ABSTRACT
This study examined the impact of dividend yield on stock prices of Nigerian banks; the impact of earnings yield on stock prices of Nigeria banks and the impact of payout ratio on stock prices of Nigeria banks. The study adopted the ex-post-facto research design and panel data covering 5-year period 2006-2010 were collated from annual reports of banks and the Nigeria Stock Exchange daily official list. The Ordinary Least Square Regression Model was used to estimate the relationship between dividend yield, earnings yield, payout ratio and stock prices. Average of daily stock prices was adopted as the dependent variable, while the independent variables included dividend yield (DY), earnings yield (EY) and payout ratio (POR). The result emanating from this study revealed that dividend yield had negative and significant impact on commercial banks’ stock prices in Nigeria (coefficient of Dyield =
-3.365; p-value = 0.035). Earnings yield had negative and significant impact on commercial banks’ stock prices in Nigeria (coefficient of Eyield = -0.331; p-value = 0.048) and dividend payout ratio had negative and non-significant impact on commercial banks’ stock prices in Nigeria (coefficient of Por = -1.411; p-value = 0.269). The study thus, revealed that the dividend yield, earnings yield and payout ratio are not factors that influences stock prices rather the bank size was found to have positive and significant impact on stock prices. The study therefore recommends among others that managers should act in the best interest of investor as to reduce the agency problem, thus complete information about the dividend polices of the firm should be provided.
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
The subject matter of dividend policy remains one of the most controversial issues in corporate finance. For a very long time now, financial economists have engaged in modeling and examining corporate dividend policy and earnings as they affect banks stock prices in Nigeria (Amidu, 2007). Black (1976) hinted that, “The harder we look at the dividend picture, it seems like a puzzle with pieces that don’t fit together”. In over thirty years since then a vast amount of literature has been produced examining dividend policy. Recently, however, Frankfurterc and Wood (2002) concluded in the same vein as Black and Scholes (1974) that the dividend “puzzle”, both as a share value-enhancing feature and as a matter of policy, is one of the most challenging topics of modern financial economics. Forty years of research have not been able to resolve it. Research no dividend policy and earnings have shown not only that a general theory of dividend policy remains elusive, but also that corporate dividend practice varies over time, among firms and across countries. The patterns of corporate dividend policies not only vary over time but also across countries, especially between developed and emerging financial institutions.
Glen, et al (1995) suggested that dividend policies in emerging markets differed from those in developed markets. They reported that dividend payout ratios in developing countries were only about two thirds of that of developed countries. Different scholars have defined the term dividend policy differently. Hamid, et al (2012) defined dividend policy as the exchange between retained earning and paying out cash or issuing new shares to share-
holders. Booth and Cleary (2010) defined dividend policy as an exclusive decision by the management to decide what parentage of profit is distributed among the shareholders or what percentage of it retains to fulfill its internal needs. Nwude (2003:112) defined the term as the guiding principle for determining the portion of a company’s net profit after taxes to be paid out to the residual shareholders as dividend during a particular financial year. Emekekwue (2005:393) defined dividend policy as the portion of firm earnings that will be paid out as dividend or held back as retained earnings. Huda and Farah (2011) pointed out
that dividend policy has been an issue of interest in financial literature; academics and researchers has developed many theoretical models describing the factors that managers should consider when making dividend policy decisions. Key factors behind the dividend decision have been studied by numerous researchers. Lintner (1956) suggested that dividend payment pattern of a firm is influenced by the current year earnings and previous year dividends. In this case, dividend may be seen as the free cash flows which comprises of cash remaining after all business expenses have been met (Damodaran, 2002). The dividend decision in corporate finance is a decision made by the directors of a company. It relates to the amount and timing of any cash payments made to the company’s stockholders.
The decision as stated by Pandey (2005), is an important one for the firm as it may influence the financial structure and stock price of the firm. In addition, the decision may determine the amount of taxations that stockholders pay. The dividend payment ratio is a major aspect of the dividend policy of the firm, which affects the value of the firm to the share holders (Litzenberger and Ramaswany, 1982). The classical school of thought holds this view and they believe that dividends are paid to influence their share prices. They also believe that market price of an equity is a representation of the present value of estimated cash dividends that can be generated by the equity (Gordon, 1959). Another classical school of thought, on the other hand, believes that the price of equity is a function of the earnings of the company. They believe that dividend payout is irrelevant to evaluating the worth of equity. What matters, they say is earnings (Miller and Modigliani, 1961).
Mayo (2008: 364-365) observed that retained earnings provide funds to finance the firms on long term growth. It is the most significant source of financing a firm’s investment. Dividends are paid in cash, thus the distribution of earnings utilizes the available cash of the company. When the firm increases the retained portion on net earnings, shareholders’ current income in the form of dividends decreases, but the use of retained earnings to finance profitable investments is expected to increase future earnings. On the other hand, when dividends increase, shareholders’ current income will increase but the firm may be unable to retain earnings and, thus, relinquish possible investment opportunities and future earnings.
The theoretical rationale for corporate dividend policy has been an important topic in corporate finance for a very long time. After the dividend policy-irrelevance proposition by Miller and Modigliani (1961), several theories have attempted to explain why and how companies pay out the cash generated by their business operations as dividend. Three main factors may influence a firm’s dividend decision. These are: – Free cash flows, Dividend clientele and Information signaling (Pandey, 2005). Under the free-cash flow theory of dividends, the payment of dividends is very simple: the firm simply pays out, as dividend, any surplus cash after it invests in all available positive net present value projects. Criticism of the theory is that it does not explain the observed dividend policies of real world companies. Most companies pay relatively consistent dividend from one year to the next and managers tend to prefer to pay a steadily increasing dividend rather than paying dividend that fluctuates dramatically from one year to the next. These criticisms have led to the development of other models that seek to explain the dividend decision (Brigham, 1995).
Under the dividend clientele, a particular pattern of dividend payments may suit one type of stockholders more than another. A retiree may prefer to invest in a firm that provides a consistently high dividend yield, whereas, a person with a huge income from employment may prefer to avoid dividends due to their high marginal tax rate on income. If Clientele exists for a particular pattern of dividend payment, a firm may be able to maximize its stock price and minimize its cost of capital by catering to a particular clientele. This model may help to explain the relatively consistent dividend policies followed by most listed companies (Okafor, 1983). According to the clientele effect theory of dividend policy, investors who would like to receive some cash from their investment always have the option of selling a portion of their holding. This argument is even more cogent in recent times with the advent of very low-cost discount stockholders. Thus, it remains possible that there are taxation based clientele for certain types of dividend policies (Pandey, 2005).
Information content or signaling says that investors regard dividend changes as signals of management earning potentials. The model was developed by Ezra (1983). It suggests that dividend announcements convey information to investors regarding the firm’s value prospects (Ezra, 1983). He said many earlier studies had shown that stock prices tend to increase when an increase in dividend is announced but tend to decrease when a decrease or omission is announced. Therefore, Ezra pointed out that, this is likely due to when investors have complete information about the firm, they will look for other information that may provide a clue as to the firm’s future prospects and also managers have more information than investors about the firm and such information may inform their dividend decision. It could be seen, therefore, that when mangers lack confidence in the firm’s ability to generate cash flows in the future, they may keep dividends constant or possibly even reduce the amount of dividends payout. Conversely, managers that have access to information that indicates very good future prospects for the firm are more likely to increase dividends (Ezra, 1963).
Hence, the purpose of this study is to perform a cross-sectional study to find the situations in Nigeria which these hypotheses apply and also determine how stock prices react to such dividend and earnings report as indicated by investors’ ratio values with bias to bank stocks.
1.2 STATEMENT OF PROBLEM
The goal of corporate entities is to maximize the value of shareholders’ investment in the firm. Managers pursue this goal through their investment, financing and dividend decisions. Investment decisions involve the selection of positive net present value projects. Financing decisions involve the selection of a capital structure that would minimize the cost of capital of the firm while dividend decisions of the firm determine the reward which investors and potential investors of the firm receive from their investment in the firm. Apart from the investment and financing decisions, managers need to decide, on regular basis, whether to pay out of the earning to shareholders, reducing the agency problem (Jensen and Meckling, 1976). However, the question remains whether paying out of earnings would essentially create value for the shareholders or not. A dividend payment provides cash flow to the shareholders but reduces firm’s recourses for investment; this dilemma is a myth in the finance literature.
A great deal of theoretical and empirical research on dividend policy effects has been done over the last several decades. Theoretically, cash dividend from earnings means giving reward to the shareholders, that is, something they already own in the company; but this will
be offset by the decline in stock value. In an ideal world (without tax and any restrictions) therefore dividend payments would have no impact on the shareholders’ value. In the real world, however a change in the dividend policy is often followed by a change in the market value of stocks. The economic argument for investor’s preference for dividend income was offered by Graham and Dodd (1934). Subsequently, Walter (1963) 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 expected dividend payments in the future.
Another researcher made efforts to further understand the dividend controversy. Average investors, subject to their personal tax rates, would prefer to have less cash dividend if it is taxable: size of optimal dividend inversely related to personal income tax rates (Pye, 1972). 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 is important to the shareholders because of its tax effect and information content.
Given the above problems and the controversies surrounding the impact of dividend policy and earnings on stock prices of Nigeria banks, the lacuna which this study seeks to fill is to provide empirical evidence on the impact of dividend policy and earnings on stock prices of Nigeria banks using investment ratios such as dividend yield, earnings yield, payout ratio with the introduction of some control variables in an emerging market like Nigeria. Hence, the contribution of this study is in terms of geography.
1.3 OBJECTIVES OF THE STUDY
The general objective of this study is to determine the impact of dividend policy and earnings on bank stock prices. However, the specific objectives are:
1. To determine the impact of dividend yield on stock prices of Nigerian banks.
2. To determine the impact of earnings yield on stock prices of Nigerian banks
3. To determine the impact of dividend payout ratio on stock prices of Nigeria banks.
1.4 RESEARCH QUESTIONS
As a result of the objectives stated above the following research questions will be asked. These are:
1. To what extent does the dividend yield of banks listed on the Nigerian Stock
Exchange have positive significant impact on their stock prices?
2. To what extent does the earnings yield of banks listed on the Nigerian Stock
Exchange have positive significant impact on their stock prices?
3. To what extent does the payout ratio of banks listed on the Nigerian Stock Exchange have positive significant impact on their stock prices?
1.5 RESEARCH HYPOTHESES
The research questions raised above therefore led to the formulation of the following hypothetical statements. These are:
1. Dividend yield does not have positive and significant impact on stock prices of
Nigerian banks.
2. Earnings yield does not have positive and significant impact on stock prices of
Nigerian banks.
3. Dividend payout ratio does not have positive and significant impact on stock prices of Nigeria banks.
1.6 SCOPE OF THE STUDY
The banking sector represents the lending spectrum of any economy, thus responsible for the supply of funds to the productive sub-sectors of the Nigerian economy, hence its importance to the growth of the Nigerian Economy. The study covers a five years period (2006-2010), and is based on reports of twenty (20) banks (Data on Spring Bank Plc was not available). The choice becomes appropriate within the period culminated in the reduction of banks in the country to 21 banks. However, also, the post consolidated financial statements and accounts of these banks were published in 2006. As also observed since 2005, the Banking sector of the Nigerian Stock Exchange has been the most active till date. Panel data series was collated from the Annual Statements and Accounts as well as stock prices of these banks from the Nigeria Stock Exchange at the end of the year
1.7 SIGNIFICANCE OF THE STUDY
This research will be particularly significant to the following groups:
1) INVESTORS AND POTENTIAL INVESTORS
The major beneficiaries of an enhanced value created firm as indicated by the share prices are investors and potential investors. Their contribution, in monetary terms in the promotion, incorporation, continual existence to the growth of the firm must be rewarded with a premium above their risk free rate, thus, acting as a compensation for time and risk inherent in these firms. Therefore, this research will contribute, along with other similar literatures available in this area of finance, to enhancing the maximization of investors and potential investors’ objectives as concern capital gains from their investment.
2) ACADEMIC
Essentially, this research intends to contribute significantly to the volume of literature available in this area of finance. In academics, the unknown is never exhausted, as the list of what we do not know could go on forever. Therefore, as a contribution to this area, hints, recommendations about dividends, earnings and stock prices will be examined.
3) MANAGEMENT
In large firms, there is a divorce between management and ownership. The decision taking authority in a company lies in the hands of managers. Shareholders as owners of the company are the principals and managers are their agents. Thus, there is principal-agent relationship between shareholders and managers therefore managers should and must act in the best interest of shareholders as consistent with shareholders’ wealth maximization objectives of the firm. Therefore, this research will enable management to understand what must be done in order to act in the best interest of shareholders in choosing dividend policies that will maximize shareholders’ value.
This material content is developed to serve as a GUIDE for students to conduct academic research
THE IMPACT OF DIVIDEND POLICY AND EARNINGS ON STOCK PRICES OF NIGERIA BANKS
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