Dividend Policy and Its Impact on Stock Price

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Effect Of Dividends On Stock Prices

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EFFECT OF DIVIDENDS ON STOCK PRICES

Effect of Dividends on Stock Prices– A Case of Chemical and Pharmaceutical Industry of Pakistan Kanwal Iqbal Khan University of Central Punjab, Lahore

Proceedings of 2nd International Conference on Business Management (ISBN: 978-969-9368-06-6)

Effect Of Dividends On Stock Prices

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Abstract In Pakistan corporate sector is adversely facing competition due to economic downturn in the world and making efforts to survive in a competitive and uncertain economic environment. This study will help to improve dividend decisions of corporate sector through proper implementation of their dividend policies. This paper is an attempt to explain the effect of dividend announcements on stock prices of chemical and pharmaceutical industry of Pakistan. A sample of twenty five companies listed at KSE-100 Index is taken from the period of 2001to 2010. Results of this study is based on Fixed and Random Effect Model which is applied on Panel data to explain the relationship between dividends and stock prices after controlling the variables like Earnings per Share, Retention Ratio and Return on Equity. Results indicate that Cash Dividend, Retention Ratio and Return on Equity has significant positive relation with stock market prices and significantly explains the variations in the stock prices of chemical and pharmaceutical sector of Pakistan while Earnings per Share and Stock Dividends have negative insignificant relation with stock prices. This paper further shows that Dividend Irrelevance Theory is not applicable in case chemical and pharmaceutical industry of Pakistan.

Keywords: Cash or Stock Dividends, Stock Price, Fixed and Random Effect Model, Dividend Irrelevance Theory

Proceedings of 2nd International Conference on Business Management (ISBN: 978-969-9368-06-6)

Effect Of Dividends On Stock Prices

3

1. Introduction Dividend policy is one of the most widely researched topics in the field of finance but the question whether dividend policy affects stock prices still remains debatable among managers, policy makers and researchers for many years. Dividend policy is important for investors, managers, lenders and for other stakeholders. It is important for investors because investors consider dividends not only the source of income but also a way to assess company from investment point of view. It is the way of assessing whether the company 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 the amount of dividends that they pay to their shareholders. If company pay more dividends then fewer funds available for investment in future projects. Lenders are also interested in the amount of dividend that a company declares, as more amounts is paid as dividend means less amount would be available to the company for servicing and redemption of their claims and finally it is important for other stakeholders especially for claimholders to help them in reducing agency cost. The basic objective of shareholder is to maximize their return and this return may be in the form of dividends or capital gain. Investors’ decision regarding the return on investment is affected by dividend policy of the company. Arnold (2008) explains the main objective of dividend policy is to maximize shareholders’ wealth by maximizing their purchasing power. So maximizing shareholders’ wealth depends on the dividend policy of the company because of this shareholders would satisfy their purchasing and consumption patterns. There are certain important factors that companies consider in designing their dividend policies like managerial and behavioral environment, firms’ profitability ratios, willingness of the company etc. Juma'h & Pacheco (2008) explained that management decision of dividend policy

Proceedings of 2nd International Conference on Business...
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