AbstractIn Bangladesh corporate sector is adversely facing competition due to economicdownturn in the world and making efforts to survive in a competitive anduncertain economic environment. This study will help to improve dividenddecisions of corporate sector through proper implementation of their dividendpolicies. This paper is an attempt to explain the effect of dividendannouncements on stock prices of Dhaka Stock Price of Pakistan. Academicliterature suggests that dividend payments should have no impact onshareholders’ value in the absence of taxes and market imperfections. Hence,companies should invest excess funds in the positive net present value projectsinstead of paying out them to the shareholders.Literature also suggests that market valuation of stocks depends on the expectedfuture dividends.If company pays out all of the earnings, funds for future investment will decreaseand dividend may not increase in the future. Moreover, when dividend is taxable,paying out more cash would increase the shareholders tax liability. Despite thesetheoretical arguments for not paying dividends, companies often pay cashdividends to their shareholders possibly to signal information about the futureearnings prospects. Our empirical results based on 137 samples of dividendpaying companies listed on Dhaka Stock Exchange, showed that investors do notgain value from dividend announcement. Indeed shareholders lost about 20percent of value over a period of 30 days prior to the dividend announcementthrough to 30 days after the announcement.The lost value may be partially compensated because of the current dividendyield. Overall, the evidence tends to support the dividend irrelevancy hypothesis.Evidence also indicates that dividend payment does not signal any information tothe investors, which needs to be further investigated.1. IntroductionDividend policy is one of the most widely researched topics in the field of finance butthe question whether dividend policy affects stock prices still remains debatable amongmanagers, policy makers and researchers for many years. Dividend policy is importantfor investors, managers, lenders and for other stakeholders. It is important for investorsbecause investors consider dividends not only the source of income but also a way toassess company from investment point of view. It is the way of assessing whether thecompany is cash generative or not. Selecting a suitable dividend policy is an important
decision for the company because flexibility to invest in future projects depends on theamount of dividends that they pay to their shareholders. If company pay moredividends then fewer funds available for investment in future projects. Lenders are alsointerested in the amount of dividend that a company declares, as more amounts is paidas dividend means less amount would be available to the company for servicing andredemption of their claims and finally it is important for other stakeholders especiallyfor claimholders to help them in reducing agency cost. The basic objective ofshareholder is to maximize their return and this return may be in the form of dividendsor capital gain. Investors’ decision regarding the return on investment is affected bydividend policy of the company. Arnold (2008) explains the main objective of dividendpolicy is to maximize shareholders’ wealth by maximizing their purchasing power. Somaximizing shareholders’ wealth depends on the dividend policy of the companybecause of this shareholders would satisfy their purchasing and consumption patterns.A great deal of theoretical and empirical research on dividend effects has been doneover the last several decades. Theoretically, cash dividend means giving reward to theshareholders that is something they already own in the company; hence this will beoffset by the decline in stock value (Porterfield, 1959 and 1965). In an ideal world(without tax and any restrictions) therefore dividend payments would have no impacton the shareholders’ value (Miller and Modigliani, 1961)1. In the real world, however achange in the dividend policy is often followed by change in the market value of stocks.The economic argument for investor’ preference to dividend income was offered byGraham-Dodd (1951). Subsequently, Walter (1956) and Gordon (1959 and 1962)forwarded the dividend relevancy idea, which has been formalized into a theory,postulating that current stock price would reflect the present value of all expecteddividend payments in the future.Other researchers made efforts to further understand the dividend controversy. Amongthem, Brennan (1970 and 1973), Litzenberger and Ramaswamy (1979 and1980)showed that it is not optimal for the investors to receive dividends if theirmarginal tax rate is greater than zero, and investors’ after-tax expected rate of return(discount rate) depends on the dividend yield and systematic risk.2 This leads to an ideathat at least dividend might have some tax-induced effect on the share prices. Averageinvestors, subject to their personal tax rates, would prefer to have less cash dividend ifit is taxable:Size of optimal dividend inversely related to personal income tax rates (Pye, 1972).Hence, stocks prices tend to decline after announcement of dividend increase.Empirical studies however showed mixed evidence, using the data from US, Japan andSingapore markets. A number of studies found that stock price has a significant positiverelationship with the dividend payment [Gordon (1959), Ogden (1994), Stevens andJose (1989), Kato and Lowenstein (1995), Ariff and Finn (1986), and Lee (1995)], while
others found a negative relationship [Loughlin (1989) and Easton and Sinclair (1989)].A negative relationship between dividend announcement stock returns is expected dueto tax effect, but researchers tended to relate the positive relationship between thestock returns and dividend announcement with the information effect of dividend. Thedividend information hypothesis postulates that cash dividend carries informationregarding the future cash flows of firm that is to be reflected in the market price of stockafter announcement of dividend, particularly when dividend increases [Bhattacharya(1979) Bar-Yosef and Huffman (1986) and Yoon and Starks (1995)].The theoretical literature on dividend effects has been well developed.Researchers largely accepted that dividend per-se has no impact on the shareholders’value in an ideal economy. However, in a real world, dividend announcement isimportant to the shareholders because of its tax effect and information content. In thisstudy, we have examined the dividend effect on shareholders’ value in Dhaka StockOur results showed that Cumulative Abnormal Return (CAR) of 152 stocks portfolioincreased shortly before the announcement of dividendsbut this value increase did notsustain in the ex-dividend periods. Indeed, theshareholders’ of dividend payingcompanies lostsignificant amount of value over aperiod of 30 days after the dividendannouncement. However, the lost value can be partially compensated by the dividendyield.As CARs are negative in the periods after dividend announcement, evidence suggestsdividend announcements do not carry information about the future earnings and cashflows of the companies. Hence, our findings are not consistent with the dividendinformation hypothesis. The negative CAR in the ex-dividend periods is apparentlyconsistent with the dividend tax-effect hypothesis. This could be possible becausedividend income generally needs to be included in the investors’ personal income fortax purposes. Since the dividend yield partially compensates the value lost in the ex-dividend periods, investors’ overall value remains largely unchanged after dividendpayments.Hence, evidence seems to be consistent with Miller and Modigliani hypothesis (1961).The rest of the paper is organized as follows: in Section 2, we discuss the methodology.Characteristics of samples are described in Section 3. The empirical findings arepresented and analyzed in Section 4. Finally, Section 6 concludes the paperMETHODOLOGYIn order to study the impact of dividend announcement on shareholders’ valuewe use two measures: (i) daily market-adjusted abnormal return (MAAR) and (ii)daily cumulative abnormal return (CAR). MAAR indicates the relative daily
percentage price change in the dividend paying stocks compared to the change inaverage market price.We use DSE all-share price index as the proxy of average market price. MAAR iscalculated as follows:MAARit= Rit– RmtWhereMAARitis the market adjusted abnormal return for security i over time tRitis the time t returns on security i, calculated as (Pit – Pit-1)/Pit-1. Where, Pit is the market closing price of stock i on day t. Pit-1 is The market closing price of stock i on day t-1.Rmtis the time t return on the DSE all-share price index calculated as (It –It-1)/It-1. Where, Iitis the market index on day t. It-1 is the marketindex on day t-1.The market adjusted abnormal return (MAAR) shows the change in individual stock’svalue due to the dividend announcement. As the percentage change in market index(average market price) is deducted, the remainder gives us the unsystematic portion ofthe value change, which is specific to that particular stock resulting from its dividendannouncement. MAAR is calculated over a period starting to –30 days to +30 daysrelative to the dividend announcement day (0-day).The second measure used is cumulative abnormal returns (CAR), which measures theinvestors’ total return over a period starting from well before the announcement ofdividend to well after the dividend announcement day. We use a 61-day windowperiod starting from -30-day to +30-day relative to the dividend announcement day (0-day).CAR is computed as follows:CARt =∑ MAARtWhere, CARt is cumulative abnormal return, MAARt as defined above, j denotes the day-30 through day +30.Finally, we used parametric test to determine the statistical significance of market adjustedaverage abnormal return of dividend paying stocks over the window period (-30 day to +30day relative to dividend announcement). The t-statistics were calculated cross-sectional byusing the standard deviation of abnormal returns of the portfolio of 152dividend-payingstocks. Moreover, t-test suggested in Brown and Warner (1980, p. 251-252) is also applied to test the statistical significance of the cumulative abnormal returns.Sample description:The market of 2010-2011 is downtown in DSE. So I choose this year to differ theannouncement dividends from the other year. There are 152 companies run their business inDSE some company lack behind and some get gain. But it makes a big difference between.Also there is some problem to calculate the dividends.
The number of dividend paying companies increased by more than 5 percent in the first halfthis year, as a total of 152 listed firms paid dividends during the period.In the first half last year, a total of 144 companies paid dividends. Of these, 56 companiesgave cash dividends, while 88 bonus or stock dividends.This year, 55 companies paid cash dividends and 97 companies’ stock dividends, accordingto statistics from the Dhaka Stock Exchange.Five companies, however, did not declare any dividend this year, as against 13 companies inthe same period last year, a drop by more than 60 percent.Nine companies declared more than 100 percent cash dividend, one announced more than 50percent to 100 percent, eight companies more than 30 percent to 50 percent, nine companiesmore than 20 percent to 30 percent and 19 companies between 10 percent and 20 percent,while nine companies declared less than 10 percent cash dividend up to June 2011.The value of bonus shares, issued by companies in different sectors up to June, stood at Taka4,252 core.The sector-wise weighted average dividend distribution performance showed that 11 sectorspaid higher dividend in the first half of 2011, compared to that in the same period last year,according to the DSE statistics.However, offering of rights shares by listed firms declined in the first half this year. Fifteencompanies declared rights shares up to June 2011 as against 25 in 2010.A total of Taka 794.48 core worth rights shares were adjusted on the trading floor during theperiod.Table 1 shows the average dividends of 152 companies in DSE. We can also see the mostdividends Provider Company and also lowest dividends company.Table 1: Distribution of Sample Companies Listed on DSE Sector Dividend Dividend Average dividends ( June 2010) ( June 2011) Banks 2.6 2.53 2.565 Financial institutions 3.59 2.28 2.935 Investments 4.94 5.42 5.18 Engineering 18.58 31.48 25.03 Food allied 85.58 111.98 98.78 Fuel power 23.09 15.42 19.255 Jute 12 10 11 Textiles 2.2 20.85 11.525 Pharmaceuticals 28.55 17.71 23.13 Paper Printing 10.16 5 7.58
Service and real estate 24.7 18.32 21.51 Cement 4.52 5.51 5.015 IT 1.56 2.94 2.25 Tannery 65.11 74.88 69.995 Ceramic 0.36 8.71 4.535 Insurance 3.67 3.98 3.825 90 18.475 Telecoms 60 120 Miscellaneous 22.74 14.21 100 90 80 70 60 50 40 30 Series1 20 10 0DSE classify the listed companies into A, B and Z categories. A category companies aregood stocks as their operating performance are assessed to be good and pay regular
dividends, B-category companies are moderate companies whose operatingperformance are satisfactory and pay some dividends from time to time, and Z-categorycompanies are those whose operating performance are not good and normally pay nodividend.Analysis and Findings:COMPARING MARKET ADJUSTED ABNORMALRETURNS (MAAR)Comparison between the market adjusted average abnormal returns (MAAR) forstock dividend and the MAAR for the cash dividend is shown with theirrespective t values with n-1 degrees of freedom (n=16 for stock and n=23 forcash). The findings have been reported under the table-1. This indicates that themarket adjusted average abnormal returns attributed solely to the dividendannouncement day is statistically insignificant for both stock and cash dividends.Thus, it is evidence that there are no differences in the impact of cash or stockdividend as far as the announcement day is concerned.However, the significant negative returns for equity dividend prior to theannouncement day (such as day-23, - 18, and -13) indicate speculative nature ofthe investors’ behavior. As it is with the nature of weak form efficient market topredict the returns around an upcoming event, the rumors and hearsaydominates the market. It is also possible that the news has been leaked outearlier resulting in the negative effect of the event. In such a case the negativereturns associated prior to the announcement justify that the speculators are inaction with negative News about the announcement. On the other hand positivereturns for stock dividends are reported after the announcement, (such as day 9,12, 22) Indicating positive attitude during the post announcement period. Thepositive returns could be attributed to the lag between the announcement dayand the record day. As the record day becomes nearer, the stock indicates somepositive returns, though the length of the lag may vary for A, B or Z categories ofcompanies as far as the DSE is concerned. Therefore, the investors in generalshows more positive attitude towards stock dividends rather than cash dividend.As far as cash dividend is concerned, there is no significant returns exist as aresult of cash dividend declaration.Furthermore, the negative MAAR (though not statistically significant) on thedeclaration day may indicate the investors unfulfilled expectation for stockdividend.Table-1: Comparison between markets adjusted abnormal turn of stockand cash dividend.Continue…………….