Dividend Policy

Topics: Dividend, Dividend yield, P/E ratio Pages: 17 (6456 words) Published: February 28, 2013
Effects of Dividends on Stock Prices in Nepal
Rabindra Joshi* Abstract
This paper examines the impact of dividends on stock price in the context of Nepal. A majority of earlier studies conducted in developed countries show that dividend has a strong effect than retained earnings. The study examines whether this is consistent in the context of Nepal (or not) and the implication particularly to the banking and non-banking sector. To achieve the objective of the study, a descriptive and analytical research design has been administered. The secondary data are used to test this impact. In order to examine the impact of dividends on stock prices, a multivariate linear regression analysis has been implied in which current market stock price is taken as a dependent variable and four other variables namely Dividend Per Share (DPS), Retained Earnings Per Share (REPS), Lagged Price Earnings Ratio (P/E ratio) and Lagged Market Price Per Share (MPS) as the explanatory variables. This attempt has been made to test the dividends retained earning hypothesis and to examine the estimated relationship over the period of time. The overall conclusion drawn in this study reveals that, the impact of dividends is more pronounced than that of retained earnings in the context of Nepal. Dividend has a significant effect on market stock price in both banking and non-banking sector. Key words: Dividends, stock price, banking and non- banking sector, multivariate linear regression analysis

JEL Classification: D53, G10, G14

Dividend is the result of a discretionary decision made by the board of directors of a firm. Generally, a firm announces dividend on the profit. Corporate dividend policy is one of the most enduring issues in modern corporate finance. Dividend policy determines the division of earnings between payments to stockholders and reinvestment in the firm (Weston, Copeland & Shatri: 2004). Miller and Modigliani (1961) have given a theory *

Faculty Member, Tribhuvan University, Central Department of Management, Kathmandu, Nepal. Email: joshirabin2003@yahoo.com


stating that the shareholders should be indifferent between amount distributed and retained in the firm. However, in practice, the assumption of capital market perfection does not exist that lead to the situation where dividend policy is relevant. Friend and Puckett (1964) studied dividend and stock prices using cross section data to test the effect of dividend payout on share value using regression model. Chawla and Srinivasan (1987) studied the relationships between dividend and share price in the Indian context. The result concluded that the impact of dividends is more pronounced than that of the retained earnings. Similarly, Kumar and Mohan (1975) concluded that the stock market has started recognizing the impact of retained earnings in Indian stock market. The study of Lintner (1956) revealed that the determinants of changes in dividends are current earnings and the dividends distributed in the past are subject to mitigate the dividend cash flow relationships. Khan (2009) found the evidences that dividends, retained earnings and other determinants have dynamic relationship with market share price. The study suggests that the overall impact of dividends on stock prices is comparatively better that of retained earnings. There are two different views regarding the dividend policy and stock price. Those who think dividends have more impact in determining share price, argues that shareholder prefers current return rather than future return and dividend distribution is an indicator of earning capacity in future. The other views are based on the importance of retained earnings. They argue that retained earnings are indicator of future investment opportunities. The shareholders can enjoy tax advantages in retained earnings. For tax purpose, retained amount is not treated as income until it is realized. A number of studies on impact of...
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