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WELCOME TO

Effects of Dividends on Common

Stock Prices: The Nepalese Evidence

Research in Nepalese Finance

Copyright by R. S. Pradhan All rights reserved.

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Effects of Dividends on Common Stock Prices: The Nepalese Evidence

Empirical Results MPS = 1709.62 + 4.57 DPS 12.54 RE .. (4) (2.41) (4.72*) (1.71) R-bar2=0.43 F = 7.6 SEE = 225.9 DW = 1.29

MPS = 1701.37 + 4.54 DPS 12.43 RE + 0.09 PEt-1 (2.38) (4.71*) (1.69) (0.28) R-bar2=0.42, F = 5.04, SEE = 229.13, DW = 1.3

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Log-linear model: ln MPS = 3.62 + 0.60 ln DPS + 0.24 ln RE (0.92) (5.28*) (0.29) R-bar2= 0.63, F=20.91, SEE = 0.86, DW = 1.44
ln MPS=3.96+0.63 ln DPS0.05 ln RE+0.32 lnPEt-1 (1.10) (5.75*) (0.06) (3.70*) R-bar2 = 0.56, F=13.04, SEE = 0.787, DW = 1.42 ln MPS=3.73+0.01 ln DPS0.51 ln RE+0.77 ln MPSt-1 (1.38) (0.07) (0.91) (8.55*) R-bar2= 0.64, F=39.84, SEE = 0.591, DW = 2.28

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Copyright by R. S. Pradhan All rights reserved.

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Effects of Dividends on Common Stock Prices: The Nepalese Evidence Purpose: to explain share price, dividend and retained earnings relationships in the context of Nepal.
Whether there is customary strong dividend or retained earning effect on market price of share in Nepal.

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1-5 Literature review In USA, studies indicated that shareholders are indifferent towards dividends and retained earnings. More favorable tax rate on capital gains favors retention of earnings (Elton and Gruber, 1970). If there exists a net preference for capital gains as opposed to dividends, then the firms dividend policy would be a residual decision. In India, studies conducted during 1960s and early 1970s concluded that the retained earnings had no effect on the share price. However the studies conducted after late 1970s started revealing impact of retained earnings.
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Those who believe that dividend payment affects share price base their arguments on the following hypotheses: 1. Shareholders prefer current to future income. 2. Dividend has information content & the payment of dividend indicates that company has a good earning capacity. Those who believe in retention of earnings base their arguments on the following hypotheses: 1. If earnings are retained in the business, it indicates that the company has good investment opportunities. 2. Dividend in the form of capital gain is subject to lower taxes.
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Methodology: The Basic Model The model to be estimated is the one most commonly applied to cross-section data such as the following (Friend and Puckett, 1964): MPSit = a + b DPSit + c REit + eit Where, MPSit = Market price per share DPSit = Dividend per share REit = Retained earning per share The above model assumes the following reasonable a priori hypothesis: DPSit > 0 REit > 0 Market price per share is the average of high, low and closing prices of the year. Copyright by R. S. Pradhan All rights reserved.

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 This study also takes into account a partial adjustment or flexible accelerator model. For the purpose, lagged price variable has been included in the above model: MPSit = a + b DPSit + c REit + MPSit-1 + eit This model hypothesizes that each company has a desired target level of increasing market price per share, and that each company, finding its actual market price per share not equal to optimum or desired level, attempts only a partial adjustment towards the optimum or desired level within any one period. The model indicates the speed with which firms adjust their actual share price to the desired share price. Copyright by R. S. Pradhan All rights reserved.

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Empirical Results Regression of dividends & retained earnings on average market prices produced the following: MPS = 1709.62 + 4.57 DPS 12.54 RE .. (4) (2.41) (4.72*) (1.71) R-bar2=0.43 F = 7.6 SEE = 225.9 DW = 1.29 The results show the customary strong dividend & very weak retained earnings effect. The dividend coefficient is statistically significant at 5 percent level of significance indicating attractiveness of dividends among Nepalese investors. The negative coefficient obtained for retained earnings as indicated above is questionable.
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 The linear regression of market price per share on DPS, RE, and PEt-1 produced the following: MPS = 1701.37 + 4.54 DPS 12.43 RE + 0.09 PEt-1 (2.38) (4.71*) (1.69) (0.28) R-bar2=0.42, F = 5.04, SEE = 229.13, DW = 1.3 Results indicate that dividends are relatively more attractive. The sign of retained earning coefficient is not as per priori hypothesis indicating the absence of its effect on share price which is contradictory to the findings of Friends and Puckett, etc. One of the issues in dividend models is whether linear or logarithmic models explain better relations.
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 A re-computation of the regression equations utilizing logarithms produced the following : ln MPS = 3.62 + 0.60 ln DPS + 0.24 ln RE (0.92) (5.28*) (0.29) R-bar2= 0.63, F=20.91, SEE = 0.86, DW = 1.44 The equation confirms earlier result indicating a higher dividend effect rather than retained earnings effect. Dividend coefficient is significant with a priori expected sign. Coefficient of retained earning has a correct sign though it is not significant. A one percentage point increase in dividends led on the average to about 0.60 percent increase in share price, holding the other variables constant. Copyright by R. S. Pradhan All rights reserved.

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 The estimate of other equations by using logarithmic forms produced the following: ln MPS=3.96+0.63 ln DPS0.05 ln RE+0.32 lnPEt-1 (1.10) (5.75*) (0.06) (3.70*) R-bar2 = 0.56, F = 13.04, SEE = 0.787, DW = 1.42 ln MPS=3.73+0.01 ln DPS0.51 ln RE+0.77 MPSt-1 (1.38) (0.07) (0.91) (8.55*) R-bar2= 0.64, F = 39.84, SEE = 0.591, DW = 2.28 Again, the two equations confirm higher dividend effect than the effect of retained earnings. The dividend coefficients are significant with a priori expected signs.
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 A one percentage point increase in dividends led on the average to about 0.63 increase in share price, holding the other variables constant. Looking at the overall results, higher investor valuation may be placed on dividends than on retained earnings.

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1 - 14 In the last equation, the coefficient of the lagged dependent variable has been observed to be 0.77. Since the coefficient of lag dependent variable is equal to 1 minus the adjustment coefficient, the adjustment coefficient is equal to 0.23. Thus the speed of adjustment between desired and actual share prices as implied by this value is therefore slow. It seems that only 23 percent of the adjustment, of actual to desired share price is completed within a year. In the partial adjustment model, the estimated coefficients of the independent variables are equal to the elasticities of these variable times the adjustment coefficient, e.g., c1= b1 & c2= b2, b1=c1/ & b2=c2/. These coefficients are thus .01/.23=0.043 for DPS & .51/.23=2.2 for RE which again support the conclusions drawn earlier. The capacity utilization as a significant variable affecting the demand for inventories is doubtful. Thanking you Copyright by R. S. Pradhan All rights reserved.