A STUDY ON DIVIDEND POLICY AND VALUE OF THE FIRM:
MANAGERIAL PERSPECTIVES IN MALAYSIA
BY:
OSWALD TIMOTHY EDWARD
CHU HONG HENG
LAU GEE CHOON
DECEMBBR
2OO5
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Kami
Tarikh
Sui-at
ffi
600-iRDcissP 5t3t1395
:
21 Disember 20A4
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Pengarah
U|TM Cawangan Johor
Kampus Segamat, Batu
Jalan Muar
85009 Segamat
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Website : http I I : www.uitm.edu.my/brc
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Tuan/ Puan
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:
:
A Study On Dividend policy and Value of the Firm:
Managerial perspectives in Malaysia
En Oswald Timothy Edward
Kos Yang diluluskan
:
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; Geran Dalaman
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Sekian, terima kasih.
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rffiB-
PROF MADYA DR ROSMIMAH MOHD ROSLTN
Ketua Penyelidikan (Sains Sosial dan pengurusan)
s.k: 1.
2
3.
;r;a
--::i-?.,;-
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En Oswald Timothy Edward
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projeci iifie: A Study On Diviciend Policy
anci Value of the Firm: Managerial Perspectives in Malaysia
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Penolong Naib Canselor (Penyelidikan)
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Yang berbahagia Prof.,
LAPORAN AKHIR PENYELIDIKAN "A STUDY ON DIVIDEND POLICY
AND VALUE OF THE FIRM: MANAGERIAL PERSPECTIVES IN
MALAYSIA''
Merujuk kepada perkara di atas, bersama-sama ini disertakan 3 (tiga) naskah
Laporan Akhir Penyelidikan bertajuk "A STUDY ON DIVIDEND POLICY
AND VALUE OF THE FIRM: MANAGERIAL PERSPECTIVES IN
MALAYSIA".
Sekian, terima kasih.
Yang benar,
OSWALD TIMOTHY EDWARD
Ketua
Proiek Penvelidikan
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KUMPULAN PENYELIDIKAN
OSWALD TIMOTHY EDWARD
Ketua Penyelidikan
Tandatangan
CHU HONG HENG
Ahti
G
7
Tandatangan
LAU GEE CHOON
Ahti
Tandatangan
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Acknowledgement
I
wish to acknowledge the assistance of many persons within the industry who
responded to the questionnaires and numerous requests for timely information not
available in regularly published sources. To them I am ever so grateful. I would like
to
express
my gratitude to my mentor for his suggestions and challenges
completing this project.
I am extremely grateful to URDC
in
members for their support.
Finally, I dedicate this study to my beloved ones for their understanding and support.
Any remaining errors are my own.
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CONTENTS
lv
Acknowledgement
Abstract
List of Tables
vi
Chapter
1.0
2.0
3.0
4.0
INTRODUCTION
1.1
1.2
1.3
|.4
l.5
1.6
Background of the Study
Problem Statement
Research Questions
Objectives of Studies
Importance of Study
Organizing of Study
THEORETICALFRAMEWORK
2.1
2.2
2.3
2.4
2.5
2.6
Introduction
Behavioral Model of Dividend Policy
Traditional View of the Significance of Dividend Policy
Dividend and Taxes
The Irrelevance of Dividend Policy
The Signaling Theory
LITERATURE REVIBW
3.1
3.2
Dividend Irrelevance Theory
Dividend Relevance Theory
3.2.1 Bird-in-the-Hand Theory
3.2.2 The Signaling Explanation
3.2.3 The Tax Preference Explanation
3.2.4 The Agency Explanation
RESEARCHMETHODOLOGY
4.1
4.2
4.3
4.4
4,5
4.6
Introduction
Sources of Data
4.2.1 Primary Data
4.2.2
Secondary Data
Data Collection Method
Sampling Process
4.4.1 Relevant Population
4.4.2 Sampling Frame
4.4.3 Sampling Method
4.4.4 Sample Size
QuestionnaireDesign
4.5.1 Data measurement Scale
Data Analysis
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I
I
6
7
7
8
9
ll
ll
13
t4
16
24
27
31
3l
3l
3l
)z
35
JI
39
39
40
40
4l
41
42
A'
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A1
+l
ta
+)
44
44
45
A1
4.6.1 Statistical Package
4.6.2 Statistical Technique
5.0
FINDINGS AND ANALYSIS
5. I
Characteristics of Respondents
5. I .l Position of Respondents In The Company
5.1.2 Duration of Years Involved in Determining Dividend
Policy
5.1.3 Type of Industries and Response Rate
Reliability Analysis
5.2
5.3
5.4
5.5
5.6
6.0
Relationship Between Responding and Nonresponding Firms
Analysis on Relationship between Dividend Policy and
Value
Dividend Relevance Theory
Setting Dividend Policy
CONCLUSION AND DISCUSSION
6.1
6.2
6.3
Conclusion
Limitations of Study
Recommendations for Further Research
Bibliography
Appendix A. Questionnaire
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A1
.+l
50
50
50
5l
52
53
53
55
57
63
65
65
67
68
LIST OF TABLES
Table 2.1
Example of difference in share prices as a result of low and
high dividend payout policies under Brennan's proposition.
19
Table 2.2
Elton and Gruber's evidence for dividend vield statistic
ranked by deciles
24
Table 4.1
Likert's scale
46
Table 5.1
Characteristics of the Respondents
51
Table 5.2
Type of Industry and Response Rate
52
Table 5.3
Reliability Coefficient (Alpha Values)
53
Table 5.4
Characteristics of Responding and Nonresponding Firm
55
Table 5.5
Relationship Between Dividend Policy and Value of The
Firm (Panel A)
57
Table 5.6
The Bird-in-the-Hand Explanation (Panel
Table 5.7
The Signaling Explanation (Panel 82)
60
Table 5.8
The Tax Preference Explanation (Panel B3)
6l
Table 5.9
The Agency Explanation (Panel 84)
62
Table 5.10
Setting Dividend Policy (Panel C)
64
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Bl)
58
Abstract
This study investigates the views of corporate managers about the relationship between
dividend policy and value; explanations of dividend relevance including the bird-in-thehand, signaling, tax-preference, and agency explanations; and how firms determine the
amount of dividends to pay. We obtain data from 2004 mail survey sent to 207 chief
financial officers/financial controller/corporate managers
of firms listed on the Bursa
Malaysia. Based on 64 usable responses, the empirical result show that most survey
respondents believe that dividend policy affects firm value. Of the four explanations for
dividend relevance, the respondents generally express the highest level of agreement with
statements about signaling. The results also show that managers are concerned about the
continuity of dividends when setting dividend payments
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CHAPTER ONE
INTRODUCTION
1.1
Background ofthe Study
Many companies pay dividend to their shareholders as yield or return for the money they
invest in the company. Dividend can be regarded as any direct payment by
the
corporation to the shareholders. Cash dividend is popular and very desirable from the
view of investors.
In addition to the declaration of cash dividend, the firm has other options for distributing
profits to the shareholders. These options are the stock dividend, stock split and stock
repurchase.
A share dividend represents a distribution of additional
shareholders.
shares to the existing
It involves nothing more than a bookkeeping transfer from
retained earning
to capital stock accounts (common stock plus capital surplus); a shareholder's percentage
ownership remains constant. Stocks dividends are frequently used to conserve cash and
still appease investors' desire for dividends.
A stock split is a change in the number of outstanding
shares
of stock achieved through
a
proportional reduction or increase in the par value of the stock. Only the par value and
number of outstanding shares are affected. The amounts in the common stock, premium
and retained earning accounts do not change. Stock dividends and stock split can be used
to keep the market price of the stock within a popular trading range. Many companies
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believe in the existence of such a trading range for their stocks, and they attempt to keep
their stock process within the range.
If
there is such a popular trading range, a large
volume of low-priced stocks should provide a broader and more stable market for the
stock.
However, both stock dividends and stock splits are more costly to administer than cash
dividend. Cash dividends represent a transfer of assets to stockholder and thus increase
stockholder wealth; they represent income to the recipient. But both stock dividends and
stock splits do not involve a transfer of corporate assets to stockholders; consequently,
they did not represent incoming increase the number
of shares outstanding. If
the
company maintains the same amount of cash dividends per share after the stock dividend,
the total payment is increased proportionally.
A
repurchase
of
share occurs when a
firm buys back outstanding shares of its common
share. Firms repurchase share for three major reasons, which are
for stock option
purpose, acquisition reason and to increase earning per share by retiring the share. The
third motive is the reason why repurchase decision can be treated as dividend decision.
The firm chooses to reduce the number of shares outstanding so that future dividend
could be increased. Stock repurchases have distinct advantages such as an increase in
earnings per share, certain tax benefits, and a significant shift in capital structure within a
short period of time.
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Dividend policy can be categorized as guiding principle chosen by the firm to pay
dividend to its shareholders. There are various types of dividend policy such as stable
dividend policy, constant dividend payout policy and residual dividend policy. Stable
dividend policy refers to two situations; constant dividend policy and stable growth
dividend. Stable growth dividend upholds a constant growth rate of dividend eventually.
Constant dividend policy maintains a relatively stable dollar dividend over time. An
increase in the dollar dividend usually does not occur until management is convinced that
the higher dividend level can be maintained in the future. Management also will not
reduce the dollar dividend until the evidence clearly indicates that a continuation of the
present dividend cannot be supported.
As a consequence, firms are generally to
set
dividend at a sustainable level and to raise it only when the new level can be sustained.
In the constant dividend payout policy, the percentage of earning paid out in dividend is
held constant.
It
means that some firms would pay dividend equaling
a constant
percentage of their earning. For example, a firm having a 40Vo constant payout ratio and
earning RM2.00 per share would pay a dividend of RMO.80 per share. In general, earning
is quite volatile, fluctuating with changes in the economy and each firm's own special
circumstances.
dividends
If
a firm follows a constant payout dividend policy, the volatility of
will match the volatility of earnings. A
constant payout dividend policy is
likely to be a disaster for most firms. It would result in wildly fluctuating dividends,
which would scare away all investors seeking a particular level of dividend, as they could
not plan on a steady income. By the same token, investors interested primarily in capital
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gains would never know when they might receive a large dividends and the large tax
liability that goes with it. As such, very few firms follow such a policy.
The residual dividend policy is widely known. The theory hypnotizes that the amount
of
dividends should not be the focus of the company. Instead, the primary issue should be to
determine the amount of earning retained within the firm for investment. The amount
of
earnings retained, according to this view, depends on the number and size of acceptable
capital budgeting projects and the amount of earning available to finance the equity
portion ofthe funds needed to pay for these projects. Any earning left after these projects
have been funded is paid out in dividends. Because the dividends arise from residual, or
leftover earnings, this is known as Residual Dividend Policy.
From these three dividend policies, stable dividend policy is much more appreciated by
both shareholders and firms. This is because the shareholders look upon a stable dividend
as a sign
of firm stability. It will also reduce a lengthy quarterly discussion on dividend
levels by board of directors. Unless circumstances warrant a possible change, the regular
dividend can be declared. This policy avoids wasting the time of the board and allows its
members to concentrate on more important matters facing the firm.
Corporate dividend policy is an important issue for at least two reasons. First, there may
be conditions where a change in dividend policy can alter the value of the
firm. Second,
if
dividend policy can alter the market value of the firm or its asset, it might also affect the
value of its new capital projects.
If
dividend policy does affect the value of capital
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projects, the net present value of a given capital project
will
be different for a company
with different dividend policy.
Dividend policy might affect the value of the firm for two reasons. First, tax rates on
capital gain are usually different from tax rates on dividend.
If the company could
reduce
taxes by transforming dividend into capital gains, shareholders might value the firm at a
correspondingly higher level.
value of the firm is that
it
A
second reason why dividend policy might affect the
could provide valuable information to shareholders. For
example, suppose that a firm has important information about the profitability of new
investment opportunities that
it
wishes to convey
to
shareholders without disclosing
details that might be useful to competitors. Changing the level of dividends might be an
effective method of signalling favourable developments, helping to ensure that the market
value of the firm reflects fullv all the information that is available to manasement.
The board's decision to pay a dividend is called declaring a dividend. This occurs on the
declaration date. At that date a liability, called dividend payable, is created on the firm's
balance sheet. Because the common stock of public corporations typically is traded every
day in the marketplace, the board of director must select a cutoff date, or date of record,
to determine who will receive the dividend. At the end of business on this date. the
company stockholder records are checked.
All
owners of the common stock at that time
receive the forthcomins dividend.
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When stock is traded on an exchange or in the over-the-counter market, it would take
several days to process the paperwork necessary to record the change of ownership that
occurs when the stock changes hand. On the date of record, the company's transfer agent
will
have not yet known of stock trading that occurred in the days immediately preceding
the date of record. The transfer agent is the party, usually a commercial bank that keeps
the records of stockholder ownership for a corporation. The transfer agent pays dividends
to the appropriate stockholders of record after the company has deposited the required
money with the transfer agent.
it
of stock
trade to reach the transfer agent, the rules
of
trading dictate that two days before the date of record, common stock that has
an
Because
takes time for news
upcoming dividend payment
will
begin to trade ex-dividend. Investors who buy the stock
on or after the ex-dividend date will be buying it "without" entitlement to
the
forthcoming dividend. The two-day period gives exchange officials enough time to notiff
the transfer agent
ofthe last batch trades that occurred before the ex-dividend period. The
extra time ensures that the stockholder records
1.2
will be correct on the date of record.
Problem Statement
Dividend policy is the most controversial subject in finance. Why company keep paying
cash dividend
to
shareholder? Why some companies keeps changing their dividend
policy? Does dividend really affect value of the company? Is there an optimal dividend
policy? Lintner (1956), Baker and Powell (1999), Shelor and Officer (1994) are among
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financial scholars whom found out that dividend policy does affect the value of the firm.
Contradictory, Miller and Modigliani (1961) have theoretically explained that the value
of the firm is unaffected by dividend policy in the world without tax, and support by
other scholars [e.g. Black and Scholes (1974), Miller and Scholes (1978)]. So, why
corporate managers
still insist to pay dividend to shareholder if it is irrelevant? Today
many academicians and corporate managers still debate whether the dividend policy
matters.
If it is true that dividend
does affect value
of the company, which
relevant
theory of dividend can best explained the dividend phenomenon in Malaysia? So, this
study wants to reveal the puzzle of dividend issues by looking at the view of corporate
managers in Malaysia context.
Research Questions
1.3
This study addresses three-research question:
1. Do corporate managers believe that dividends are relevant?
2.
What explanation of relevance dividend theories do managers tend to favor?
3.
How do firms set the amount of dividends that they pay?
t.4
Objectives of Study
There are various theories being discussed that are conflicting and controversial in the
case
of dividend. Understanding the theories is very important in order to
comprehend
better with the reasons why firms give dividend to the shareholders. The contradictory
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issue of whether dividend impinges on the value of the
firm is still debatable.
Perhaps,
by looking at the practitioners' opinion will help us to reduce the confusion and to
understand more on this subject, as they are the decider of dividend policy in the firm.
Thus, the main objective of this study is to investigate the views of corporate managers
towards the dividend policy in Malaysia. The main objective of this study
will
be
supported by specific objectives, which are:
l.
To find out the relationship of dividend policy and value of the company from
corporate managers view.
2.
To explain the dividend relevance theory in Malaysia including the bird-in-thehand, signaling, and clientele tax preference and agency explanations.
3.
1.5
To learn how firms determine the amount of dividends paid to shareholders
Importance of Study
Some finance scholars have engaged in extensive theorizing to explain why companies
should pay or not pay dividends [e.g. Miller and Modigliani (1961)]. Some researchers
have developed and empirically tested various models to explain dividend behavior [e.g.
Lintner (1956)]. Other researchers have surveyed corporate managers and institutional
investors to determine their views about dividends [e.g. Baker and Powell (1999) and
Baker, Farrelly and Edelman (1985)]. Regardless of extensive research and debate, the
actuaf rationale for paying dividends remains puzzle.
It is important to investigate the
dividend policy issues in order to determine to what extent the corporate managers agree
with the various interpretation of dividend policy contained in the academic literature.
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Understanding the beliefs of managers who are involved in setting dividend policy may
contribute to our understanding of why firms pay cash dividend. This study
will help to
reveal the issue of dividend policy in Malaysia from the view of corporate managers.
1.6
Organizing of Study
Chapter One defined the meaning of dividend and explained the relationship of dividend
policy with value of the company. In this chapter, the objectives of study and problem
statement on dividend policy are also included. Importance of this study is also enclosed
in this chapter.
Chapter two comprises of theoretical framework of dividend policy, which discuss the
commencing of several theories in dividend policy.
Chapter three consists
of literature review regarding dividend
irrelevance theory and
dividend relevance theories such as bird-in-the-hand, signaling, and clientele effect and
agency explanation.
Chapter four describes the methodology of the research. The discussion on the research
design, sampling technique, questionnaire design, data collection and data analysis will
also be included.
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Chapter five is basically the continuation of Chapter four that explained the analysis
study, findings, and interpretation of d,ata that
will
show the real situation
of dividend
policy from corporate managers' perspective.
Chapter Six ends the paper with conclusion, recommendation and limitation of study.
l0
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of
CHAPTER TWO
THEORETICAL FRAMEWORK
2.1
Introduction
The most crucial issue in the area of dividend policy is whether a company's choice of
dividend policy can affects its share price. As often happens
in
finance, there are
conflicting points of view.
One school of thought, the traditional one, advocates high payout ratios. According to the
traditional view, shareholders prefer immediate dividends to less certain and more distant
capital gains, which would presumably result
instead
if the
cash were reinvested in the business
of being paid out as dividends. For obvious
reasons, finance textbooks have
dubbed this view the "bird-in-the-hand arsument".
A
second school
of
thought takes the opposite stance. According
to that
view,
shareholders prefer capital gains over dividends, and hence low payout ratios, because
capital gains are taxed at a lower rate than dividends.
A third
school
of
thought, which owes its origin
to Merton Miller and Franco
Modigliani's classic article on dividend policy, maintains that a company's stock market
value is relatively insensitive to its choice of dividend policy. Their article demonstrated
that under somewhat idealized conditions and with a company's capital expenditure
il
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program held fixed, changes in the company's payout ratio would not affect its stock
market value. According to this view, dividend policy is a passive rather than an active
decision; each period a company should first determine its capital investment program
and then pays out as dividends whatever cash
is Ieft over. However, this
so-called
"dividend irrelevance" does depend on Miller and Modigliani's assumptions.
A fourth
school of thought, which has attracted growing support in recent years, has
brought the dividend policy debate full circle. According to this view, dividend changes
represent
an important signal to investors regarding changes in
expectations as
to the company's future
earnings.
signals the expectation of higher future earnings.
management's
In particular, a dividend
increase
It is widely acknowledged that, at least
in this particular sense, dividend policy is relevant to share valuation.
Most important from a practical standpoint, companies actually behave as
though
dividends do matter. For example, it is not uncommon to find rapidly growing companies
with fund needs that are growing more rapidly than earnings but which nevertheless pay
small dividends. Also, there are many companies, such as electric utilities, that have
relatively high payout ratios and that sell new issues of common stock from time to time.
If dividend policy really
does not matter, it would be cheaper for these companies to pay
out smaller dividends and finance capital investment with retained earnings rather than
more expensive new issue.
t2
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2.2
Behavioral Model of Dividend Policy
Lintner (1956) conducted interviews with 28 carefully selected companies to investigate
their thinking on the determination of dividend policy. His fieldwork suggested that:
1.
Managers focused on the change in the existing rate of dividend payouts, not on
the amount of the newly established payout as such;
2.
Most managements sought to avoid making changes in their dividend rates that
might have to be reversed during the year or so;
3.
Major changes in earnings "out of line" with existing dividend rates were the
most important determinants of a companyos dividend decisions; and
4.
Investment requirements generally had little effect on modifuing the pattern of
dividend behavior.
Taken together, the observations suggest that most companies had somewhat flexible but
nevertheless reasonably well-defined standards regarding the speed
with which
they
would try to move toward a full adjustment of dividend payout to earnings. Lintner
suggests that corporate dividend behavior can be described on the basis
of following
equation.
A Div,t
:
ai
+ ci(Divi1* - Divi.1-1)
:
U;1,
where
A
Divrt: the change
in dividends
ci - the speed of adjustment to the difference
between a target dividend payout and
last year's payout
la
IJ
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Div;1*
:
the target dividend payout
Divi,t-r: last period's dividend payout
&i,(Jir,
:
a constant and a normally distributed random error term
The target dividend payout, Divtt* is a fraction, ri, of this period's earnings, NIit. Upon
fitting the equation to annual data from l9l8 through 1941, Lintner finds that the model
explain 85% of the changes in dividends forhis sample of companies. The average speed
of adjustment is approximately
2.3
30o/o per year, and the
target payout is 50% of earnings.
Traditional View of the Significance of Dividend Policy
(Birds-in-the-Hand)
If
the amount of dividends a company pays affects its share price, there exists some
optimum level of dividends that maximizes the company's stock market value. In the
extreme,
if
one believes that shareholders always prefer more dividends to less, the
company should pay out all its earnings. However, few would take the argument that far.
Several models have been developed to assist in determining the optimal dividend policy.
One of the earliest, which was served as a foundation
for later models, was presented in
Graham and Dodd's classic book on securities analysis:
Share
price :
price-earnings multiple x (dividends per share
IA
t-
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* 1/3 of earning
per share)