5 FACTORS AFFECTING DIVIDEND DECISION Dividend is a widely researched arena but still its fathom has to be explored as numerous questions remains unanswered. The question of “Why do corporations pay dividends?” has puzzled researchers for many years. Despite the extensive research devoted to solve the dividend puzzle, a complete understanding of the factors that influence dividend policy and the manner in which these factors interact is yet to be established. Allen et al. (2000)1 stated that:

“Although a number of theories have been put forward in the literature to explain their pervasive presence, dividends remain one of the thorniest puzzles in corporate finance.”

The dividend decision is taken after due considerations to number of factors like legal as well as financial. This is so because one set of dividend policy cannot be evolved that can be applied to all firms rather the dividend decision vary from firm to firm in light of the firm specific considerations. Lintner (1956)2 suggested that dividend depends in part on the firm's current earnings and in part on the dividend for the previous year. He found that major changes in earnings with existing dividend rates were the most important determinants of the firm's dividend policy. Ramcharran (2001)3 observed that:

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“…dividend policy in the equity emerging markets from a corporate finance

perspective

has

not

been

empirically

examined

to

date…Continuing financial reforms in emerging markets, together with the validity of more published data, will encourage further research on other determinants of dividend policy, including the impact of agency costs, information, and taxes as well as the capital structure of firms”.

This suggested that much more research needed to be undertaken on dividend policy in developing economies.

5.1 FACTORS AFFECTING DIVIDEND DECISION Dividend decision, one of the important aspects of company’s financial policy, is not an independent decision. Rather, it is a decision that is taken after considering the various related aspects and factors. There are various factors influencing a firm's dividend policy. For example, some studies suggest that dividend policy plays an important role in determining firm capital structure and agency costs. Many studies have provided arguments that link agency costs with the other financial activities of a firm. Easterbrook (1984)4 argued that firms pay out dividends in order to reduce agency costs. Dividend payout keeps firms in the capital market, where monitoring of managers is available at lower cost. If a firm has free cash flows, it is better to share them with shareholders in the form of dividend in order to reduce the possibility of these funds being wasted on unprofitable (negative net present value) projects (Jensen, 1986)5.

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Crutchley and Hansen (1989)6 examined the relationship between ownership, dividend policy, and leverage and concluded that managers make financial policy tradeoffs to control agency costs in an efficient manner. More recently, researchers have attempted to establish the link between firm dividend policy and investment decisions. Smith and Watts (1992)7 investigated the relations among executive compensation, corporate financing, and dividend policies and concluded that a firm's dividend policy is affected by its other corporate policy choices. Also, Jensen, Solberg and Zorn (1992)8 linked the interaction between financial policies and insider ownership to informational asymmetries between insiders and external investors. Despite this rich literature, most prior work recognizes differences in determinants of financial decisions between different firms.

5.1.1 Basic Factors Affecting Dividend Decision Theoretically, over the past number of years, it has been believed by the academicians that the dividend decision is influenced by number of factors. Some of the factors that affect the dividend decision of a firm are listed as follows:

1. Legal Provisions: Indian Companies Act, 1956 has given the guidelines regarding legal provisions as to dividends. Such guidelines are required to be followed by the companies whenever the dividend policy is to be formulated. As per the guidelines, a company is required to transfer a certain percentage of profits to reserves in case the dividend to be paid is more than 10 percent. Further, a

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company is also required to pay dividend only in cash but only with the exception of bonus shares.

2. Magnitude of Earnings: Another important aspect of dividend policy is the extent of company’s earnings. It serves as the introductory point for framing the dividend policy. This is so because a company can pay dividends either from the current year’s profit or the past year’s profit. So, if the profits of a company increase, it will directly influence the dividend declaration as the latter may also increase. Thus, the dividend is directly linked with the availability of the earnings with the company.

3. Desire of Shareholders: The decision to declare the dividends is taken by Board of Directors but they are also required to consider the desire of the shareholders, which depend on the latter’s economic condition. The shareholders, who are economically weak, prefer regular dividend policy while the rich shareholders may prefer capital gains as compared to dividends. However, it is very difficult for the board to reconcile the conflicting interests of different shareholders yet the dividend policy has to be framed keeping in view the interest of all the interested parties.

4. Nature of Industry: The nature of industry in which a company is operating, influences the dividend decision. Like the industries with stable demand

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throughout the year are in a position to have stable earnings, thus, should have the stable dividend policy and vice-versa.

5. Age of the Company: A company’s age also determine the quantum of profits to be declared as dividends. A new company should restrict itself to lower dividend payment due to saving funds for the expansion and growth as compared to the already existing companies who can pay more dividends. Grullon et al. (2002)9 suggested that as firms mature, they experience a contraction in their growth which results in a decline in their capital expenditures. Consequently, these firms have more free cash flow to pay as dividends. Similarly, Brav et al. (2005)10 suggested that more mature firms are more likely to pay dividends. In contrast, younger firms need to build up reserves to finance the future growth opportunities, thus, making them to retain the earnings.

6. Taxation Policy: The tax policy of a country also influences the dividend policy of a company. The rate of tax directly influences the amount of profits available to the company for declaring dividends.

7. Control Factor: Yet another factor determining dividend policy is the threat to loose control. If a company declares high rate of dividend, then there is the possibility that a company may face liquidity crunch for which it has to issue new shares, resulting in dilution of control. Keeping this threat in view, a company

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may go for lower level of dividend payments and more ploughing back of profits in order to avoid any such threat.

8. Liquidity Position: A company’s liquidity position also determines the level of dividend. If a company does not have sufficient cash resources to make dividend payment, then it may go for issue of bonus shares.

9. Future Requirements: A company while faming dividend policy should also consider its future plans. If it foresees some profitable investment opportunities in near future then it may go for lower dividend and vice-versa.

10. Agency Costs: The separation of ownership and control results in agency problems. Agency costs can be reduced by distributing dividends (Rozeff, 198211, Easterbrook, 198412, Jensen et al., 199213). In this stratum, dividends are paid out to stockholders in order to prevent managers from building unnecessary empires to be used in their own interest. In addition, dividends reduce the size of internally generated funds available to managers, forcing them to go to the capital market to obtain external funds (Easterbrook, 198414). As explained in Rozeff (1982)15, firms with a larger percentage of outside equity holdings are subject to higher agency costs. The more widely spread is the ownership structure, the more acute the free rider problem and the greater the need for outside monitoring. Hence, these firms should pay more dividends to control the impact of widespread ownership.

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11. Business Risk: Business risk is a potential factor that may affect dividend policy. High levels of business risk make the relationship between current and expected future profitability less certain. Consequently, it is expected that firms with higher levels of business risk will have lower dividend payments. Many researchers argued that the uncertainty of a firm’s earnings may lead it to pay lower dividends because volatile earnings materially increase the risk of default. In addition, field studies using survey data (e.g., Lintner, 195616) reported compelling evidence that risk can affect dividend policy. In these surveys, managers explicitly cited risk as a factor that influences their dividend choice.

5.1.2 Financial Factors Affecting Dividend Decision The above mentioned factors are not limited and many more can be there that affect the determination of dividend. Keeping in view the above-mentioned factors and the review of literature, some variable has been identified within the arena of the theoretical factors. Those variables include both the dependent and independent variables. However, their interpretation depends upon their measurement. The present study covers the following set of variables:

1. DPS to Face Value: This ratio evaluates the relationship between dividend per share and face value of the share. It is calculated as:

Dividend Yield ratio=

Dividend per share/Face value per share

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2. DPS to Market Value (Yield ratio): This ratio evaluates the relationship between dividend per share and market value of the share. It is calculated as:

Dividend Yield ratio=

Dividend per share/Market value per share

3. Dividend Payout Ratio: It indicates the extent to which the earnings per share have been retained by a company. It enables the company to plough back the profits which will result in more profits in future and hence, more dividends. It is calculated as:

Dividend Pay-Out Ratio=

Dividend per equity share/Earnings per share

The higher the ratio, lower is the dividend payment and vice-versa.

4. Current Ratio: It is a measure of firm’s liquidity and is basically used for measuring the short-term financial position or liquidity of the firm. It indicates the ability of the firm to meet its current liabilities. It is calculated as:

Current Ratio=

Current assets/Current liabilities

A high ratio indicates that firm’s liquidity position is good and it has the ability to honor its obligations while a low ratio implies that firm’s liquidity position is not

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so good so as to honor all its obligations. However, a ratio of 2:1 is considered satisfactory. The expected relation between current ratio and dividend payment is positive.

5. Net Profit Ratio: This ratio establishes the relation between net profits and sales and indicates the management’s efficiency. It is calculated as:

Net Profit ratio=

(Net Profit/Net sales)*100

As dividends are declared from the net profits of a firm, so higher the net profit ratio, higher will be the expected dividend payment.

6. Net Profit to Net worth: This ratio indicates the relation between net profits earned by a company and the net worth which is represented by shareholder’s capital. It is composed of equity share capital, preference share capital, free reserves and surpluses, if any. It is also referred to as return on investment and is calculated as:

Return on shareholder’s investment=

Net Profit/Net Worth

This ratio is an indication of company’s ability to earn profits. If the earning capacity of the company is more, more dividend payment can be expected and vice-versa.

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7. Debt Equity Ratio: This ratio measures the claims of outsiders and owners against the firm’s assets. It indicates the relation between outsider funds and shareholders funds. It is calculated as:

Debt-equity ratio=

Outsiders funds/Shareholders funds

This ratio tells the solvency position of the firm. Higher the ratio, better will be the solvency as well as the ability of firm to pay dividends. The vice-versa will hold true in case of low ratio.

8. Lagged Profits: The dividend is not only influenced by the past year’s dividend but also by the past year’s profits. This is so because a company can follow the stable dividend policy if it has sufficient current year’s profit or the past year’s profit.

9. Behavior of Share Prices: The prevailing share prices also influence the dividend payment by a company. If the share prices of a company are unfavorable, then it may increase the dividend in order to boost up the share prices. It can be calculated as:

Behavior of share prices=

Higher share price - Lower share price Higher share price + Lower share price

10. Growth in Earnings: If the earnings of a company increase, then the chances of

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increase in dividend payment are also there. Growth is must for the survival of a company. This ratio can be calculated as:

Growth in Earnings=

EPSt- EPSt-1 / EPSt-1

Where, EPSt= Current earnings per share EPSt-1= Previous earnings per share

12. Growth in Working Capital: This ratio indicates increase in the working capital of a company.

Growth in Working Capital=

WCt- WCt-1 / WCt-1

Where, WCt= Current working capital WCt-1= Previous working capital

Higher ratio indicates the increase in the capacity of a company to pay dividends but this is interrelated with other factors also. Like, if a company has increase the working capital to match the increased level of operations, then this ratio will not be useful in studying the impact on the dividend payments.

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14. Lagged Dividends: A company may consider the past year’s dividend as a benchmark. If a company prefers stability of dividend payments, it may consider the past year’s dividend rate and can act accordingly.

15. Tobin’s Q: This variable represents the investment opportunities for a company. It is measured as

(MV of equity-BV of equity +Total Assets)/Total Assets

16. Investment Opportunity Set (Market to Book Value): It represents the availability of investment opportunities to the company and generally is believed to have negative relationship with dividend payout.

17. Free Cash Flow: This variable is used to measure the availability of cash with the company. It is calculated as

(Cash flow from Operations-Cash flow from investment activities)/Total assets

18. Cash Holdings: It is another financial variable to analyse the liquidity position of the firm. It is calculated as

(Cash + Short-term investment)/Total assets

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19. Uncertainty in Earnings: It refers to the variation in the earnings from one year to another. Some companies might witness irregular earnings and thus, may not have stable dividend policy. Uncertainty in earnings can be measured as

σ = √ (∑x2/N)

A small value of standard deviation means high degree of uniformity in the earnings and vice-versa.

20. Solvency Ratio: This ratio is a small variant of equity ratio. It indicates the relationship between total liabilities to outsiders to total assets of a firm. It can be calculated as:

Solvency ratio=

Total Liabilities to Outsiders/Total Assets

21. Return on Net worth: This ratio is also termed as return on investment. This ratio indicates the relationship between net profits (after interest and tax) and the shareholders funds. It can be calculated as

Net profit (after interest and taxes)/Shareholders funds

22. Return on Capital Employed: This ratio establishes the relationship between profits and capital employed. It can be calculated as

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(Adjusted Net Profits/Gross Capital Employed)*100 or (Adjusted Net Profits/Net Capital employed)*100

5.2 DATA ANALYSIS AND INTERPRETATIONS In the present chapter, the Principal Component Analysis approach has been used in order to obtain a set of variables pertaining to dividends. The major emphasis was in deriving the exclusive cluster of the aforesaid group of variables for each of the four industrial groups: Engineering, FMCG, Information Technology and Textiles; and for the combined group of all the four industries separately for the years 2007and 2008.

For the same purpose, the following financial variables have been used: DPS to Face Value, DPS to Market Value, Payout Ratio, Lagged Dividend, Lagged Profits, Current Ratio, Solvency Ratio, Debt-Equity Ratio, Free Cash Flow, Cash Holdings, Share Price Behavior, Growth in EPS, Growth in Working Capital, Return on Capital Employed, Return on Net worth, Age of the Company, Net Profit to Net worth, Net Profit ratio, Market to Book value, Tobin’s Q and Uncertainty in EPS. The analysis has been made carried out with the help of Factor Analysis. The following steps were followed in order to extract the factors.

The principal component analysis using VARIMAX rotation of twenty one variables pertaining to Engineering, FMCG, IT and Textiles industrial sector has led to the

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extraction of numerous factors. After a meaningful set of variables have been obtained, the next task is to group the variables under particular factor and label them in order to assign some meaning to the factor loadings. Variables with higher loadings are considered more important and have greater influence on the label selected to represent the factor. For this purpose, the sampling adequacy tests have been conducted to know that whether the sample is adequate or not. KMO recommends accepting value greater than .5 as barely acceptable (value below this leads either to collect more data or to rethink which variable should be included or excluded). And Bartlett recommends the accepting value less than .05. Bartlett’s test finds that the correlations, when taken collectively are significant at .0001 level whereas measure of sampling adequacy looks at the patterns between the variables.

Derivation of the factors is based on the perusal of correlation matrix results in retaining only those components that fulfill the same criteria. The decision to choose the factor loadings has been based on the criteria of sample size (factor loading between .3-.4 if the sample ranges between 150 and 350). Since the sample size for the current study is 172, so only the loadings above .30 have been considered for the study. For obtaining the rotated factor matrix, Orthogonal rotation method viz. VARIMAX rotation has been used which shows factor loadings for each variable onto each factor. In this matrix, only the main factors have been displayed which are reliable & whose value is more than .3 and the rest have been eliminated. After identifying the significant factor loadings, next step is to study the communalities of the variables, representing the amount of variance accounted for by the factor solution for each variable. It is generally assumed that

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variable with communalities> .50 should be retained for the study. In the present analysis, no variable could be found having communality 60% variance). Table 5.2 summarises the orthogonal solution resulting from VARIMAX rotation of the original twenty one measures for Engineering industrial sector for the year 2007.

183

Table 5.2: Factor Analysis for Factors Affecting Dividend in Engineering Industry for the Year 2007 Factors Profitability and Investment Set Net Profit Ratio Return on Net worth Return on Capital Employed Market to Book Value Free Cash flow Net Profit to Net worth Ratio Dividend Rate Dividend Per Share Dividend Per Share to Market Value Dividend Per Share to Face value Dividend Payout Financial Soundness Current Ratio Debt Equity Ratio Cash Holding Solvency Ratio Liquidity Growth in Working Capital Company’s Age Age Earnings and Share Price Behavior Share Price Behavior Profit After Tax Growth in EPS Investment Opportunity Tobin’s Q Risk and Uncertainty EPS Uncertainty

Factor Loadings

Eigen Value

Percentage of Variance Explained

Cumulative Variance

5.150

21.110

21.110

3.781

17.862

38.972

2.307

12.460

51.431

1.524

7.555

58.986

1.306

6.678

65.664

1.215

6.275

71.939

1.098

5.521

77.460

1.009

5.355

82.815

.864 .961 .871 .650 .549 .956

.952 .876 .930 .948 .828 .725 .713 .858 .785

.892

.694 .569 .512 .893 .814

The factor 1 variables: “Net Profit Ratio”, “Return on Net worth”, “Return on Capital Employed”, “Market to Book Value”, “Free Cash Flow” and “Net profit to Net worth ratio” are interpreted under the construct “Profitability and Investment Set”. Factor 2 was named as “Dividend Rate” and includes the variables “Dividend per Share”, “Dividend

184

Per share to Market Value”, “Dividend per share to Face Value” and “Dividend Payout”. Factor 3 was named as “Financial Soundness” and includes variables “Current Ratio”, “Debt Equity”, “Cash Holding” and “Solvency Ratio”. Factor 4 was named as “Liquidity” and includes variables “Growth in Working Capital”. Factor 5 was named as “Company’s Age” and includes variables “Age”. Factor 6 was named as “Earnings and Share Price Behavior” and includes variables “Share Price Behavior”, “Profit after Tax” and “Growth in Earnings per Share”. Factor 7 was named as “Investment Opportunity” and includes variables “Tobin’s Q”. Factor 8 was named as “Risk and Uncertainty” and includes variables “Earnings per Share Uncertainty”.

B) FMCG Industry For the FMCG industrial sector, the overall MSA value falls in the acceptable range (above .50) with a value of .504 for KMO and .000 for Bartlett’s test (less than .5), these measures indicate that the set of variables are appropriate for factor analysis.

Table 5.3: KMO and Bartlett's Test for FMCG Industry Kaiser-Meyer-Olkin Measure of Sampling Adequacy Approx. Chi-Square Bartlett's Test of Sphericity

.504 517.791

df

210

Sig.

.000

Factor analysis has yielded seven factors for FMCG sector which represented 75.5% of the variance, of 21 variables deemed sufficient in terms of total variance explained (solution should account for >60% variance). Table 5.4 summarises the orthogonal

185

solution resulting from VARIMAX rotation of the original twenty one measures for FMCG industrial sector for the year 2007.

Table 5.4: Factor Analysis for Factors Affecting Dividend in FMCG Industry for the Year 2007 Factors Profitability and Investment Set Net Profit Ratio Return on Net worth Return on Capital Employed Market to Book Value Free Cash flow Net Profit to Net worth Ratio Dividend Rate Dividend Per Share Dividend Per Share to Market Value Dividend Per Share to Face value Dividend Payout Financial Soundness EPS Uncertainty Age Debt-Equity Ratio Profit After tax Growth in Working Capital Solvency Ratio Investment Opportunity Tobin’s Q Liquidity Current Ratio Cash Holdings Growth Rate Growth in EPS Share Price Movement Share Price Behavior

Factor Loadings

Eigen Value

Percentage of Variance Explained

Cumulative Variance

5.336

22.481

22.481

2.732

11.211

33.691

2.182

11.182

44.874

1.690

8.291

53.164

1.548

8.089

61.253

1.267

7.375

68.628

1.099

6.872

75.500

.538 .944 .955 .797 .688 .939

.551 .536 .911 .544 .855 .611 .735 .710 .527 .718 .905 .542 .836 .822 .525

The factor 1 variables: “Net Profit Ratio”, “Return on Net worth”, “Return on Capital Employed”, “Market to Book Value”, “Free Cash Flow” and “Net profit to Net worth Ratio” are interpreted under the construct “Profitability and Investment Set”. Factor 2

186

was named as “Dividend Rate” and includes the variables “Dividend per Share”, “Dividend Per share to Market Value”, “Dividend per share to Face Value” and “Dividend Payout”. Factor 3 was named as “Financial Soundness” and includes variables “EPS Uncertainty”, “Age”, “Debt Equity”, “Profit after Tax”, “Growth in Working Capital” and “Solvency Ratio”. Factor 4 was named as “Investment Opportunity” and includes variable “Tobin’s Q”. Factor 5 was named as “Liquidity” and includes variables “Current Ratio” and “Cash Holdings”. Factor 6 was named as “Growth Rate” and includes variables “Growth in EPS”. Factor 7 was named as “Share Price Movement” and includes variables “Share Price Behavior”.

C) IT Industry For the IT industrial sector, the overall MSA value falls in the acceptable range (above .50) with a value of .554 for KMO and .000 for Bartlett’s test (less than .5), these measures indicate that the set of variables are appropriate for factor analysis.

Table 5.5: KMO and Bartlett's Test for IT Industry Kaiser-Meyer-Olkin Measure of Sampling Adequacy

.554

Approx. Chi-Square

632.765

Bartlett's Test of Sphericity

df

210

Sig.

.000

Factor analysis has yielded seven factors for IT sector which represented 80.392% of the variance, of 21 variables deemed sufficient in terms of total variance explained (solution should account for >60% variance). Table 5.6 summarises the orthogonal solution

187

resulting from VARIMAX rotation of the original twenty one measures for IT industrial sector for the year 2007.

Table 5.6: Factor Analysis for Factors Affecting Dividend in IT Industry for the Year 2007 Factors Profitability Position Net Profit Ratio Return on Net worth Return on Capital Employed Free Cash Flow Net Profit to Net worth Ratio Growth in Working Capital Dividend Rate Dividend Per Share Dividend Per Share to Market Value Dividend Per Share to Face value Dividend Payout Financial Soundness Current Ratio Cash Holding Debt Equity Solvency Ratio Company’s Age Age Investment Opportunity Market Value to Book Value Tobin’s Q Share Prices and Uncertainty EPS Uncertainty Share Price Behavior Earnings and Growth Rate Profit After Tax Growth in EPS

Factor Loadings

Eigen Value 5.475

Percentage of Variance Explained 22.637

Cumulative Variance 22.637

3.274

11.999

34.636

2.365

11.179

45.815

1.984

10.036

55.851

1.571

9.853

65.704

1.169

7.415

73.119

1.044

7.273

80.392

.940 .629 .670 .846 .650 .778 .494 .419 .852 .418 .836 .746 .873 .593 .764 .846 .891

.505 .720 .864 .898

The factor 1 variables: “Net Profit Ratio”, “Return on Net worth”, “Return on Capital Employed”, “Market to Book Value”, “Free Cash Flow” , “Net profit to Net worth ratio” and “Growth in Working Capital” are interpreted under the construct “Profitability Position”. Factor 2 was named as “Dividend Rate” and includes the variables “Dividend 188

per Share”, “Dividend Per share to Market Value”, “Dividend per share to Face Value” and “Dividend Payout”. Factor 3 was named as “Financial Soundness” and includes variables “Current Ratio”, “Cash Holding”, “Debt Equity” and “Solvency Ratio”. Factor 4 was named as “Company’s Age” and includes variables “Age”. Factor 5 was named as “Investment Opportunity” and includes variables “Market Value to Book Value” and “Tobin’s Q”. Factor 6 was named as “Share Prices and Uncertainty” and includes variables “EPS Uncertainty” and “Share Price Behavior”. Factor 7 was named as “Earnings and Growth Rate” and includes variables “Profit after Tax” and “Growth in Earnings per Share”.

D) Textile Industry For the Textiles industrial sector, the overall MSA value falls in the acceptable range (above .50) with a value of .546 for KMO and .000 for Bartlett’s test (less than .5), these measures indicate that the set of variables are appropriate for factor analysis.

Table 5.7: KMO and Bartlett's Test for Textiles Industry Kaiser-Meyer-Olkin Measure of Sampling Adequacy Approx. Chi-Square Bartlett's Test of Sphericity

.546 655.154

df

210

Sig.

.000

Factor analysis has yielded seven factors for Textiles sector which represented 86.306% of the variance, of 21 variables deemed sufficient in terms of total variance explained (solution should account for >60% variance). Table 5.8 summarises the orthogonal

189

solution resulting from VARIMAX rotation of the original twenty one measures for Textiles industrial sector for the year 2007.

Table 5.8: Factor Analysis for Factors Affecting Dividend in Textiles Industry for the Year 2007 Factors Profitability Position Return on Net worth Return on Capital Employed Net Profit to Net worth Ratio Profit After Tax Growth in EPS Financial Soundness Growth in Working Capital Net Profit Ratio Cash Holdings Solvency ratio Investment and Risk EPS Uncertainty Tobin’s Q Market Value to Book value Dividend Rate Dividend Per Share DPS to Market Value DPS to Face Value Dividend Payout Capital Structure and Share Price Behavior Debt Equity Share Price Behavior Company’s Age Age Liquidity Position Current Ratio Free Cash Flow

Factor Loadings

Eigen Value 5.109

Percentage of Variance Explained 23.449

Cumulative Variance 23.449

4.103

16.11

39.559

3.096

13.427

52.986

2.220

11.953

64.938

1.317

8.000

72.938

1.262

7.114

80.052

1.110

6.254

86.306

.928 .851 .905 .880 .666 .820 .947 .826 .958 .886 .762 .943 .890 .811 .713 .780

.743 .754 .798 .732 .581

The factor 1 variables “Return on Net worth”, “Return on Capital Employed”, “Net Profit to Net worth”, “Market to Book Value”, “Profit after Tax” and “Growth in Earnings per Share” are interpreted under the construct “Profitability Position”. Factor 2 was named as “Financial Soundness” and includes the variables “Growth in Working Capital”, “Net

190

profit Ratio”, “Cash Holdings” and “Solvency Ratio”. Factor 3 was named as “Investment and Risk” and includes variables “EPS Uncertainty”, “Tobin’s Q” and “Market Value to Book Value”. Factor 4 was named as “Dividend Rate” and includes variables “Dividend per Share”, “Dividend to Market Value”, “Dividend to Face Value” and “Dividend Payout”. Factor 5 was named as “Capital Structure and Share Price Behavior” and includes variables “Debt Equity Ratio” and “Share Price Behavior”. Factor 6 was named as “Company’s Age” and includes variables “Age”. Factor 7 was named as “Liquidity Position” and includes the variables “Current Ratio” and “Free Cash Flow”.

5.2.2) FACTOR ANALYSIS RESULTS FOR GROUPED DATA FOR THE YEAR 2007 The sampling adequacy tests have been conducted to know that whether the sample is adequate or not. For the grouped data, the overall MSA value falls in the acceptable range (above .50) with a value of .648 for KMO and .000 for Bartlett’s test (less than .5), these measures indicate that the set of variables are appropriate for factor analysis.

Table 5.9: KMO and Bartlett's Test for Grouped Data Kaiser-Meyer-Olkin Measure of Sampling Adequacy

.648

Approx. Chi-Square

1982.956

Bartlett's Test of Sphericity

df

210

Sig.

.000

Factor Analysis has resulted in retaining seven factors for the grouped data which retained represented 68.771% of the variance, of 21 variables deemed sufficient in terms of total variance explained (solution should account for >60% variance). Table 5.10

191

summarises the orthogonal solution resulting from VARIMAX rotation of the original twenty one measures for the grouped data for the year 2007.

Table 5.10: Factor Analysis for Factors Affecting Dividend for Grouped Data for the Year 2007 Factors Profitability and Investment Set Return on Net worth Return on Capital Employed Market Value to Book Value Net Profit to Net worth Ratio Profit After Tax Dividend Rate Dividend Per Share Dividend per Share to Market Value Dividend per Share to Face Value Dividend Payout Financial Soundness Net Profit Ratio Current Ratio Cash Holdings Free Cash Flow Solvency Ratio Share Price Movement Share Price Behavior Capital Structure and Investment Opportunity Debt-Equity Ratio Tobin’s Q Growth Rate Growth in EPS Growth in Working Capital Company’s Age and Uncertainty EPS Uncertainty Age

Factor Loadings

Eigen Value 4.037

Percentage of Variance Explained 17.519

Cumulative Variance 17.519

3.018

13.740

31.259

2.403

9.365

40.624

1.465

8.229

48.853

1.343

6.790

55.642

1.126

6.616

62.259

1.049

6.512

68.771

.956 .887 .644 .946 .356 .902 .735 .735 .916 .917 .730 .622 .553 .926 .728

.569 .709 .829 .414 .614 .769

The factor 1 variables “Return on Net worth”, “Return on Capital Employed”, “Market to Book Value”, “Net Profit to Net worth” and “Profit after Tax” are interpreted under the construct “Profitability and Investment Set”. Factor 2 was named as “Dividend Rate” and includes variables “Dividend per Share”, “Dividend to Market Value”, “Dividend to Face

192

Value” and “Dividend Payout”. Factor 3 was named as “Financial Soundness” and includes the variables “Net profit Ratio”, “Current Ratio”, “Cash Holdings”, “Free Cash Flow” and “Solvency Ratio”. Factor 4 was named as “Share Price Movement” and includes variables “Share Price Behavior”. Factor 5 was named as “Capital Structure and Investment Opportunity” and includes variables “Debt-Equity Ratio” and “Tobin’s Q”. Factor 6 was named as “Growth Rate” and includes the variables “Growth Rate in EPS” and “Growth Rate in Working Capital”. Factor 7 was named as “Company’s Age and Uncertainty” and includes the variables “EPS Uncertainty” and “Age”.

5.2.3) FACTOR ANALYSIS RESULTS FOR INDIVIDUAL INDUSTRIAL SECTORS FOR THE YEAR 2008 A) Engineering Industry For the Engineering industrial sector, the overall MSA value falls in the acceptable range (above .50) with a value of .671 for KMO and .000 for Bartlett’s test (less than .5), these measures indicate that the set of variables are appropriate for factor analysis.

Table 5.11: KMO and Bartlett's Test for Engineering Industry Kaiser-Meyer-Olkin Measure of Sampling Adequacy Approx. Chi-Square Bartlett's Test of Sphericity

.671 770.271

df

210

Sig.

.000

Factor analysis has yielded six factors for Engineering sector which represented 68.679% of the variance, of 21 variables deemed sufficient in terms of total variance explained (solution should account for >60% variance). Table 5.12 summarises the orthogonal

193

solution resulting from VARIMAX rotation of the original twenty one measures for the Engineering sector for the year 2008.

Table 5.12: Factor Analysis for Factors Affecting Dividend in Engineering Industry for the Year 2008 Factors Profitability Position Net Profit Ratio Return on Net worth Return on Capital Employed Free Cash flow Net Profit to Net worth Ratio Financial Soundness Current Ratio Debt Equity Ratio Cash Holding Growth in Working Capital Solvency Ratio Dividend Rate Dividend Per Share Dividend Per Share to Market Value Dividend Per Share to Face value Dividend Payout Company’s Age and Profitability Age Profit After Tax Investment Opportunity Market Value to Book Value Tobin’s Q Earnings and Share Price Behavior Share Price Behavior Growth in EPS

Factor Loadings

Eigen Value 5.209

Percentage of Variance Explained 18.222

Cumulative Variance 18.222

3.163

14.316

32.538

1.982

11.825

44.363

1.696

10.312

54.675

1.259

8.427

63.102

1.114

5.578

68.679

.876 .873 .785 .649 .907

.885 .613 .854 .582 .910 .818 .768 .734 .462

.623 .488 .776

.489 .467

The factor 1 variables: “Net Profit Ratio”, “Return on Net worth”, “Return on Capital Employed”, “Free Cash Flow” and “Net profit to Net worth ratio” are interpreted under

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the construct “Profitability Position”. Factor 2 was named as “Financial Soundness” and includes variables “Current Ratio”, “Debt Equity”, “Cash Holding”, “Growth in Working Capital” and “Solvency Ratio”. Factor 3 was named as “Dividend Rate” and includes the variables “Dividend per Share”, “Dividend Per share to Market Value”, “Dividend per share to Face Value” and “Dividend Payout”. Factor 4 was named as “Company’s Age and Profitability” and includes variables “Age” and “Profit after Tax”. Factor 5 was named as “Investment Opportunity” and includes variable “Market Value to Book Value” and “Tobin’s Q”. Factor 6 was named as “Earnings and Share Price Behavior” and includes variables “Share Price Behavior”, and “Growth in Earnings per Share”.

B) FMCG Industry For the FMCG industrial sector, the overall MSA value falls in the acceptable range (above .50) with a value of .556 for KMO and .000 for Bartlett’s test (less than .5), these measures indicate that the set of variables are appropriate for factor analysis.

Table 5.13: KMO and Bartlett's Test for FMCG Industry Kaiser-Meyer-Olkin Measure of Sampling Adequacy Approx. Chi-Square Bartlett's Test of Sphericity

.556 514.505

df

210

Sig.

.000

Factor analysis has yielded eight factors for FMCG sector which represented 80.717% of the variance, of 21 variables deemed sufficient in terms of total variance explained (solution should account for >60% variance). Table 5.14 summarises the orthogonal

195

solution resulting from VARIMAX rotation of the original twenty one measures for the FMCG sector for the year 2008.

Table 5.14: Factor Analysis for Factors Affecting Dividend in FMCG Industry for the Year 2008 Factors Profitability and Investment Opportunity Net Profit Ratio Return on Net worth Return on Capital Employed Market to Book Value Net Profit to Net worth Ratio Capital Structure and Risk Debt-Equity Ratio Solvency Ratio Liquidity Current Ratio Cash Holding Growth in Working Capital Dividend Rate Dividend Per Share Dividend Per Share to Market Value Dividend Per Share to Face value Dividend Payout Earnings and Uncertainty EPS Uncertainty Profit After tax Company’s Age and Risk Age Tobin’s Q Financial Soundness Free Cash Flow Growth in EPS Share Price Movement Share Price Behavior

Factor Loadings

Eigen Value

Percentage of Variance Explained

Cumulative Variance

4.723

20.505

20.505

2.830

10.531

31.036

2.319

10.069

41.105

2.027

9.757

50.862

1.539

9.205

60.067

1.355

8.439

68.506

1.109

6.262

74.768

1.048

5.949

80.717

.612 .947 .950 .763 .951 .839 .771 .710 .758 .850 .594 .698 .911 .907 .830 .789 .513 .908 .448 .862 .552

The factor 1 variables: “Net Profit Ratio”, “Return on Net worth”, “Return on Capital Employed”, “Market to Book Value” and “Net profit to Net worth Ratio” are interpreted under the construct “Profitability and Investment Opportunity”. Factor 2 was named as

196

“Capital Structure and Risk” and includes the variables “Debt-Equity Ratio”, “Solvency Ratio”, “Dividend per share to Face Value” and “Dividend Payout”. Factor 3 was named as “Liquidity” and includes variables “Current Ratio”, “Cash Holdings” and “Growth in Working Capital. Factor 4 was named as “Dividend Rate” and includes the variables “Dividend per Share”, “Dividend Per share to Market Value”, “Dividend per share to Face Value” and “Dividend Payout”. Factor 5 was named as “Earnings and Uncertainty” and includes variables “EPS Uncertainty” and “Profit after Tax”. Factor 6 was named as “Company’s Age and Risk” and includes variables “Age” and “Tobin’s Q”. Factor 7 was named as “Financial Soundness” and includes variables “Free Cash Flow” and “Growth in EPS”. Factor 8 was named as “Share Price Movement” and includes variables “Share Price Behavior”.

C) IT Industry For the IT industrial sector, the overall MSA value falls in the acceptable range (above .50) with a value of .616 for KMO and .000 for Bartlett’s test (less than .5), these measures indicate that the set of variables are appropriate for factor analysis.

Table 5.15: KMO and Bartlett's Test for IT Industry Kaiser-Meyer-Olkin Measure of Sampling Adequacy

.616

Approx. Chi-Square

535.094

Bartlett's Test of Sphericity

df

210

Sig.

.000

Factor analysis has yielded seven factors for IT sector which represented 75.881% of the variance in IT sector, of 21 variables deemed sufficient in terms of total variance

197

explained (solution should account for >60% variance). Table 5.16 summarises the orthogonal solution resulting from VARIMAX rotation of the original twenty one measures for the IT sector for the year 2008.

Table 5.16: Factor Analysis for Factors Affecting Dividend in IT Industry for the Year 2008 Factors Profitability Position Net Profit Ratio Return on Net worth Return on Capital Employed Free Cash Flow Net Profit to Net worth Ratio Dividend Rate Dividend Per Share Dividend Per Share to Market Value Dividend Per Share to Face value Dividend Payout Liquidity Cash Holding Financial Soundness Current Ratio Growth in Working Capital Solvency Ratio Leverage and Risk EPS Uncertainty Debt Equity Earnings and Investment Opportunity Tobin’s Q Market Value to Book Value Growth in EPS Share Prices and Profits Share Price Behavior Profit After Tax

Factor Loadings

Eigen Value 5.249

Percentage of Variance Explained 19.166

Cumulative Variance 19.166

2.945

11.166

30.332

2.135

10.485

40.817

1.857

10.456

51.273

1.354

9.760

61.033

1.264

8.010

69.043

1.131

6.839

75.881

.954 .912 .729 .581 .901 .735 .897 .821 .637 .921 .879 .559 .518 .921 .572

.730 .610 .799 .685 .778

The factor 1 variables: “Net Profit Ratio”, “Return on Net worth”, “Return on Capital Employed”, “Free Cash Flow” and “Net profit to Net worth Ratio” are interpreted under the construct “Profitability Position”. Factor 2 was named as “Dividend Rate” and includes the variables “Dividend per Share”, “Dividend Per share to Market Value”,

198

“Dividend per share to Face Value” and “Dividend Payout”. Factor 3 was named as “Liquidity” and includes variable “Cash Holding”. Factor 4 was named as “Financial Soundness” and includes variables “Current Ratio”, “Growth in Working Capital” and “Solvency Ratio”. Factor 5 was named as “Leverage and Uncertainty” and includes variables “Debt-Equity Ratio” and “EPS Uncertainty”. Factor 6 was named as “Earnings and Investment Opportunity” and includes variables “Tobin’s Q”, “Market Value to Book Value” and “Growth in Earnings per Share”. Factor 7 was named as “Share Prices and Profits” and includes variables “Share Price Behavior” and “Profit after Tax”.

D) Textile Industry For the Textile industrial sector, the overall MSA value falls in the acceptable range (above .50) with a value of .512 for KMO and .000 for Bartlett’s test (less than .5), these measures indicate that the set of variables are appropriate for factor analysis.

Table 5.17: KMO and Bartlett's Test for Textile Industry Kaiser-Meyer-Olkin Measure of Sampling Adequacy Approx. Chi-Square Bartlett's Test of Sphericity

.512 499.187

df

210

Sig.

.000

Factor analysis has yielded seven factors for Textile sector which represented 68 84.604% of the variance, of 21 variables deemed sufficient in terms of total variance explained (solution should account for >60% variance). Table 5.18 summarises the orthogonal solution resulting from VARIMAX rotation of the original twenty one measures for the Textile sector for the year 2008.

199

Table 5.18: Factor Analysis for Factors Affecting Dividend in Textiles Industry for the Year 2008 Factors Company’s Age and Profitability Position Net Profit Ratio Return on Net worth Return on Capital Employed Age Net Profit to Net worth Ratio Profit After Tax Financial Soundness Current Ratio Debt-Equity Ratio Solvency Ratio Dividend Rate Dividend Per Share DPS to Market Value DPS to Face Value Dividend Payout Liquidity Growth Growth in Working Capital Earnings and Uncertainty EPS Uncertainty Growth in EPS Liquidity Position Cash Holding Free Cash Flow Investment Opportunity and Share Price Movement Share Price Behavior Market Value to Book Value Tobin’s Q

Factor Loadings

Eigen Value

Percentage of Variance Explained

Cumulative Variance

6.305

26.809

26.809

3.289

13.759

40.568

2.346

13.525

54.094

2.052

8.176

62.269

1.664

8.007

70.276

1.067

7.563

77.838

1.044

6.766

84.604

.956 .932 .756 .810 .923 .911 .807 .622 .882 .926 .590 .919 .593 .854 .809 .627 .645 .830

.908 .651 .535

The factor 1 variables “Net Profit Ratio”, “Return on Net worth”, “Return on Capital Employed”, “Age”, “Net Profit to Net worth” and “Profit after Tax” are interpreted under the construct “Company’s Age and Profitability Position”. Factor 2 was named as “Financial Soundness” and includes the variables “Current ratio”, “Debt-Equity Ratio”, and “Solvency Ratio”. Factor 3 was named as “Dividend Rate” and includes variables “Dividend per Share”, “Dividend to Market Value”, “Dividend to Face Value” and

200

“Dividend Payout”. Factor 4 was named as “Liquidity Growth” and includes variable “Growth in Working Capital”. Factor 5 was named as “Earnings and Uncertainty” and includes variables “EPS Uncertainty” and “Growth in EPS”. Factor 6 was named as “Liquidity Position” and includes the variables “Cash Position” and “Free Cash Flow”. Factor 7 was named as “Investment Opportunity and Share Price Movement” and includes the variables “Share Price Behavior”, “Market Value to Book Value” and “Tobin’s Q”.

5.2.4) FACTOR ANALYSIS RESULTS FOR GROUPED DATA FOR THE YEAR 2008 The principal component analysis using VARIMAX rotation of twenty one variables pertaining to the grouped data for the four industrial sectors viz. Engineering, FMCG, IT and Textiles, has led to the extraction of numerous factors.

The tests of sampling

adequacy have been conducted to know that whether the sample is adequate or not. For the grouped data, the overall MSA value falls in the acceptable range (above .50) with a value of .703 for KMO and .000 for Bartlett’s test (less than .5), these measures indicate that the set of variables are appropriate for factor analysis.

Table 5.19: KMO and Bartlett's Test for Grouped Data Kaiser-Meyer-Olkin Measure of Sampling Adequacy Approx. Chi-Square Bartlett's Test of Sphericity

.703 1458.408

df

210

Sig.

.000

201

Factor Analysis has resulted in retaining seven factors for the grouped data which represented 64.072% of the variance, of 21 variables deemed sufficient in terms of total variance explained (solution should account for >60% variance). Table 5.20 summarises the orthogonal solution resulting from VARIMAX rotation of the original twenty one measures for the grouped data for the year 2008.

Table 5.20: Factor Analysis for Factors Affecting Dividend for Grouped Data for the Year 2008 Factors Profitability Position Net Profit Ratio Return on Net worth Return on Capital Employed Net Profit to Net worth Ratio Financial Soundness Current Ratio Debt-Equity Ratio Cash Holding Solvency Ratio Dividend Rate and EPS EPS Uncertainty Dividend Per Share Dividend per Share to Market Value Dividend per Share to Face Value Dividend Payout Investment Opportunity Market Value to Book Value Tobin’s Q Liquidity Free Cash Flow Growth in Working Capital Share Price Movement Share Price Behavior Growth in EPS Company’s Age and Profitability Age Profit After Tax

Factor Loadings

Eigen Value 4.487

Percentage of Variance Explained 18.251

Cumulative Variance 18.251

2.465

11.515

29.765

1.855

9.948

39.713

1.428

6.758

46.471

1.147

6.555

53.025

1.057

5.645

58.670

1.017

5.401

64.072

.656 .899 .823 .909 .850 .487 .791 .808 .689 .694 .790 .546 .623 .557 .724 .558 .321 .750 .795 .511 .733

202

The factor 1 variables “Return on Net worth”, “Return on Capital Employed”, “Net Profit to Net worth” and “Profit after Tax” are interpreted under the construct “Profitability Position”. Factor 2 was named as “Financial Soundness” and includes the variables “Net profit Ratio”, “Current Ratio”, “Debt-Equity Ratio”, “Cash Holdings” and “Solvency Ratio”. Factor 3 was named as “Dividend Rate and EPS” and includes variables “EPS Uncertainty”, “Dividend per Share”, “Dividend to Market Value”, “Dividend to Face Value” and “Dividend Payout”. Factor 5 was named as “Investment Opportunity” and includes variables “Market Value to Book Value” and “Tobin’s Q”. Factor 5 was named as “Liquidity” and includes the variables “Free Cash Flow” and “Growth Rate in Working Capital”. Factor 6 was named as “Share Price Movement” and includes variables “Share Price Behavior”. Factor 7 was named as “Company’s Age and Profitability” and includes the variables “Age” and “Profit after Tax”.

5.3 MAIN FINDINGS The results of the study presented above show that the determinants of dividend identified in the literature apply equally to Indian industries under study. More importantly, the results are an important first step in consolidating our understanding of the factors affecting dividend decision of industries in India in general. The “Profitability” factor is related to the extent of profits that accrue to the industry in order to take a decision on declaration of dividend. Further, it also influences the opportunities for future investments. The “Dividend Rate” factor is related to the dividend declared by the companies. The determinants in this group include the dividend per share, dividend payout, and relationship of dividend with market value and face value of shares. The

203

“Financial Soundness” factor is related with the creditworthiness of the industries which is influenced by solvency position and cash position. Further “Liquidity” factors are also one of the major factors affecting dividend in terms of free cash holdings and current ratio. An important factor “Share Price Movement” also influences the dividend decision in terms of the relationship of dividend with behavior of the share prices. Further, “Investment Opportunity” factor also has emerged as an important factor presenting the trade-off between the dividend declaration and the future investment opportunities set. The key implication of these findings is that the Indian industries decision of dividend is influenced by these factors.

REFERENCES

1

Allen, F., Bernardo, A. and Welch, I., 2000, “A Theory Of Dividends Based On Tax Clienteles”, Journal of Finance, Vol. 55, pp. 2499-2536

2

Lintner, J., 1956, “Distribution of Income of Corporation among Dividends Retained Earning and Taxes”, American Economic Review, Vol. 46, pp. 97-133

3

Ramcharran, H., 2001, “An Empirical Model of Dividend Policy in Emerging Equity Markets”, Emerging Markets Quarterly, Vol. 5, pp. 39-49

4

Easterbrook, F.H., 1984, “Two Agency-Cost Explanations of Dividends”, American Economic Review, Vol. 74, Issue-4, pp. 650-659

5

Jensen, M., 1986, “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers”, American Economic Review, Vol. 76, pp. 323-329

6

Crutchley, C. E. and Hansen, R., 1989, “A Test of Agency Theory of Managerial Ownership, Corporate Leverage, and Corporate Dividends”, Financial Management, Vol. 18, No. 4

7

Smith, C. W., and Watts, R., "The Investment Opportunity Set and Corporate Financing, Dividend, and Compensation," Journal of Financial Economics, Vol. 32,

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pp. 263-292 8

Jensen, G., Donald, R., Solberg, P., and Zorn, T. S., 1992, “Simultaneous Determination of Insider Ownership, Debt and Dividend Policies”, Journal of Financial and Quantitative Analysis, Vol. 27, Issue-2, pp. 247-263

9

Grullon, G., Michaely, R. and Bhaskaran S., 2002, “Are Dividend Changes a Sign of Firm Maturity?” Journal of Business, Vol. 75, Issue-3, pp. 387-424

10 Brav, A., Graham, J., Harvey, C. and R. Michaely, 2005, “Payout Policy in the 21st Century”, Journal of Financial Economics, Vol. 77, pp. 483-527 11 Rozeff, M.S., 1982, “Growth, Beta And Agency Costs As Determinants Of Dividend Payout Ratios”, Journal of Financial Research, Vol. 5, Issue-3, pp. 249259 12 Easterbrook, F.H., 1984, op.cit. 13 Jensen, G., Donald R., Solberg, P., and Zorn, T. S., 1992, op.cit. 14 Easterbrook, F.H., 1984, op.cit. 15 Rozeff, M.S., 1982, op.cit. 16 Lintner, J., 1956, op.cit.

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