Sample.

The population of the study was 235 firms listed in the NEPSE and the sample for the

study is 18 companies which have presented at least five years annual report. Among

them 10 are from financial sector which include bank, insurance and other financial

institutions and other eight firms from non-financial sector which are hydropower,

manufacturing and others.

1.6.5 Nature and Sources of Data.

Financial statement was used as an instrument for the study. Secondary source of data

was used for this research. Data were collected from following sources:

i. Financial documents provided by the companies in their company’s websites.

ii. Websites of Nepal Stock Exchange (NEPSE), merolagani.com and sharesansar.com.

1.6.6 Data Collection Procedure.

A panel data analysis is done to examine the factors influencing the dividend payouts

using the data of listed firms of NEPSE for the period of five years from 2013 to 2017

(2069/70 to 2073/74). Quantitative research approach was followed due to the nature of

the study. The variables examined in this study consist of secondary yearly data collected

mainly from annual report of selected firms, NEPSE and merolagani.com.

1.6.7 Validity and Reliability.

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Validity deals with the question of whether the results from a research are trustworthy and

if the measurement of a concept measures what it is supposed to measure (Saunders et al.,

2009). In order to support the conclusion, it is of importance that the factors included in

the research are related to the company’s dividend policy for this study. This research is

valid because previous studies were reviewed in order to make sure that the chosen

factors are the most important determinants of the company’s dividend policy.

Reliability deals with the question of whether the results from a research are

consistent if another research would be made based on the same conditions. This study is

based on the published financial statement of firms during the period of 2013 to 2017. As

the data is taken from reliable source and considered time period of five years makes this

study reliable.

1.7 Limitations of the Study

It is for sure that every study has some limitations and this study is no different. The

major limitations are outlined below:

i. This study has selected only 18 companies which are listed in the Nepal Stock

Exchange as a sample to disclose the determinants of dividend payout ratio.

ii. The time frame of the study is limited to the time period between 2013 and 2017.

iii. This study has decided to limit the research to six independent factors although there

are other various factors which might affect dividend policy.

iv. This study is based on secondary source of data for analysis and interpretation.

1.8 Organization of the Study

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Chapter I: Introduction

The purpose of the first chapter is to provide a general introduction to the research topic.

The chapter begins with the problem background and statement followed by the research

question. It has also explained the purpose, hypotheses and significance of study.

Chapter II: Literature Review

The second chapter provides the reader with the necessary theoretical background and it

presents the most relevant theories and previous studies related determinants of

dividends.

Chapter III: Research Methodology

The chapter consists of an overview of the methodological considerations and

assumptions underlying the research process. The choice of subject is discussed together

with the necessary methodological assumptions taken in the study.

Chapter IV: Presentation and Analysis of Data

Descriptive analysis and inferential analysis is made to find the result of the study.

Descriptive analysis contains descriptive statistics whereas inferential analysis contains

correlation and regression analysis.

Chapter V: Summary, Conclusion and Recommendation

The purpose of the final chapter is to summarize the findings, answer the research

question and further develop the analysis from chapter four. Then, this chapter discusses

the contribution and limitation of the current study. Suggestion for further research will

also be provided at the end.

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