Corporate dividend payout policy


Corporate dividend policy is one of the most debated topics in corporate finance. Many researchers have devised theories and provided empirical evidence regarding the determinants of a firm's dividend policy. The dividend policy issue, however, remains unresolved. Clear guidelines for an ‘optimal payout policy' have not yet emerged despite the voluminous literature. We still do not have an acceptable explanation for the observed dividend behavior of companies.

During the last fifty years the several theoretical and empirical studies are done leading to the mainly three outcomes:

1. The increase in dividend payout affects the market value of the firm.

2. The decrease dividend payout affects the market value of the firm.

3. The dividend policy of the firm does not affect the firm value at all.

However, we can say that empirical evidence on the determinants of dividend policy is unfortunately very mixed. Basis of on which corporations pay out dividends to share holders is still an unresolved puzzle. First prominent study that appeared in the literature of finance regarding dividend policy was that of Miller and Modigliani (1961) where they state that there are no illusions in a rational and a perfect economic environment. This was the starting point for other researchers to explore dividend payout policy phenomena. Almost all researches that followed referred back to Miller and Modigliani (1961). Various researches were carried out by many researches to explore determinants of dividend payout policy, some of them focused on profitability, some on size of the firms, some on growth rate of the firm while others on agency costs. For example researches carried out by Nissim and Ziv (2001), Brook, Yaron Charlton and Hendershot (1998), Bernheim and Wantz (1995), Kao and Wu (1994), and Healy and Palapu (1988) found out a positive association between increase in dividend payout and future profitability. Kalay and Lowenstein (1986) and Asquith and Mullins (1983) found out that dividend changes are positively associated with stock returns in the days surrounding the dividend announcement dates. Sasson and Kalody (1976) conclude that there is a positive association between the payout ratio and average rates of return. On the other hand, studies of Benartzi, Michaely, and Thaler (1997) and DeAngelo, and Skinner (1996) find no support for the relationship between dividend changes and future profitability.

Another most debated factor affecting dividend policy arguably is agency costs. Jensen (1986). Agency cost argument proposes that dividend payments reduce costs and increase cash flow Rozeff (1982). Researches carried out by Jensen, Solberg, and Zorn (1992), and Lang and Litzenberger (1989) supported this agency cost hypothesis, while others such as Lie (2000), Yoon and Starks (1995) and Denis, and Sarin, (1994) found no support for this hypothesis.

Size of the firm is another factor which seems to have an impact of dividend payout policy. Firms larger in size are considered to have more ability to payout dividends to its share holders. Lloyd, Jahera, and Page (1985), and Vogt (1994) indicated that firm size plays a role in explaining the dividend-payout ratio of firms. They argued that because larger firms are mature and have easy access to capital markets thus they are not really much dependant on internally generated funding which enables them to payout higher dividends.

The purpose of this research is to investigate the dynamics and determinants of dividend policy of oil & gas sector firms in Pakistan. The independent variables selected from the literature include: market capitalization, profitability and annual rate of growth of total assets. Analysis of these variables should reveal there exist any impact of these variables on dividend payout policy of the firms and very nature of the relationship.

The remaining part of this thesis is organized as fellows. In section 2 brief reviews of theories about the dividend will be presented. In section 3 this thesis discuss the data and possible variables that can act as proxy for different influences for analysis .In section 4 this thesis will establish the model . In section 6 thesis will establish analysis and interpretations and section 7 will present result and draw conclusion.

Literature Review

There are various theories which tell us that a firm pays the dividends.

Miller And Modigliani Theory

According to Miller and Modigliani (of Merton Miller,Franco Modigliani) (1961) dividend do not affect firms' value in perfect market. Shareholders are not concerned to receiving their cash flows as dividend or in shape of capital gain, as for as firm's doesn't change the investment policies. In this type of situation firm's dividend payout ratio affect their residual free cash flows, when the free cash flow is positive firms decide to pay dividend and if negative firms decide to issue shares. They also conclude that change in dividend may be conveying the information to the market about firm's future earnings.


It's the idea that a shareholder can simply create his own dividend policy if he wants if a person has 10,000 PKR and wants income of 3,000 PKR a year from that portfolio, that person can simply sell 3,000 PKR worth of stock. He doesn't have to receive it in dividend income. This theory says, “Who cares about dividends?”

M&M explains that under certain assumptions including rational investors and a perfect capital market, the market value of a firm is independent of its dividend policy.

Smirlock & Marshall, (1983) stated that relationship between the Dividend and Investment Decisions indicates that no causality between the dividend and investment decisions of the firm. The fact that the firm-specific data conclusively supported the separation principle is particularly convincing. This is the first application of causality tests to a large sample of firms.

The Bird In The Hand Theory

Investors always prefer cash in hand rather then a future promise of capital gain due to minimizing risk Gordon (1963).

“I do I care about dividends and investing in dividend stocks.” When a company pays me hard cash, I know that the company is really making money. It's not just telling me it making money. This is the idea that investors value a cash payment in their hands over the hope of future profits.

The Agency Theory

Traditionally, corporate dividend policy has been examined under the assumptions that the firm is one homogenous unit and that the management's objective is to maximize its value as a whole. The agency cost approach differs from the traditional approach mainly in this way that it explicitly recognizes the firm as a collection of groups of individuals with conflicting interests and self-seeking motives. According to the agency theory, these behavioral implications cause individuals to maximize their own utility instead of maximizing the firm's wealth.

The agency theory of Jensen and Meckling (1976) is based on the conflict between managers and shareholder and the percentage of equity controlled by insider ownership should influence the dividend policy. A theory concerning the relationship between a principal (shareholder) and an agent of the principal (company's managers).

Jensen and Meckling (1976) in corporations, agency problem arise from external debt and external equity. Jensen and Meckling (1976) analyzed that how firm value is affected by the distribution of ownership between inside shareholders and outside shareholders who can consume perquisites, and who cannot.

Within this framework, increased managerial ownership of equity alleviates agency difficulties by reducing incentives to consume perquisites and expropriate shareholder wealth. Jensen and Meckling (1976) argue that equity agency costs would be lower in firms with larger proportions of inside ownership. Managers are better understanding their interest with stockholders when they increase the shareholders' ownership of the firm.

Dividends are believed to play an important role in reducing conflicts between managers and stockholders. Any dividend policy should be designed to minimize the sum of capital, agency and taxation costs.

According to Bathala (1990), in the agency costs and dividends, two lines of thought can be found explaining cross-sectional variations in payout ratios.

First View

Holds that a firm's optimal payout ratio is the results of a trade-off between a reduction in the agency costs of external equity and an increase in the transaction costs associated with external financing resulting from dividend payments as the payout ratio increases.

Second View

Argues that inside ownership and external debt are substitute mechanisms in mitigating agency costs in a firm.

The basic study for the first line of thought is based on Rozeff's (1982) propositions. He suggests that dividend payout ratios may be explained by reduced agency costs when the firm increases its dividend payout and by increased more expensive external capital.

Easterbrook (1984) gives further explanation regarding agency cost problem and says that there are two forms of agency costs; one is the cost monitoring and other is cost of risk aversion on the part of directors or managers.

The agency theory is concerned with resolving two problems that can occur agency relationships.


1. The desires or the principal and agent conflict and (b) it is difficult or expensive for the principal cannot verify that the agent has behaved appropriately.

2. Is the problem of risk sharing that arises when the principle and agent have different attitudes towards risk. The problem here is that the principle and the agent may prefer different actions because of the different risk preferences.

According to (Naceur, Goaied, & Belanes, 2006) profitable firms with more stable earnings can pay larger dividend. Whenever they are growing very quick, dividend policy doesn't get any impact from financial leverage and ownership concentration. Also the liquidity of stock market and size negatively impacts the dividend payment.

Oskar kowalewski and Ivan stetsyukand olesksandr talavera (2007) study that how corporate governance determines dividend polices in Poland. They compose for the first time, quantitative measures on the quality of corporate governance for 110 non- financial listed companies. Their result suggested that large and more profitable companies have higher dividend payout ratio .further more risky and more indebted firms prefer to pay lower dividend s. The result finally, based on the period of 1998-2004.dividend policy is quite important in the valuation process of companies, but the issues still remain scarily investigated in transition countries. A study on the determinant s of dividend policy and its association to corporate governance in a transition economy both offers an interesting subject and complements the existing corporate governance literature.

The agency theory point that dividend may mitigate agency costs by distributing free cash flows that otherwise would be spend on unprofitable projects by the management .it is argued that dividends expose firms to more frequent analysis by the capital markets as dividend payout increase the likelihood that a firm has to issues new common stock .on the other hand, scrutiny by the market help alleviate opportunistic management behavior, and thus, agency costs. Agency cost, in turn, is related to the strength of shareholders rights and they are associated with corporate governance .furthermore, agency suggested that shareholders may prefer dividends, particularly when they fear expropriation by insider. They test the determinants of dividend policy in a multiple regression framework to control for firm specific characteristics other than governance. All the variables enter the regressions with expected signs. Size and return on assets are positively associated with variable cash dividend .leverage is negatively associated with variable cash dividend. Their results provide evidence that in Poland listed companies where corporate governance practices are high and as a result shareholders rights are strong payout higher dividend.

Jianguo Chen and Nont Dhiensiri(2009) suggest that relationship between dividend pay-out ratio (POR) with the pro Cash flow variability (CFV), ownership dispersion, insider ownership, free cash flow, collateral sable assets, Past growth (GROW1) ,future growth (GROW2), stable dividend policy and imputation credit (IMP). They analyze the determinants of the corporate dividend policy using a firms listed on New Zealand Stock Exchange .They examined that firms traditionally have high dividend pay-outs compared with companies in the US. They find that their is a negative relationship between dividend payout ratio and CFV, Insider, Beta ,growth and positive relationship between ownership dispersion ,free cash flow, collateral sable assets stable dividend policy and imputation credit. Their conclusion provides strong support to the agency cost theory and partially support transaction cost and residual dividend theory. They donor have any evidence to support the dividend stability theory and the signaling theory.

Signalling Theory

The explanation about the signaling theory given by Bhattacharya (1979) and John, Kose and Williams (1985) dividends allay information symmetric between managers and shareholders by delivering inside information of firm future prospects.

Effect Of Tax Preferences Theory

Miller and Scholes (1978) find that the effect of tax preferences on clientele and conclude different tax rates on dividends and capital gain lead to different clientele.

"Tax Preference Theory"

Taxes are important considerations for investors. Remember capital gains are taxed at a lower rate than dividends. As such, investors may prefer capital gains to dividends. This is known as the Furthermore, capital gains are not paid until an investment is actually sold. Investors can control when capital gains are realized, but, they can't controldividend payments, over which the related company has control.

Capital gains are also not realized in an estate situation.

For example:

Suppose an investor purchased a stock in a company 50 years ago. The investor held the stock until his or her death, when it is passed on to an heir. That heir does not have to pay taxes on that stock's appreciation.

Life Cycle Theory

Life Cycle Theory and Fama and French (2001) states that the firms should follow a life cycle and reflect management's assessment of the importance of market imperfection and factors including taxes to equity holders, agency cost asymmetric information, floating cost and transaction costs.

Catering Theory

According to Baker and Wurgler (2004) in Catering theory suggest that the managers in order to give incentives to the investor according to their needs and wants and in this way cater the investors by paying smooth dividends when the investors put stock price premium on payers and by not paying when investors prefer non payers.

Lintner's Model

John Lintner (1956) initiates with his theory based on two important things that he observed about dividend policy:

1) Companies tend to set long-run target dividends-to-earnings ratios according to the amount of positive net-present-value (NPV) projects they have available.

2) Earnings increases are not always sustainable. As a result, until managers can see that new earnings levels are sustainable, dividend policy is not changed

As regards the empirical literature the roots of the literature on determinants of dividend Policy is related to Lintner (1956) seminal work after this work the model is extended by

The Samy ben naceur, Mohamed goaied and Amel belanesthe (2006) study the dividend policy of 48 firms listed on the Tunisian Stock Exchange during the period (1996-2002). Lintner's model is applied using static and dynamic panel data regressions. They examined that Tunisian firms rely more on current earnings that past dividends to fix their dividend payments in the way that dividends tend to be more sensitive to current earnings rather than prior dividends. Any inconsistency in the earnings of the corporation is directly reflected in the level of dividends.

Samy ben naceur, Mohamed Goaied and Amel belanesthe (2006) focused on the relationship between dividend and ownership, liquidity, return on assets (ROA), profitability, investment, leverage ratio, size. The results indicate that highly profitable firms with more stable earnings can afford larger free cash flows and thus pay out larger dividends. Moreover, fast-growing firms distribute larger dividends so as to demand to investors. On the other hand, ownership concentration does not have any impact on dividend payment. In fact, being closely held Tunisian firms witness less agency conflicts and shareholders do not resort to dividends in order to reduce managerial discretion and protect their interests. The liquidity of the stock market has a negative influence, which confirms that the implementation of the electronic transaction system in the TSE has facilitated the realization of capital gains, which has reduced the need for dividend payments. Atlas, the negative coefficient on size found in the full sample has disappeared when regulated firms are excluded, which reduces the strength of this factor. Researchers have proposed many different theories about the factors that influence a firm's dividend policy.

Kanwal Anil and Sujata Kapoor (2008) analyzed that The Determinants of Dividend Payout Ratio-A Study of Indian Information Technology Sector. The period under study is 2000-2006 .as it is know that the period of 5 to 6 years cover both recession and booming of IT industry. They stated that profitability has always been considered as a primary indicator of dividend payout ratio. There are numerous other factors other than profitability also that affect dividend decisions of an organization namely cash flows, corporate tax, sales growth and market to book value ratio. They suggest that dividend payout ratio is positively related to profits, cash flows and it has inverse relationship with corporate taxes, sales growth and market to book value ratio. Statistical techniques of correlation and regression have been used to explore the relationship between key Variables. Thus, the main theme of this study is to identify the various factors that influence the dividend payout policy decisions of IT firms in India.

In short factors influencing the corporate dividend policy, according to them, may substantially vary from country to country because of inconsistency or variation in legal, tax and accounting policy between countries.

In view of these facts, the present study aims at identifying the variables influencing corporate dividend policy in Pakistan.

Dependent And Independent Varibles

Objective of this study is to determine factors that have impact on dividend of Oil & Gas Exploration and Oil & Gas Marketing sector of KSE. Dividend yield is dependent variable and the three in dependent variable are size, profitability and growth. These variables are discussed here.

Dividend Yield (DY)

Arthur A Thompson in his book Crafting and Executing Strategy says that the measure of the return that shareholder receives in the form of dividend is called dividend yield (DY).A typical dividend yield is 2 -3%, the dividend yield for fast growth companies in often below 1%(may be even 0) and the dividend yield for slow-growth companies can run 4-5%.

Dividend yield can major by annual dividend per share divided by current market price per share.

Samy ben naceur et el(2006)The DY (dividend yield ) equals to dividend per share to price per share as our measure of the dependent variable ,pay out ratio cannot be use as a measure of dependent variable because sample contains firms with negative earning.

Khamis Al-Yahyaee et el (2006) and Hafeez et el (2009) they also used dividend yield (DY) as the dependent variable.

Explanatory Varibles

This thesis selected 3 variables used by different researchers Samy ben naceur et el (2006) and Hafeez et el (2009).

Firm Size

Hafeez et el (2009) The firm size has been calculated as the total assets of the firm because a positive coefficient is expected from this variable as their is very low chance of bankruptcy in large more diversified firms and can sustain higher level of debt.

Scott and martin (1975) found that the size of the firm is very important factor which can affect the firm's dividend policy and debt policy.

A negative impact has been found by market capitalization and size of the firms on dividend payout policy which clearly shows that the firms prefer to invest in their assets rather than pay dividends to its shareholders. The financial characteristic of size has been explained by Market capitalization and the size of the firm. According to the null hypothesis for this financial characteristic there is no relation between the market capitalization and size with dividend payout ratio but the results show that there is a negative and significant relationship between dividend payout and MV. Hence null hypothesis is rejected. The evidence supported by the finding of Belans et al (2007), Jeong (2008) and deviate from Avazian et al (2006).

Samy ben naceur et el (2006) the size of the firm by total market value (LNSIZE) and it is expected to be positively correlated with dividend paid. The literature suggests that size may be inversely related to the probability of bankruptcy (Ferri and Jones 1979; Titman andWessels 1988; Rajan and Zingales 1995). In particular, larger firms should have easier access to external capital markets and can borrow on better terms, Moreover, larger firms tend to be more diversified and their cash flows are more regular and less volatile. Thus, larger firms should be more willing to pay out higher dividends. Even the conflicts between creditors and shareholders are more severe for smaller firms than larger ones.

Khamis Al-Yahyaee et el (2006) they measure size of the firm from Log of sales. Variables such as size have the potential to influence a firm's dividend policy. Larger firms have an advantageous position in the capital markets to raise external funds and are therefore less dependent on internal funds. This implies an inverse relationship between the size of the firm and its dependence on internal financing. Furthermore, larger firms have lower bankruptcy probabilities and therefore should be more likely to pay dividends. Hence, larger firms are expected to pay more dividends.

Thus as per this research the hypothesis is h3= Firm size is positively associated with dividend payouts.

Firm profitability

Empirical research found that their is positive relationship between dividend yield and profitability. The more profitable the firms are, the more internal financing they will have, and thus are able to afford larger dividends. Some of them are as fellow.

Khamis Al-Yahyaee et el (2006) measured profitability by earnings before interest and taxes to total assets as our surrogate for profitability. They expect to find a positive relationship between dividends and profitability. Since dividends are usually paid from the annual profits, it is logical that profitable firms are able to pay more dividends.

Samy ben naceuret et el (2006) measure the profitability by the return on assets (ROA) net income/total assets and it is positively correlated with dividend payments. Firms with high profitability can afford larger free cash flows and hence new investment opportunities. Therefore, paying higher dividends does not disturb them. In the same vein and according to the pecking order theory, firms prefer using internal sources of financing first, then debt and finally external equity obtained by stock issues. The more profitable the firms are, the more internal financing they will have, and thus are able to afford larger dividends.

Hafeez et el (2009) measured Profitability Net Earnings and Earning Per Share after tax. The net earnings show the positive relationship with the dividend yield. The net earnings after interest, depreciation and after tax has been used the explanatory variable to examine the role of earnings to pay dividends.

Thus as per this research the hypothesis is H2= There is a positive relationship between a firm's profitability and dividend payouts.

Firm Growth

Samy ben naceur et el (2006) measure investment and growth by MBV (market value of equity/ book value of equity) and annual rate of growth of total assets. Firms anticipate higher growth, when they establish lower dividend payout ratio because growth entails higher investment expenditures. When firms retain higher proportion of earning to finance future investment need due to high cost of external financing, their dividend pay out in anticipation of future growth get reduced. Hence, a negative relationship between dividend payout and expected growth is expected.

Khamis Al-Yahyaee et el (2006) measure the growth opportunities through market-to-book ratio. They expected a negative relationship between dividends and growth opportunities. Large additions of capital are required by the firms experiencing substantial success and rapid growth. Consequently, growth firms are expected to pursue lower dividend payout policies. Similarly, the pecking order theory predicts that firms with a high proportion of their market value accounted by growth opportunities should retain more earnings so that they can minimize the need to raise new equity capital. Free cash flow theory also predicts firms with high growth opportunities will have lower free cash flow and will pay lower dividends.

On the other hand Hafeez et el (2009) argued with the above researcher .According to the signaling theory the higher the firm grows, the higher they pay dividends to shareholders. The shareholders get signals from the growth of the firms having high growth opportunity. The sales growth has been used as proxy of Growth in the empirical analysis of the study and has been use as percent age change in sales annually as proxy of the growth.

Where as Kanwal Anil et el (2008), measured growth and investment by sales growth and MTBV. Hafeez Ahmed et el (2009) measure investment as SLACK = accumulated retained earnings/ total asset.

Thus as per this research the hypothesis is H3= Firm growth is negatively associated with dividend payouts.


Data Collection Method

The data is collected from Securities Exchange Commission of Pakistan, State Bank of Pakistan and the Karachi Stock Exchange. The variables of the study are calculated from the Audited Annual Accounts of 6 firms for the period of 2001 to 2008. Which are about 240 observations for each variable and it is a long period enough to smooth out variable fluctuations. (Rozeff, 1982)


Sample Size consists of six companies from oil and gas exploration and marketing sectors in Pakistan, listed on Karachi Stock Exchange (KSE) Total of six companies listed on Karachi Stock Exchange (KSE). Data collected from year 2001 to year 2008.

Statistical Test

Linear Regression test was performed to analyze data. Dividend yield is a depended variable and growth, size and profitability are taken as independent variable.

Regression Model

This study uses multiple regression analysis.This thesis estimate that

Y = Dividend yield.

X0 = Intercept of the equation

X1 = Firm size.

X2 = Firm profitability.

X3 = Firm sale growth.

e = Error Term.

Y= X0 + X1 + X2 + X3 + e

Results indicate that size of the firm is statistically significant as shown in table 3 and show that size is negatively correlated with dividend which is significant at 1% as shown in table 3. Since the size is also statistically significant but the hypothesis for this thesis shows that the growth is negatively related to dividend hence this hypothesis rejected

The result of the research by Hafeez Ahmed et el (2009) is similar to this thesis result. The results indicates that the size of the firms have the negative impact on dividend payout policy which shows that the firms prefer to invest in their assets rather than pay dividends to their shareholders.

The result of the research by Julia Sawicki is also similar to our result .The results indicate that Dividend payout and firm size are negatively related. Which show that the large firms dominate and may be involved in greater scale production, and thus distribute less cash dividends as compared to smaller size firm.

Profitability is positively correlated with dividend which is significant at 10 % .This shows that more profitable firms are give more dividend then the firm which are less profitable.

The result of the research by Hafeez et el (2009) and Samy ben naceuret et el (2006) is similar to this thesis result. The results indicate that highly profitable firms with more stable earnings can afford larger free cash flows and thus pay out larger dividends.

Since the Growth is also statistically significant as shows in Table 3 and the hypothesis for this thesis shows that the growth is negatively related to dividend but the result of this thesis differs from the hypothesis because it is positive related to the dividend hence this hypothesis rejected .The result conclude that growing firms gives more dividend .

The result of the research by Samy ben naceuret et el (2006) and Julia Sawicki is similar to this thesis result. The results indicate that fast-growing firms distribute larger dividends so as to appeal to investors.


In this research, three variables were tested to analyze their possible impact and relationship with dividend yield policy, namely size, profitability and growth. The thesis uses multiple linear regression models, the data analysis covering from 2001 to 2008 of Oil & gas sector in Pakistan. Results show that dividend yield and independent variables are statistically significant.

Size is statistically significant which shows that relationship exists between firm size and dividend yield. The significant level which we took was 1%, in an article by author Khamis Al-Yahyaee et el (2006) the significant level was also 1% since the size is significant but the Result shows that there is a negative relationship between dividend yield and size. This shows that hypothesis of this research is rejected.

Profitability is also statistically significant .positive relationship exist between the dividend and profitability, the significant level we took here is 10% in an article by author Yahyaee et el (2006) the significant level was also 10%, this shows that H0 is rejected . The more the firms are profitable the large they give dividends. We measured the profitability by ROA.

Growth is also statically significant. The significant level of our research is 1%. There is a positive relationship between growth and dividend yield which indicate that the hypothesis of this thesis is rejected because in this thesis hypothesis the growth is negatively related.


In this research, three variables were tested to analyze their possible impact and relationship with dividend yield, but study of available literature reveals that there some other variables that may have an impact on dividend yield policy of a firm such as price to earnings ratio, profit margin, debt to equity ratio, current ratio, float, insider ownership, institutional ownership, and investment.Further researches can be carried out to test the relationship of these variables on firm's dividend policy and what kind of relation they have can also be tested.

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