School Papers

CHAPTER 1807 by Robert W. Kolb, which means

CHAPTER
2

LITERATURE
REVIEW

2.1
Dividend policy

The
concept of dividend policy is introduced in 1807 by Robert W. Kolb, which means
Dividend and dividend policy aim to be important guide to dividend and their
impact on shareholder’s wealth. . The optimal dividend policy is that which
increase the share prices of the company which in return increase the
shareholder’s wealth. Dividend policy considered as independent variable which
include Return on equity, Dividend per share, price earnings ratio, Earning
(EAR) which is not depend  The
investment, financing and dividend decisions are interdependent and must be
resolved simultaneously.
).A study of corporate dividend policy in which he found that firms typically
set long term target dividend payout ratio. He also found that dividend changes
tend to lag behind earning changes in order to give management to assess the
performance of any rises in earnings which could exert a positive impact on
shareholder’s wealth (Lintner 1956). Dividend are not as much risky as capital
gain (Linter , 1959).It argues that under certain
simplifying assumptions, the dividend decision does not affect the value of a
firm and is, therefore, irrelevant. Yet, conventional wisdom with changed
assumptions suggests that a properly managed dividend policy is important to
shareholders because it can affect share prices and shareholder wealth (Miller
and Modigliani (M) (1961).
The research indicated that the subsequent increase in the dividend payments to
the shareholders has a positive effect on the shareholders wealth strength
and gives information about an organization’s prospects of development (Black
1976). It indicates that managers can use costly dividend to signal expected
cash flows (Bhattacharya 1979). Dividend policy and stock price volatility in the context of Bangladesh is
introduced by (Rashid and Rahman (2006)

 

·       
Return
on equity:

Return on equity
is the amount of net income returned as percentage of shareholder equity.
Return on equity measures a corporation’s profitability by revealing how much a
profit a company generates with the money shareholders have invested.

ROE is expressed as a percentage and calculated
as:

Return on Equity =
Net Income/Shareholder’s Equity

Net income
for full fiscal year (before dividends paid to common stock holders but after dividends to preferred stock.) Shareholder’s equity does not include preferred shares

·       
Dividend
per share

Dividend per share is the sum of
declared dividend issued by the company for every ordinary share outstanding.
Dividend per share is the total dividend paid out by the business including
interim dividend by the ordinary number of shares outstanding issued.

DPS is expressed as a percentage and calculated
as:

DPS = Total
dividend / No. of equity shares outstanding

·       
Price
earnings ratio

It is the ratio of valuing the
company that measure its current share price relative to its per earning share.
The price earning share is also sometime known price multiple or earning
multiple

The P/E ratio can be calculated as:

Price earnings ratio = Market Value per
Share / Earnings per Share

High price earnings ratio indicates that investors anticipate
high growth in future

·       
Dividend payout ratio

It is the ratio of
total amount of dividend paid to out to the shareholder relative to their
income. It is the percentage of earning paid to shareholder in dividend

The dividend payout ratio can
be calculated as:

Dividend payout ratio = dividend per share
/ Earnings per Share

 

 

2.2 Shareholder wealth

Shareholders wealth is
represented in the earning per share, which, in turn, is the function of the
company’s investment, financing and dividend decisions. Among the most crucial
decisions to be taken for efficient performance and attainment of objectives in
any organization are the decisions relating to dividend. When business merger
try to maximize the wealth of the firm, they are actually try to increase their
stock price as the stock price increase the individual who hold the stock
wealth increases. The primary goal of management team in a company is to
maximize the shareholders’ wealth which also known as maximizing the value of
the company as determined by the value of the common stock in the particular
company (Azhagaiah & Priyah, 2008). Moreover, tax effect also affects the
dividend supply where management will increase retained earnings to maximize shareholder
wealth (Malkawi et al., 2010). This study can give a clear idea to investors
that how the dividend policy is important in order to get maximum return on
investment (Tahir & Raja, 2014).

·       
Earnings
per share

It is the portion of company’s
profit allocated to each outstanding share of common stock. Earnings per share serve as an indicator of a company’s
profitability.

EPS is calculated as:

 

EPS = (Net
Income – Dividends on Preferred Stock) / Average Outstanding Shares

Dividend relevance theory

There are two dividend
relevance theories by Walter and Gordon which show that firms which pay
dividend to their shareholder are considered positively and bear a good image
in their mind. If companies don’t pay dividend that it increases the
uncertainty in the eye of investors and the payment of dividend increases the
share price of firm.

Bird in hand theory

According to this theory that investor is risk avoider and desire
to obtain dividend instead of capital gain in future.
So dividend payments have a great impact on market price of share. While making
investment decisions, investors monitor the firm dividend policy and compare
dividends with capital gains. This theory suggests that a bird in hand is
usually better than the bird in bush. Here bird in the hand is considered as
dividend whereas bird in bush is assumed to be capital gain. Thus, it is good to
receive an income right now instead of waiting for future gain with some degree
of risk involved in it. On the other hand, dividends are not as much risky as
capital gains (Litner & Gordon, 1959).

 

Clientele
Effect:

 

Clientele
effect highlights another aspect of relevance theory. It suggests that due to
the changes in dividend policies, firm’s share price also reacts to changes in
dividend policies. Accordingly, investor takes decision on the basis of firm’s
dividend polices. Whenever firms change their dividend policies, investors make
their investment decisions accordingly (Black and Scholes, 1974; Elton and
Gruber, 1970; Miller and Modigliani, 1961). Shareholders and investors purchase
the shares of those firms whose dividend policy satisfy their needs.

Hypotheses development

In the view of the theory of dividend policy identification is
considered as an important consequences of shareholder wealth initiative.
Different scholars have explored the relationship among various determinant of
dividend and its association with return on equity, earning per share, dividend
per share, dividend payout ratio, price earning ratio.
Some have studied the effect of macroeconomic factors on dividend policy
whereas some have investigated the impact of firm specific factors on dividend
policy. Others have also studied the consequences of dividend policy.

 

Shareholders’
wealth (EPS) was considered as response variable while predictor variables
were: return on equity (ROE), dividend payout ratio (DPR), dividend per share
(DPS), price earnings ratio (PER).
Nwidobie (2013) is of the opinion that the higher these dividends, the
satisfied are these owners who see such financial investments as rewarding, and
thus attractive to non-owners to invest in; as payment of the reward, dividend,
signals good prospects of higher earnings for firms. He stated, while citing
Park (2009) that dividend payments are associated with firms with good
corporate governance, concluding that firms in legal regimes that focus on
protecting investors are more likely to earn more and pay even higher dividends
than firms in legal regimes with less investor protection. In terms of
shareholders wealth, the conventional wisdom is that a properly managed
dividend policy had an impact on share prices and shareholders’ wealth (Gill,
Biger and Tibrewala, 2010), as efforts are made by management and the board to
continually enhance corporate earnings. 

 

    
H1:     There is significant relationship
between return on equity and earning per share

According to the researchers such
Campbell & Shiller (1988), Asghar et al. (2011) and Hashemijoo et al.
(2012), there is a positive significant between return on equity and
shareholders’ wealth (FPS) In other words, the high return will lead to the
increase of share price. Consequently, it eventually affects the optimal
dividend policy for corporations.

 

   
H2:     There is significant relationship
between dividend per share and earning per share

From the study of
Lixin & Lin (n.d) and Altan & Arkan (2011), they showed that there is a
positive relationship between long term debt and shareholders’ wealth (EPS).The
higher amount of dividend debt significantly increases the firm value.

    
H3:     There is significant relationship
between dividend payout ratio and earning per share

 

The result further reveals that a very
strong relationship exists between EPS and DPR at approximately intend to
increase their dividend pay-out propensity in order to give the shareholders
and other proposed investors the signal that they are very healthy, in line
with the signaling theory, should, therefore, pursue strategies geared towards
cost reduction, elimination of wastes, full automation of production lines and
being more socially and corporately responsible to their host communities, in
order to improve their earning capacity.

H4:     There
is significant relationship between price earning ratio and earning per share

The relationship between a company’s earnings and its stock
price can be complicated. High profits don’t necessarily mean a high stock
price, and big losses don’t always lead to a low stock price. Of course,
without earnings it is hard for companies to stay in business for long.