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Dividends Policy and Common Stock Prices

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The issue of how much a company should pay its stockholders, as dividend is one that has been of concern to managers for a long time. The optimal dividend policy of a firm may be defined as the one that increases shareholders wealth by the greatest amount. It is therefore necessary, to understand the nature of the relationship between dividend and value of the firm. It is in the light of this that the study examines the possible effects of a firm’s dividend policy on the market price of its common stock with reference to the Nigerian context, using Nestle Nigeria Plc. as case study. In so doing, the methodology adopted include the use of ex post facto research techniques to acquire data and the use of co-relational research techniques, which featured the simple regression analysis used to establish the nature of any relationship existing between the two variables. The methodology also featured the use of Person’s Product Moment Correlation to test the significance of any empirically derived relationship between the variables based on the data that collected on the company in focus.

The analysis led to the rejection of the null hypotheses and formulation of conclusion that dividend policy has an inverse relationship with common stock prices in the Nigerian stock market. It was, therefore, recommended that Nigerian firms should take the advantage of rising earnings and keep the level of dividends at a fixed amount which would mean a reduction in the proportion of earnings that is distributed as profit though the face value of the dividends may be fixed. The analysis also showed a high significance in the relationship between dividend policy and common stock prices in the Nigerian stock market. As such, it was also recommended Nigerian firms should consider all the other factors that affect stock prices before formulating a dividend policy, in order to have an optimal policy that satisfies its shareholders and other interested third party.

The essence of investing is the earnings expected either in the form of appreciation in value of the assets involved or from the returns created by the use of the assets involved. These returns could be in the form of share of profits (dividends) or interest to be received for the usage of money lent. These expectations are what drive all other investment objectives. Investors who invest in stocks are highly expectant of dividends or capital gains. However, every publicly traded company has to decide whether to return cash to its stockholders at the end of each year, and, if yes, how much in form of dividends. This is the dividend decision and is central to the dividend policy of firms. Dividends are usually paid out of the current year’s profit and sometimes out of general reserves. It is usually expressed as a percentage of face value of the company’s shares as stated in its articles of association or as a fixed amount per share. The owners of a company stocks are entitled to dividends.

The value of the share corresponds to the present value of the dividends that would be paid on the share. However, some equity investors prefer capital gains to dividends while some others are interested in the income (dividends). Shareholders’ don’t only get returns just from dividend payments but also from the additional gains resulting from any appreciation in the value of the share. Whether or not (and the extent to which) dividends would be paid from the earnings of a public limited company depends on the dividend policy adopted by its management. In early corporate finance, dividend policy referred to a corporation’s choice of whether to pay its shareholders a cash dividend or to retain its earnings. The policy also addressed the frequency of such payments of dividends (whether annually, semiannually or quarterly) and how much the company should pay if it decides to do so. The optimum dividend policy of a firm depends on investor’s desire for capital gains as opposed to dividends, their willingness to forgo present dividends for future returns, and their perception of the risk associated with postponement of returns. In today’s corporations, dividend policy has gone beyond paying cash to shareholders to include such issues as whether to distribute earnings through bonus issue of shares or through other special means.

This means that firms could also pay dividends in the form of stocks, though stocks do not provide liquidity to the investors; however, it ensures capital gains to the shareholders. The expectation of dividends by shareholders helps them determine the share value. As such, dividend policy is a significant decision taken by the financial managers of any company. Other issues considered also include how to maintain and improve the value of its stocks in the market and how to balance the preferences of investors. Coming up with a dividend policy is challenging for the directors and financial managers of a company, because different investors have different views on present cash dividends and future capital gains. Another confusion that pops up is regarding the extent of effect of dividends on the share price. Due to this controversial nature of a dividend policy, it is often called the dividend puzzle. Dividends paid by the firms are viewed positively both by the investors and the firms.

The firms which do not pay dividends are rated in oppositely by investors. This has a tendency of affecting the share price of such firms, since investors’ perception about companies influence investors’ decisions which in turn affect the company’s share prices. However, any approach to dividend policy intended to be operative under real world conditions should consider the firm’s investment opportunities, investors’ preferences for dividends and capital gains, and difference in the cost of retaining earnings, declaring dividends and issuing new shares. Various firms adopt dividend policies depending on the company’s articles of association and the prevailing economic situation. Some make high pay out, while others make low pay out and yet others pay stock dividends (bonus issue) in place of or in addition to cash dividend while others pay cash only. All in a bid to maximize shareholders wealth which, in this case, is the market value of the firm’s common stock.

The dividend policy of companies has, thus been a common subject of research over the years (Litner, 1959; Gordon, 1959; Modigliani, 1982; etc.) and it has been related to several vital corporate matters ranging from agency problems to share valuation. The argument is based upon the relevance of dividends. Modigliani and Miller (1961) in Adefila et al (2006) demonstrated the irrelevance of dividend policy under a set of assumption, that is, dividend policy has no effect on stock prices. But, according to Adefila et al (op.cit.), when these assumptions are relaxed, the theory begins to collapse.

Based on the Nigerian context, however, with several fluctuations in economic variables, one might ask what the stand is of these postulates put forward by earlier researchers. In Nigeria, issues of dividends are guided by the corporate legislation provided in the Company and Allied Matters Act (CAMA), 1990 which provided for declaration of dividends only on the recommendation of the Directors and that dividend shall be payable only out of the distributable profit of the company (i.e. profit-after-tax). The Act (CAMA) also stipulated that a company shall not declare or pay dividends if after the payment would have an adverse effect on the company’s ability to meet up with its liabilities as they become due. 1.2STATEMENT OF THE PROBLEM

Those who support relevance of dividends clearly state that regular payment of dividends reduce the uncertainty of the shareholders (i.e. the earnings of the firm is discounted at a lower rate) thereby increasing the market value. However, it’s exactly opposite in the case of increased uncertainty due to non-payment of dividends. The vital questions asked today by corporate managers are the very same ones asked by managers in the 1950s. Litner (1959), in Mgbame, Mgbame and Okafor (2011), identified these questions as whether dividend payments should be maintained at its current level or changed, whether investors would prefer stable dividend payouts or those that fluctuate with earnings, whether dividend policy should favour older or young investors, etc. With the Nigerian economy being characterized by several fluctuations in economic variables, questions can be raised thus “does dividend policy have any effect on the value of firms in Nigeria? If yes, to what extent?” Consequently, this study is assessing the impact of dividends policy on the stock price movements within the Nigerian economic environment. 1.3 OBJECTIVES OF THE STUDY

The broad objective of this study is to critically examine the possible effects that a firm’s dividend policy might have on the market price of its common stock. Specifically, it further attempts to identify:

those factors that influence firm’s dividend policy;
those factors that influence firm’s share prices;
the trend of dividend payout of Nestle Nigeria Plc. from 2007 to 2011;
the trend of Nestle Nigeria Plc.’s share prices from 2007 to 2011; and
The current level of dividend payments in Nestle Nigeria Plc. 1.4RESEARCH QUESTIONS
The study will be guided by the following research questions:
What factors influence the dividend policy of firms?
What factors influence the share prices of firms?
What is the trend of Nestle Nigeria Plc.’s dividend payout from 2007 to 2011?
What is the trend of Nestle Nigeria Plc.’s share prices from 2007 to 2011?
What is the current level of dividends payment in Nestle Nigerian Plc.? 1.5STATEMENT OF HYPOTHESIS
H0: There is no significant relationship between dividend policy of a company and the prices of its common stocks in the Nigerian Stock

It is also hoped that the result of the study would be of benefit to all participants in the Nigerian stock market and aid organisations to secure a viable rating among investors and other stakeholders in the financial environment. It will educate financial managers on the impact their dividend decisions on the share price and on the general rating placed on their company. Furthermore, the study would be useful to the general public that may have access to the work by increasing their knowledge about the relationship between companies’ dividends policies and the movement of common stock prices in the stock exchange. Finally, it will serve as source of information to other researchers in the sense that it will serve as reference and reading material and contribute intellectually, thus serving as reference to the academic community by enhancing the knowledge of readers and those interested in carrying out further on areas concerning investment as a tool for economic growth. 1.7SCOPE OF THE STUDY

This study shall focus mainly on the effect of dividend policy on the market value of stocks with a particular reference to the Nigerian economy using Nestle Nigeria Plc. as the focus of study. The case study is chosen of their recorded activeness in the Nigerian stock market over the years. The study shall be conducted on the movements in the share price of Nestle Nigeria Plc. with emphasis placed on periods in which dividends are declared and paid within 2007 to 2011 inclusive. The range of years is chosen because it has recorded series of dividend declarations as well as raise in the dividends declared. 1.8DEFINITION OF TERMS

STOCKS – A unit of capital of title of ownership in a company. This carries the right to share of the company’s profits and to vote in the company’s general meetings. DIVIDENDS – Dividends are returns to shareholders from company earnings. A dividend is a cash payment from a company’s earnings announced by a company’s board of directors and distributed among stockholders. In other words, dividends are an investor’s share of company profits, given to him or her as part owner of the company. DIVIDEND PAYOUT RATIO: The percentage of earnings paid to shareholders in dividends. Payout is the ratio of total dividends to total earnings.

The payout ratio is set to one in cases where a total dividend exceeds total cumulative profits. This is the total dividend paid as a percentage of the net profit. DIVIDEND POLICY: The policy a company uses to decide how much it will pay out to shareholders in dividends. SHAREHOLDERS’ VALUE: The value delivered to shareholders because of management’s ability to grow earnings, dividends and share price. In other words, shareholder value is the sum of all strategic decisions that affect the firm’s ability to efficiently increase the amount of free cash flow over time. INFORMATION ASSYMETRY: A situation in which one party in a transaction has more or superior information compared to another. This often happens in transactions where the seller knows more than the buyer, although the reverse can happen as well. CHAPTER TWO – LITERATURE REVIEW

All research works should seek to build on previous knowledge. They may exist in published forms in newspapers, journal, and articles and other media. This chapter exclusively serves as the moving train through which the researcher visits some related literatures which wrote on dividend policy and stock prices. As such, the chapter starts by giving a conceptual examination of the variables under study – dividend policies and stock prices. In it, the researcher went further to review the works of past researchers which have direct bearing on the variables and the problem of the study. The chapter closes by a review of existing theories derived or constructed as a result of previous research works and which are relevant to the problem under study. 2.2CONCEPTUAL FRAMEWORK

The conceptual frame work entails the background definition of terms which provides meaning to the concepts or variables, including the technical words and the proxies used by the researcher in observing and measuring such concepts or variables. By such, the researcher identifies the ideas behind the variables under study and the methods measuring them based on sources that refer to past literatures which call for new work arguing directly for a need for this work. This section, therefore, reviews the following conceptual issues. 2.2.1CONCEPT OF DIVIDENDS

Pandey (2010) defines dividend as that portion of a company’s net earnings which the directors recommend to be distributed to shareholders in proportion to their shareholdings in the company. It is usually expressed as a percentage of nominal value of the company’s ordinary share capital or as a fixed amount per share. Oxford dictionary of accounting defines dividends as the distribution of part of the earnings of a company to its shareholders. The dividend is normally expressed as an amount per share on par value of the share. The size of the dividend payment is determined by the board of directors of a company, who must decide how much to pay out to shareholders and how much to retain in the business. Dividend is that part of the profits of a company which is distributed amongst its shareholders. According to Institute of Chartered Accountants, Ireland (ICAI), “Dividend is a distribution to shareholders out of profits or reserves available for this purpose”. OF DIVIDEND

Cash Dividend: – This is the most common form of dividends payments. It results in cash outflow from the firm. As such, the firm should have adequate cash resources at its disposal before declaring cash dividend (Olowe, 2008).

Stock Dividend: – This is a distribution of additional shares to the existing shareholders in proportion to their existing share capital instead of paying them in cash. Stock dividend is popularly termed as issue of bonus shares (Olowe, 2008).

Bond Dividend: – This is where a company issues bonds for the amount due to shareholders. The main purpose of bond dividend is postponement of payment of immediate dividend in cash. The bond holders get regular interest on their bonds besides payment of the bond money on the due date (Olowe, 2008). DECISION: DIVIDEND POLICY VS PROFIT RETENTION POLICY According to AL-Shubri (2009), the dividend decision of the firm is crucial for the finance manager because it determines:

The amount of profit to be distributed among the shareholders – dividend policy, and The amount of profit to be retained in the firm – profit retention policy. Dividend policy is a policy to maintain dividend at a certain level with the aim of sustaining the price of the ordinary shares on the stock exchange. (Oxford Dictionary of Accounting, 2008). Due to market imperfections and uncertainty shareholders are indifferent between dividends and retained earnings. However, they give a higher value to the current year dividend than the future dividend and capital gains. It holds that dividends are desirable from the shareholders point of view since it increases their current wealth. On the other hand, profit retention policy is a policy to keep the earnings of the firm and not distribute them to shareholders (Oxford Dictionary of Accounting, 2008).

This strengthens the internal finance of the firm and puts it in a better position to take opportunities. As such, the net earnings of the firm may be viewed as a significant source of financing the growth of the firm. Dividends paid to shareholders represent a distribution of earnings that cannot be profitably reinvested by the firm. Dividend pay-out reduces the amount of earnings to be retained in the firm and affect the total amount of internal financing (Van Horne, 1971). There is an inverse relationship between cash dividends and retained earnings. While taking the dividend decision the management takes into account the effect of the decision on the maximization of shareholders’ wealth. Maximizing the market value of shares is the objective. Dividend payout or retention is guided by this objective (Olowe, 2008). POLICY

According to Van Horne (1971), dividend policy entails the division of earnings between shareholders and reinvestment in the firm. Retained earnings are a significant source of funds for financing corporate growth, but dividend constitutes the cash flows that accrue to shareholders. In Okafor et al (2011), dividend policy is a firm’s policy with regards to paying out earnings as dividend versus retaining them for reinvestment in the firm. It is the division of profit between payments to shareholders and reinvestment in the firm. Dividend policy is thus an important part of the firm’s long-run financing strategies. The dividend policy of a company determines what proportion of earnings is distributed to the shareholders by way of dividends, and what proportion is ploughed back for reinvestment purposes. Since the main objective of financial management is to maximise the market value of equity shares, one key area of study is the relationship between the dividend policy and market price of equity shares (Akinsulire, 2011)

According to Brealey and Myers (2002), dividend policy has been kept as the top ten puzzles in finance. The most pertinent question to be answered here is that how much cash should firms give back to their shareholders? Should corporations pay their shareholders through dividends or by repurchasing their shares, which is the least costly form of payout from tax perspective? Firms must take these important decisions period after period (some must be repeated and some need to be revaluated each period on regular basis) (Okafor . There are two types of dividend policy: managed and residual. In residual dividend policy the amount of dividend is simply the cash left after the firm makes desirable investments. In this case the amount of dividend is going to be highly variable and often zero. If the manager believes dividend policy is important to their investors and it positively influences share price valuation, they will adopt managed dividend policy. The optimal dividend policy is the one that maximizes the company’s stock price, which leads to maximization of shareholders’ wealth. OF DIVIDENDS

The term stability of dividends means consistency in the payment of dividends. It refers to regular payment of a certain minimum amount as dividend year after year (www.answers.com). Even if the company’s earnings fluctuate from year to year, its dividend should not. This is because the shareholders generally value stable dividends more than fluctuating ones. Stable dividend can be in the form of:

Constant dividend per share
Constant percentage
Stable naira dividend plus extra dividend
Stable dividend policy may sometimes prove dangerous. Once a stable dividend policy is adopted by a company, any adverse change in it may result in serious damage regarding the financial standing of the company in the mind of the investors (www.answers.com). THAT INFLUENCE DIVIDENDS POLICY

According to Dinesh (2006), a number of considerations affect the dividend policy of a company. He put forth the following major factors:
Stability of Earnings. The nature of business has an important bearing on the dividend policy. Companies with stable earnings can have a more consistent dividend policy than those having an uneven flow of incomes because they can predict easily their savings and earnings.

Age of corporation. A newly established company may require much of its earnings for expansion and plant improvement and may adopt a rigid dividend policy while, on the other hand, an older company can formulate a clear cut and more consistent policy regarding dividend.

Liquidity of Funds. Dividends represent cash outflow. Availability of cash and sound financial position puts a firm in a better position to pay dividends. In other words, the greater the funds and the liquidity of the firm the better the ability to pay dividend. The liquidity of a firm depends very much on the investment and financial decisions of the firm which in turn determines the rate of expansion. If cash position is weak, stock dividend will be distributed.

Extent of share Distribution. Nature of ownership also affects the dividend decisions. A company with few shareholders is likely to get the assent of the shareholders for following a conservative dividend policy. On the other hand, a company having a good number of shareholders widely distributed and forming low or medium income group would face a great difficulty in securing such assent because they will emphasize to distribute higher dividend.

Needs for Additional Capital. Companies retain a part of their profits for strengthening their financial position. The income may be conserved for meeting the increased requirements of working capital or of future expansion. Small companies usually find difficulties in raising finance for their needs of increased working capital for expansion programmes. They having no other alternative, use their ploughed back profits. Thus, such Companies distribute dividend at low rates and retain a big part of profits.

Trade Cycles. Dividend policy is adjusted according to the economic wave. During a boom, prudent managers retain earnings as reserves for situations which follow the inflationary period. Ina depression, higher rates of dividend can be used as a tool for marketing the securities. The financial solvency can be proved and maintained by the companies in dull years if the adequate reserves have been built up.

Government Policies. The earnings capacity of the enterprise is widely affected by the change in fiscal, industrial, labour, control and other government policies. Sometimes government restricts the distribution of dividend beyond a certain percentage in a particular industry or in all spheres of business activity.

Taxation Policy. High taxation reduces the earnings of the companies and consequently the rate of dividend is lowered down. Sometimes government levies dividend-tax of distribution of dividend beyond a certain limit.

Legal Requirements. In deciding on the dividend, the directors take the legal requirements too into consideration. In order to protect the interests of creditors and outsiders, CAMA, 1990 prescribes certain guidelines in respect of the distribution and payment of dividend.

Past dividend Rates. While formulating the Dividend Policy, the directors must keep in mind the dividend paid in past years. The current rate should be around the average past rat. If it has been abnormally increased the shares will be subjected to speculation. In a new concern, the company should consider the dividend policy of the rival organisation.

Ability to Borrow. Well established and large firms have better access to the capital market than the new companies and may borrow funds from the external sources if there arises any need. Such companies may have a better dividend pay-out ratio. Whereas smaller firms have to depend on their internal sources and therefore they will have to build up good reserves by reducing the dividend payout ratio for meeting any obligation requiring heavy funds.

Policy of Control. Policy of control is another determining factor is so far as dividends are concerned. If the directors want to have control on company, they would not like to add new shareholders and therefore, declare a dividend at low rate. Because by adding new shareholders they fear dilution of control and diversion of policies and programmes of the existing management. So they prefer to meet the needs through retained earnings. If the directors do not bother about the control of affairs they will follow a liberal dividend policy. Thus control is an influencing factor in framing the dividend policy.

Repayments of Loan. A company having loan indebtedness is vowed to a high rate of retention earnings which will naturally lower down the rate of dividend, unless other arrangements are made for the redemption of debt on maturity. Sometimes, the lenders (mostly institutional lenders) put restrictions on the dividend distribution. Management is bound to honour such restrictions and to limit the rate of dividend payout.

Time for Payment of Dividend. Payment of dividend means outflow of cash. It is, therefore, desirable to distribute dividend at a time when is least needed by the company because there are peak times as well as lean periods of expenditure. Wise management should plan the payment of dividend in such a manner that there is no cash outflow at a time when the undertaking is already in need of urgent finances.

Regularity and stability in Dividend Payment. Dividends should be paid regularly because each investor is interested in the regular payment of dividend. The management should, in spite of regular payment of dividend, consider that the rate of dividend should be all the most constant. For this purpose sometimes companies maintain dividend equalization Fund. PERSPECTIVE OF DIVIDENDS IN NIGERIA

According to section 370, sub-section (1) of the Company and Allied Matters Act (CAMA), 1990, a company may in the annual general meeting, declare dividend only on the recommendation of the Directors. The Company may from time to time pay to the members such interim dividends as appear to the directors to be justified by the profits of the company. According to sub-section (3), the general meetings shall have power to decrease the amount of dividend recommended by the directors, but shall have no power to increase the amount recommended. While sub-section (5) stated that, subject to the provisions of these act, dividend shall be payable only out of the distributable profit of the company. Furthermore, section 381 of CAMA states that a company shall not declare or pay dividends if there are reasonable grounds for believing the company is or would be, after the payment, unable to meet up with or pay its liabilities as they become due. 2.2.2CONCEPT OF STOCK

Stock refers to a type of security that signifies ownership in a corporation and represents a claim on part of the corporation’s assets and earnings (www.investopedia.com). They refer to a security issued by a corporation such that represents an ownership right in the assets of the corporation and a right to a proportionate share of profits after payment of corporate liabilities and obligations. (West’s Encyclopedia of American Law, 2008). Ownerships of stocks are represented in written documents known as stock certificates. The stocks are broken down into units called shares. Each share represents a standard unit of ownership in a corporation. There are two main categories of stock: common stocks and preferred stocks. An owner of common stocks is typically entitled to participate and vote at stockholders’ meetings. In addition to common stock, some corporate bylaws allow for the issuance of preferred stock. Preferred stockholders have priority over common stock holders if a corporation should liquidate. Other classifications of stocks, according to ICAI include:

Blue chip stocks are stocks traded on a securities exchange (listed stock) that have minimum risk due to the corporation’s financial record.
Listed stock means a company has filed an application and registration statement with both the Securities and Exchange Commission and a securities exchange. The registration statement contains detailed information about the company to aid the public in evaluating the stock’s potential. Floating stock is stock on the open market not yet purchased by the public.

Growth stock is stock which is purchased for its perceived potential to appreciate in value, rather than for its dividend income.
Penny stocks are highly speculative stocks that usually cost under a dollar per share. PRICES
A share price is the price of a single share of a number of saleable stocks of a company. Once the stock is purchased, the owner becomes a shareholder of the company that issued the share (Oxford Dictionary of Accounting). The value of a share of stock depends upon the value placed on the issuing corporation by the participants of the stock market. This value is based on profitability and future prospects. The market price reflects what purchasers are willing to pay based on their evaluation of the company’s prospects. The face or stated value of a share of stock is known as its Par value. In the case of common stocks, par value usually does not correspond to the market value of a stock (Olowe, 2008). The price of a stock fluctuates fundamentally due to the theory of supply and demand.

Like all commodities in the market, the price of a stock is sensitive to demand. However, there are many factors that influence the demand for a particular stock. Stock price may be influenced by the business forecasts of analysts and potentials for the company’s general market segment. In economics and financial theory, analysts use ‘random walk’ techniques to model behaviour of asset prices, in particular share prices on stock markets, currency exchange rates and commodity prices. This practice has its basis in the presumption that investors act rationally and without bias, and that at any moment they estimate the value of an asset based on future expectations. Under these conditions, all existing information affects the price, which changes only when new information comes out. By definition, new information appears randomly and influences the asset price randomly (Criss, 1995).

The value of a share of a company at any given moment is determined by all investors voting with their money. If more investors want a stock and are willing to pay more, the price will go up. If more investors are selling a stock and there aren’t enough buyers, the price will go down. However, that does not explain how people decide the maximum price at which they are willing to buy or the minimum at which they are willing to sell. According to the efficient market hypothesis (EMH), the price of a stock at any given moment represents a rational evaluation of the known information. Such information might bear on the future value of the company. In other words, prices are the result of discounting expected future cash flows (Criss, 1995). THE AFFECT STOCK PRICES

This is the most frequent question that most stock/options traders may have in their minds. Stocks price changes due to market forces, i.e. buying and selling of the available stocks in the market. According to Smith (2008), the following are some factors that affect or even predict the buying or selling of stock that ultimately affects stock prices of companies.

Market Sentiment.
The Performance of the Industry
The Earning Results and Earning Guidance
Take-over or Merger.
New Product Introduction to markets or introduction of an existing product to new markets.
New Major Contracts or Major Government Orders.

Share Buy-Back.
Stock Splits.
Insider Trading.
Investment Gurus / Hedge Funds Trading.
Analyst Upgrade / Downgrades.
Addition/Removal to/from Stock Index.
Others factors that affect the demand and supply of stocks include news about new technology, patent approval, war, natural disaster, product recalls and lawsuits that shall have positive and negative impact to the relevant company stocks. The health or mishap of a key leader in a company may also affect the stock price of the company. PRICES AND MARKET VOLATILITY

Volatility is a measure related to the variance of a security’s price. Thus, if a stock is labeled as volatile, its price would greatly vary over time, and it is more difficult to say in certainty what its future price will be (Criss, 1995). The volatility of ordinary stock is the systematic risk faced by investors who possess ordinary stock investments (Guo, 2002). From the finance literature, the operating definition of volatility is the relative dispersion of changes in stock prices relative to some average for a period (Jones and Wilson, 1989). The volatility of stock market investment can be defined as the dispersion of investment returns below and above the mean, other known as the standard deviation of returns. It is used to quantify the risk of the financial instrument over the specified time period and is normally expressed in annualized terms. There is a strong relationship between volatility and market performance (Criss, 1995, Guo, 2002).

Usually, the greater the volatility, the greater the risk in the short run. Volatility tends to decline as the stock market rises and increase as the stock market falls. When it increases, risk increases and returns decrease and vice versa (Kinder, 2002). Typically, the allocation of investment strategies to an investment plan is based on the respective volatilities of the stocks involved and whether it fits the risk profile of the prospective investor. Investors’ preference is for less risk. The lesser the amount of risk, the better the investment is (Kinder, 2002). In other words, the lesser the volatility of a given stock, the greater its desirability to investors. Therefore, it is important for investors to understand the limitations and uses of volatility as a barometer of investment risk. 2.3REVIEW OF THE LITERATURE

The linkage between the dividend policy of corporations and the volatility of their stock prices has been explored at different times by different researchers (Allen and Rachim, 1996; Baskin, 1989; Nishat and Irfan, 2003; Schwert, 1989). This section on literature review is focused on earlier researches that are relevant to our study. The review of the literature is organised into the different focuses of this study. 2.3.1STOCK PRICE DETERMINANTS

In the light of the preceding literature review, many factors both micro and macro-economics, have impact on equity pricing in the stock market, the impact differs from country to country firm to firm, industry to industry, economy to economy and from time to time. But one comforting conclusion is that most of the factors appear to have the same behaviour regardless of time, industry or firm constraints. For instance, increased inflation and interest rates, declining dividends, earnings, poor management leave negative impact on equity pricing and vice-versa. A lower degree of efficiency in less developed countries market might be caused by common characteristics of loose disclosure requirements as well as thinness and discontinuity of trading (AL- Shubiri, 2010). Numerous research works have been conducted over such factors that affect the prices of common stock. The most basic factors that influence price of equity share are demand and supply factors. If most people start buying then prices move up and if people start selling prices go down. Government policies, firm’s and industry’s performance and potentials have effects on demand behaviour of investors, both in the primary and secondary markets.

Al-Qenae, Li & Wearing (2002) in their study cited in Akintoye, Oseni, and Somoye (2009) of the effects of earning (micro-economic factor), inflation and interest rate (macro-economic factors) on the stock prices on the Kuwait Stock Exchange, discovered that the macro-economic factors significantly impact stock prices negatively. A previous study by Udegbunam and Eriki (2001) of the Nigerian capital market also shows that inflation is inversely correlated to stock market price behaviour. Al – Tamimi (2007) identified company fundamental factors (performance of the company, a change in board of directors, appointment of new management, and the creation of new assets, dividends, earnings), and external factors ( government rules and regulations, inflation, and other economic conditions, investor behavior, market conditions, money supply, competition, uncontrolled natural or environmental circumstances) as influencers of asset prices. (Akintoye, Oseni, and Somoye, 2009).

In a study of the impact of dividend and earnings on stock prices, Hartone (2004) argues that a significantly positive impact is made on equity prices if positive earnings information occurs after negative dividend information. Also, a significantly negative impact occurs in equity pricing if positive dividend information is followed by negative earning information. A number of studies found that stock price has a significant positive relationship with dividend payments {Gordon (1959) ,Oggden (1994) ,Stevents and Jose(1989),Kato and Loewenstein (1995) ,Ariff and Finn(1986),and Lee(1985)}, while others found a negative relationship like Loughlin (1989) and Easton and Sinclair(1989). Docking and Koch (2005) also discovered that there is a direct relationship between dividend announcement and equity price behavior. 2.3.2CORPORATE DIVIDEND POLICY DETERMINANTS

The dividend polices of companies, among other variables, have been a common subject of research for more than half of a century (Litner, 1959; Gordon, 1959; Modigliani, 1982; etc.) and it has been related to several vital corporate matters ranging from agency problems to share valuation. The outcomes of the studies vary depending on the scope of the study, the assets and factors examined. The dividend polices in turn are affected by a number of factors. Black (1976) in his study concluded with the following question: “What should the corporation do about dividend policy? We don’t know”. A number of factors have been identified in previous empirical studies to influence the dividend policy decisions of the firm. Profits have long been regarded as the primary indicator of the firm’s capacity to pay dividends. Litner (1956) conducted a classic study on how U.S. managers make dividend decisions. He developed a compact mathematical model based on survey of 28 well established industrial U.S. firms. According to him the current year earnings and previous year dividends influence the dividend payment pattern of a firm.

However, Baker, Farrelly and Edelman (1986) surveyed 318 New York stock exchange firms and concluded that the major determinants of dividend payments are anticipated level of future earnings and pattern of past dividends. Fama and Babiak (1968) studied the determinants of dividend payments by individual firms during 1946-64. The study concluded that net income seems to provide a better measure of dividend than either cash flows or net income and depreciation included as separate variables in the model. Alli et al (1993) reveal that dividend payments depend more on cash flows, which reflect the company’s ability to pay dividends, than on current earnings, which are less heavily influenced by accounting practices. Baker and Powell (2000) concluded from their survey on the listed firms of New York Stock Exchange (NYSE) that dividend determinants are industry specific and anticipated level of future earnings is the major determinant. Shapiro and Balbier (2000) submit that the following issues, based on empirical evidence and theoretical suggestions, are vital for firms to consider when setting dividend policy.

What are our investment opportunities? Setting dividend payouts in relation to long term growth opportunities maximizes financial flexibility and reduces the financial frictions associated with raising external capital. Hence, a rapidly growing firm, with an abundance of positive net present value projects, should retain a larger share of its operating cash flow than a firm with few profitable investment opportunities.

What kind of Business Risk Do We Face? A firm with unstable or cyclical earnings should set a low dividend payout rate to reduce the odds that it will be forced to cut its dividend. On the other hand, firms with stable earnings should be more willing to pay dividends.

Who Are Our Stockholders? Dividend policy should match the choice of the stockholders between dividends and capital gains; though there is no evidence that one dividend clientele is better than another.

How is Our Liquidity Position? All else being equal, firms with high liquidity and good access to the financial markets are in a better position to pay dividends than those firms with limited financial resources.

Is Control an Issue? If a firm’s owners or managers are concerned about retaining control, they may be reluctant to issue additional stock. Retained earnings are a preferred source of capital for such firms, mandating low dividend payout ratio if the present debt-equity ratio is at its upper limit. Arnott and Asness (2003) based their study on American stock markets (S&P500) and found that higher aggregate dividend payout ratios were associated with higher future earnings growth. Both Zhou and Ruland (2006), and Gwilym et.al. (2006) supported the findings of Arnot and Asness. Zhou and Ruland examined the possible impact of dividend payouts on future earnings growth. Their study used a sample of active and inactive stocks listed on NYSE with positive, non- zero payout ratio companies covering the period from 1950- 2003.Their regression results showed a strong positive relation between payout ratio and future earnings growth.

Mancinelli and Ozkan (2006) undertook an empirical investigation of the relationship between the ownership structure of companies and dividend policy using 139 firms listed in Italian exchange. Their results suggested that the dividend payout ratio is negatively associated with the voting rights of the largest shareholders (Kapoor, 2009). Mohammed Amidu and Joshua Abor(2006) examined the factors affecting dividend payout ratios of listed companies in Ghana. The results of their study showed that payout ratios were positively related to profitability, cash flow and tax but are negatively related risk and growth (Kapoor, 2009). POLICY AND AGENCY PROBLEMS

According to Kapoor (2009), the level of dividend payments is in part determined by shareholders preference as implemented by their management representatives. However, the impact of dividend payments is borne by a variety of claim holders, including debt holders, managers, and supplier. He put forward that agency relationship exists between:

The shareholders versus debt holders conflict, and
The shareholder versus management conflict
Shareholders, who are the sole receipients of dividends, prefer to have large dividend payments, all things being equal; conversely, creditors prefer to restrict dividend payments to maximize the firm’s resources that are available to repay their claims. The empirical evidence discussed is consistent with the view that dividends transfer assets from the corporate pool to the exclusive ownership of the shareholders, which negatively affects the safety of claims of debt holders. In terms of shareholder-manger relationships, all things being equal, managers, whose compensation (pecuniary and otherwise) is tied to the firm’s profitability and size, are interested in low dividend payout levels.

A low dividend payout maximizes the size of the assets under management control, maximizes management flexibility in choosing investments, and reduces the need to turn to capital markets to finance investments. Shareholders, desiring managerial efficiency in investment decisions, prefer to leave little discretionary cash in management’s hands and to force mangers to turn to capital markets to fund investments. These markets provide monitoring services that discipline managers. Accordingly, shareholders can use dividend policy to encourage managers to look after their owners’ best interests; higher payouts provide more monitoring by the capital markets and more managerial discipline. POLICY AND ASYMMETRIC INFORMATION

Dividends are meant convey private information to the market, predictions about the future earnings of a firm based on dividend information should be superior to forecasts made without dividend information. A number of studies have tested these implications of the information content of dividends which includes studies by Benartzi, Michaely, and Thaler (1997), Brook, Charlton, and Hendershott (1998), Nissim and Ziv (2001), Grullon, Michaely and Swaminathan (2002), etc. 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 after lengthy hiatus), and elimination of dividend payments are announced regularly in the financial media. In response to such announcements, share prices usually increase following dividend increases and dividend initiations, and share prices usually decline following dividend cuts and dividend eliminations. In Bernado and Welch (2000) cited in Kapoor (2009), Pettit (1972) documented that announcements of dividend increases are followed by significant price increases and that announcements of dividend decreases are followed by significant price drops. Information about the prospects of a firm may include the firm’s current projects and its future investment opportunities. 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. 2.4THEORETICAL FRAMEWORK

A number of dividend theories exist that attempt an explanation of the influence of corporate dividend policy. Various models have been developed to help firms analyse and evaluate the perfect dividend policy. This section is focused on the various models and theories that are relevant to our study. The theories are organised into various schools of thoughts on dividend policy. There is no agreement between these schools of thought over the relationship between dividends and the value of the share or the wealth of the shareholders in other words. Their disagreement is based on the relevance of dividends. However, the EMH model and the behavioural finance theory propose about how the prices of stocks are affected by the decisions of the participants. MARKET HYPOTHESIS (EMH) MODEL

EMH states that investing is overall (weighted by the standard deviation) rational; that the price of a stock at any given moment represents a rational evaluation of the known information that might bear on the future value of the company; and that share prices of equities are priced efficiently, which is to say that they represent accurately the expected value of the stock, as best it can be known at a given moment. In other words, prices are the result of discounting expected future cash flows (Pandey, 2010). The EMH model, if true, has at least two interesting consequences. First, because financial risk is presumed to require at least a small premium on expected value, the return on equity can be expected to be slightly greater than that available from non-equity investments: if not, the same rational calculations would lead equity investors to shift to these safer non-equity investments that could be expected to give the same or better return at lower risk.

Second, because the price of a share at every given moment is an “efficient” reflection of expected value, then—relative to the curve of expected return—prices will tend to follow a random walk, determined by the emergence of information (randomly) over time. Professional, equity investors, therefore, immerse themselves in the flow of fundamental information, seeking to gain an advantage over their competitors (mainly other professional investors) by more intelligently interpreting the emerging flow of information (news) (AL-Shubiri, 2009). The EMH model does not seem to give a complete description of the process of equity price determination. For example, stock markets are more volatile than EMH would imply. In recent years, it has come to be accepted that the share markets are not perfectly efficient, perhaps especially in emerging markets or other markets that are not dominated by well-informed professional investors (Pandey, 2009). BEHAVIOURAL FINANCE THEORY

Another theory of share price determination comes from the field of Behavioral Finance. According to Behavioral Finance, humans often make irrational decisions—particularly, related to the buying and selling of securities—based upon fears and misperceptions of outcomes. The irrational trading of securities can often create securities prices which vary from rational, fundamental price valuations. For instance, during the technology bubble of the late 1990s, technology companies were often bid beyond any rational fundamental value because of what is commonly known as the “greater fool theory”. The “greater fool theory” holds that, because the predominant method of realizing returns in equity is from the sale to another investor, one should select securities that they believe that someone else will value at a higher level at some point in the future, without regard to the basis for that other party’s willingness to pay a higher price. Thus, even a rational investor may bank on others’ irrationality (Pandey, 2010). 2.4.2 DIVIDEND IRRELEVANCE PROPOSITION

The Modigliani and Miller school of thought believes that investors do not state any preference between current dividends and capital gains. They say that dividend policy is irrelevant and is not deterministic of the market value. Therefore, the shareholders are indifferent between the two 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. There are two conditions discussed in relation to this approach:

decisions regarding financing and investments are made and do not change with respect to the amounts of dividends received.

When an investor buys and sells shares without facing any transaction costs and firms issue shares without facing any floatation cost, it is termed as a perfect capital market. Two important theories discussed relating to the irrelevance approach, the residuals theory and the Modigliani and Miller approach. &MILLER APPROACH (1961)

In 1961, two noble laureates, Merton Miller and Franco Modigliani (M&M) showed that under certain simplifying assumptions, a firms’ dividend policy does not affect its value. Their theorem states that the division of retained earnings between new investment and dividends do not influence the value of the firm (Adefila, Adeoti and Oladipo, 2002). It is the investment pattern and consequently the earnings of the firm which affect the share price or the value of the firm (Olowe, 2008). The basic premise of their argument is that a firm’s 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 (Olowe, 2008).

They argued that, from the perspective of investors, dividends policy is irrelevant, because any desired stream of payments can be replicated by 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:

Information is costless and available to everyone equally.
No distorting taxes exist
Flotation and transportation costs are non- existent. No time lag and transaction costs exist.
Non contracting or agency cost exists
There is a rational behavior by the investors and there exists perfect capital markets.
Securities can be split into any parts i.e. they are divisible
The investment decisions are taken firmly and the profits are therefore known with certainty. The dividend policy does not affect these decisions.

The dividend irrelevancy in this model exists because shareholders are indifferent between paying out dividends and investing retained earnings in new opportunities. The firm finances opportunities either through retained earnings or by issuing new shares to raise capital. The amount used up in paying out dividends is replaced by the new capital raised through issuing shares. This will affect the value of the firm in an opposite ways. The increase in the value because of the dividends will be offset by the decrease in the value for new capital raising. THEORY OF DIVIDENDS

This theory was first proposed by Miller and Modigliani in 1961. Investors prefer to have the firm retain and reinvest earnings rather than pay them out in dividend if the return on the investment earnings exceeds the rate of return the investors could themselves obtain on other comparative investment. Otherwise, the investors prefer dividend (Akinsulire, 2011). One of the assumptions of this theory is that external financing to re-invest is either not available, or that it is too costly to invest in any profitable opportunity. If the firm has good investment opportunity available then, they’ll invest the retained earnings and reduce the dividends or give no dividends at all. If no such opportunity exists, the firm will pay out dividends.

If a firm has to issue securities to finance an investment, the existence of floatation costs needs a larger amount of securities to be issued. Therefore, the pay out of dividends depend on whether any profits are left after the financing of proposed investments as floatation costs increases the amount of profits used. Deciding how much dividends to be paid is not the concern here, in fact the firm has to decide how much profits to be retained and the rest can then be distributed as dividends. This is the theory of Residuals, where dividends are residuals from the profits after serving proposed investments (Akinsulire, 2011). This residual decision is distributed in three steps:

Evaluating the available investment opportunities to determine capital expenditures.
Evaluating the amount of equity finance that would be needed for the investment, basically having an optimum finance mix. Cost of retained earnings

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