Stability of Dividends in India

Topics: Dividend, Random effects model, Dividend yield Pages: 33 (10549 words) Published: September 17, 2010
NSE Research Initiative, Project Report no. 229 / 2009

Determinants and the Stability of Dividends in India:
Application of Dynamic Partial Adjustment Equation using Extended Instrumental Variable Approach

Dr. Manoj Subhash Kamat Dr. Manasvi Manoj Kamat

This paper improves on earlier research on stability and determinants of dividend policies by using a more advanced estimation methodology, a larger and more representative sample of panel data (PD), and different proxies for a longer time window 1971-2007. It is aimed to find whether the Indian private corporate sector follow stable cash dividend policies, whether dividends smoothen earnings in India, to estimate the implicit target payout ratio and speed of adjustment of dividends towards a long run target payout ratio. We further test applicability of dividend stability hypothesis and add to the relatively limited literature on aspects of dividend decision by examining the dynamics of relationship between dividend payouts and a host of other explanatory variables. We estimate the basic static PD model, GMM-in-Levels {GMM (in-Lev)} model, and its other variations GMM-in-first-differences {GMM (in-Diff)] and GMM-in-Systems {GMM (in-Sys)}so to include other lag structures. This procedure shows us how much the size of the dividend determinants, the speed of adjustment coefficient and the one of the implicit target payout ratio varies across the different estimation techniques. In addition, it will also be useful to compare our results with those of Pooled OLS-estimation with alternate data definitions for checking the robustness of the results.

Keywords: Dividends, Determinants, Stability, Panel Data, Partial Adjustment Model, GMM, GMM (in-Diff), GMM (in-Sys), India.


Determinants and the Stability of Dividends in India:
Application of Dynamic Partial Adjustment Equation using Extended Instrumental Variable Approach Introduction There is no consensus in the financial markets or in financial literature about the need, importance and factors affecting dividend policy behavior. On one hand there is a view that dividends significantly affect the value of firm and shareholders’ wealth as per Jensen (1986); while there prevails a skeptical view about the ‘value added’ by dividends on the other hand according to Modigliani and Miller (1958) and Miller and Modigliani (1961). Though Damodaran (2000) points, dividend decisions like investments and financing decisions are crucial and involve tradeoffs, there seems to be little consensus on what should lead us in terms of a “right” dividend policy. The theories in financial literature dealing with determinants and stability of dividend can be grouped into two categories. Those based on the implicit assumption of asymmetric information, and that based on the explicit assumption. The seminal work in that of Lintner (1956), Fama and Babiak (1968) and Marsh and Merton (1986) hypothesize asymmetric information, whereas the theories based on explicit assumption of dividends include the agency theory, pecking order theory and the dividend signaling theory. Among the foremost papers on dividend policy, Lintner (1956) embodies dominant patterns of decision-making with respect to dividends. The decisive contribution to the theoretical modeling of dividends by Miller and Modigliani’s (1961) view dividend payment policies as a passive residual of retentions; prior to their work it was believed that the dividend payment by firms would increase firm value. Further the proponents of signaling theories like Aharony and Swary (1980) and Kwan (1981) present that the firms change their dividend policies to signal relatively better information to the market. Since Lintner neither considers the factors like size, debt, investment, managerial aspects etc. nor considers regulatory constraints in determining dividends, of late this led other researchers to explore and investigate other plausible variables which might possibly be...
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