DIVIDEND POLICY AS A DETERMINANT OF INVESTORS INTEREST IN FIRMS (A CASE STUDY OF UBA PLC)

ABSTRACT

This project examines the dividend policy as a determinant of investors interest in firms. The objective of this study is to ascertain the point at which the dividend policy would be at optimal. In a bid to carrying out this study, the researcher  developed some hypotheses where were used in carrying out its findings. A research design was drawn up for the study and the shareholders of UBA was taken to represent the population and due to time and financial resources, a sample size of 27 was used for effective result. From the analysis, it was discovered that the major tools that motivate an investor to invest in a firm is the dividend, which the investors will get in return for their investment. It was concluded that the board of director seems to have little or no recognition for dividend, but what they are concern about is the retain earnings. It was recommended among others government should come out with a deliberate policy complying all quoted companies to pay dividend to its shareholders at the end of each financial year of operation.   

TABLE OF CONTENTS

Title page                                                                         i

Certification                                                             ii

Dedication                                                               iii

Acknowledgments                                                    iv

Abstract                                                                   v

Table of contents                                                     vi

Chapter One: Introduction

1.1   Background to the Study                                                 1

1.2   Statement of Problem                                              7

1.3   Research Questions                                                         9

1.4   Objectives of the Study                                            9

1.5   Statement of Hypotheses                                         10

1.6   Significance of the Study                                                 11

1.7   Scope of the Study                                                   13

1.8   Limitations of the Study                                          13

Chapter Two: Review of Related Literature

2.1   Introduction                                                             15

2.2   Dividend Policy and Agency Problems                     17

2.3   Dividend and Asymmetric Information                    19

2.4   Determinants of Dividend Policy                              22

2.5   The Irrelevance of Dividend Policy: Miller and Modigliani Theory (1961)                                                                 27

2.6   The Relevance of Dividend Policy                             29

2.7   Current Literature Base on each of the Relevant Variables of the Model or Theory                     32

2.8   Form of Dividend Payment                               38

2.9   Types of Dividend Policy                                  40

2.10 Factors that Determine Dividend Policy           44

2.11 The Size and Stability of Earnings                   49

2.12 Shareholders view Point on Dividend Policy    52

2.13 Type of Investors                                              54

Chapter Three: Research Method and Design

3.1   Introduction                                                     56

3.2   Research design                                               56

3.3   Description of the Population of the Study              57

3.4   Sample Size                                                     57

3.5   Sampling Techniques                                      58

3.6   Method of Data Collection                               58

3.7   Method of data Presentation                            59

3.8   Method of Data Analysis                                  59

Chapter Four: Data Presentation, Analysis and Interpretation  

4.1   Introduction                                                     61

4.2   Presentation of Data                                        61

4.3   Data Analysis                                                   64

4.4   Testing of Hypothesis                                       75

Chapter Five: Summary of Findings, Conclusion and Recommendations

5.1   Introduction                                                     80

5.2   Summary of Findings                                      80

5.3   Conclusion                                                      82

5.4   Recommendation                                             82

References                                                       84

Appendix A                                                      88

Appendix B                                                      89

CHAPTER ONE

INTRODUCTION

Background to the Study

Dividends are distribution of the earned capital of a corporation to its shareholder. They are appropriate or distribution of profit that a company gives to its shareholders after deducting tax and fixed interest on debt capital. According to Alli, Khan and Ramirez (1993), dividend is seen as return on shareholder investment for taking risk, in other words, it is the part of earnings that the corporation is willing to pay out to its shareholders for the capital they invested in the corporation.

Dividend policy has been an issue of interest in financial literature since Joint Stock Companies came into existence. Dividends are commonly defined as the distribution of earnings (past or present) in real assets among the shareholders of the firm in proportion to their ownership. According to Frankfurter (2003), dividend policy connotes to the payout policy, which managers pursue in deciding the size and pattern of cash distribution to shareholders over time. Managements‟ primary goal is shareholders‟ wealth maximization, which translates into maximizing the value of the company as measured by the price of the company’s common stock. This goal can be achieved by giving the shareholders a “fair” payment on their investments. However, the impact of firm’s dividend policy on shareholders wealth is still unresolved

MM provided their irrelevance theory of dividend policy; this theory is based on the assumptions of perfect markets. They concluded that dividend policy has no effect on either the price of firm's stock or its cost of capital. Research in the area of dividend policy has been concerned with relaxing the assumptions of MM model. Bird-in-the-hand theorem suggests that the relationship between dividend policy and the firm's value can be explained by investors‟ preference for dividend payments rather than the expected capital gains from stocks.

Under perfect capital markets, Miller & Modigliani’s (1961) conclusion that dividends are not relevant to the firm’s value is generally held to be valid. However, real world financial markets do not satisfy the strict conditions of perfect capital markets. The presence of market imperfections, such as taxes, asymmetric information, agency costs, and transaction means that we cannot dismiss the proposition that dividend policy is relevant to the firm’s value. The existence of market imperfections has led to the development of a number of dividend theories such as signaling theory, tax clientele theory, agency theory, residual theory and stability theory of dividends

However, investors have different tax preferences, which lead them to prefer firms with dividend policies that fit their tax preferences. This is what is called in the financial literature the “clientele effect”. Furthermore, the signaling theory reveals the way that investors receive the signals from firms due to the asymmetric information. It highlights the problems or the conflicts that might arise because of the information asymmetry in the market. According to Brealey and Myers (2002), dividend policy has been kept as the top ten puzzles in finance. Brealey, (1994), the most pertinent question to be answered here is that how much cash should firms give back to their shareholders? Should corporations pay their shareholders through dividends or by repurchasing their shares, which is the least costly form of payout from tax perspective? Firms must take these important decisions period after period (some must be repeated and some need to be revaluated each period on regular basis.)

Dividend policy can be of two types: managed and residual. In residual dividend policy the amount of dividend is simply the cash left after the firm makes desirable investments using NPV rule. In this case the amount of dividend is going to be highly variable and often zero. If the manager believes dividend policy is important to their investors and it positively influences share price valuation, they will adopt managed dividend policy. The optimal dividend policy is the one that maximizes the company’s stock price, which leads to maximization of shareholders’ wealth. Whether or not dividend decisions can contribute to the value of firm is a debatable issue

Firms generally adopt dividend policies that suit the stage of life cycle they are in. For instance, high- growth firms with larger cash flows and fewer projects tend to pay more of their earnings out as dividends. The dividend policies of firms may follow several interesting patterns adding further to the complexity of such decisions. First, dividends tend to lag behind earnings, that is, increases in earnings are followed by increases in dividends and decreases in earnings sometimes by dividend cuts. Second, dividends are “sticky” because firms are typically reluctant to change dividends; in particular, firms avoid cutting dividends even when earnings drop. Third, dividends tend to follow a much smoother path than do earnings.

These dividends may take the form of cash assets, other than cash or additional shares of the corporations, stocks. The usual way of distributing dividend is in the form of cash dividend, the declaration and payment of dividend is at the discretion of the board of directors. Generally, owners of this corporation purchase their shares because they know they can count on the regular receipt of dividends. In most cases they use these regular cash inflows from dividend as a means of livelihood and for further investment.

Dividend policy is the determination of earnings to be distributed to shareholders and the amount to be retained in the firm. It can also be seen as the rule that guides the board directors on the declaration and payment of dividend. Dividend policy is the third major decision of a firm. It is the percentage of earning that the corporation is willing to pay out to its shareholders. Dividend policy is concerned with the allocation of earnings between dividends and retains earning; hence reduce the amount to be retained.

Dividend policies are of different kind and there are factors that determine the dividend policy that will guide a corporation. The ultimate responsibility for dividend policy, rest with the board of directors. The kind of dividend policy and how much to be retained for growth and expansion of the corporation is also their responsibility. The idea of not declaring dividend at all or a low dividend payment will create fear, uncertainty, doubt and loss of interest on the part of the shareholders and prospective investor while a very high dividend payment will reduce the growth of the firm drastically. Dividend policy is an indispensable tool in the management of a corporation and also it is the reward that an investor derives from investing.

Every corporation that is capable of selling shares to the public is expected to have a policy that will guide them, when the issue of dividend is raised in Annual Genera Meeting (AGM).

Dividend policy is relevant because it is a guide to the, Board of Directors on how best to declare and to pay dividend to its investor. On the other hand dividend policy is irrelevant, because in the long-run equilibrium, the value of two identical corporations will be the same regardless of their various dividend policies.

Statement of Problem

Dividend policy is regarded as a connecting rod between the corporation and investors because all interactions revolve round a dividend policy network. Dividend policy which is a determinant of investor’s interest in the corporation should not be gambled with because it is the main concern of investors in the corporation. The fact remains that dividend policy differs in terms of payment, in relation to the amount to be paid, the number of shareholders to be paid, the volume of profit available for distribution and the need to retain earnings if possible. Most corporations do not declare dividend and the amount declared if they do is always very small and also most corporation are not concern about the dividend of investors, what they are concern about is the retained earnings and another problem is that most firms do not consider the factor that determine the kind of dividend policy to operate with.

One of the major problems today in dividend is that when dividends are declared and the shareholders did not claim their dividends, in most cases the firm may decide to re-invest it, after re-investing it, the profit are not given to the shareholders.

1.3   Research Questions

The following research question will be aid the researcher in carrying out this research work.

i.      To what extent does dividend policy have any impact on investors in the firm?

ii.     To what extent does dividend policy in any way improve investor’s credibility and reliability in investors’ interest in the firm?

iii.    To what extent does dividend policy have significant influence on the investors in the firm?

1.4   Objectives of the Study

In this research, the study of dividend policy is with the view of ascertaining the interest of investor as a result of a particular dividend policy as it exists in the firms in Nigeria. A bank may be able to overcome an absorbed capital shortage caused by the increase in dividend declared by selecting carefully a dividend policy to adopt. The purpose of this research project includes:

a.     To ascertain the point at which the dividend policy would be at optimal.

b.     To examine and establish the significance of dividend policy as a reward for investment.

c.     To discuss the underlying principle this guides suitable dividend policy.

d.     To examine and establish significance of dividend policy as a reward for investment.

1.5   Statement of Hypotheses

The following are the stated hypotheses for this study.

Hypothesis One

HO:   There is no relationship between the market value of share and dividend policy.

HI:    There is relationship between the market value of share and dividend policy.

Hypothesis Two

HO:   Dividend policy does not determines the interest of investors in a firm.

HI:    Dividend policy determines the interest of investors in a firm.

1.6   Significance of the Study

This research work will be so useful to prospective investors and existing investors, in the sense that it will aid investors in taking appropriate decision in establishing investment interest. It will also give the banking sector and other firms the insight of how best to declare and pay dividend, since it is the major link between the investor and investment.

Scanning through past and recent Annual Report of the banking sector, I discovered that the percentage of profit after tax transfer to reserves or retain earning is always more than dividend declared thereby increasing retain earning and reducing dividend declared.

This research work is important as it will open new areas research work to student, the banking sector and others, including the government.

The Banking Sector: Dividend policy is of great importance the Board of Director because it will enable them to know, compare and understand how best to allocate dividend to its existing shareholders. Dividend policy that is favourable would make the interest of investor higher and hence existing investors will have the more and it will also attract the interest of prospective investor.

The Government: The government is the closest monitoring unit as far as the issue of dividend is concerned. The government derives revenues from dividend declared by banks. The individual investors and corporate bodies are taxed by the government.
In establishing monetary or fiscal policies of a nation, the Gross National Income or Net National Income is taking into cognizance of which dividends earned is a stern post. The government should encourage a stable dividend policy that would be beneficial to both the firms and the investors because it will encourage and ensure a better standard of living through increased Net National Income.

Student: The student as a researcher has the opportunity and privilege of contributing or suggesting to how a good dividend policy can attract investors. The research work has also enhanced the knowledge of the researcher.

Furthermore, it is a requirement as a particular fulfillment for the award of an (OND) in Accountancy. This research work will also serve as information to all students studying financial management and other related courses.

1.7   Scope of the Study

This research work is concerned with the dividend policy of the banking sector. It seeks to identify the reaction of shareholders/investors to dividend declared by bank whether favourable or not. This study is limited to the application of the dividends theory to the Nigeria inventors

1.8   Limitations of the Study

There are many limitations which often hinder the successful completion of a research work. In carrying out this research work however, it is design to provide reasonable assurance but not absolute assurance in regard to dividend policy as a determinant of investor’s interest on firms and thee reliability of financial information and the compliance with law and regulation.

In view of these, there is lack of adequate data on specific areas of investigation this cause some limitation to the researcher, Unwillingness of staff to release some vital information due to the overriding duty of secrecy militated vary low and often at times vague and distorted information.

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  1. Definition of Terms

• Capital: This can be defined as something owned which provides ongoing services. It also refers to as money, property and other valuables which collectively represent the wealth of an individual or business.
• Capital Structure: This refers to the balance between the assets and liabilities of a company, the nature of its assets and the composition of its borrowings. Assets may be fixed or current while borrowing may be long term or short term.
• Corporate Performance: This is the area of business intelligence involved with monitoring and managing an organization’s performance according to key performance indicators such as revenue, return on investment, overhead and operational costs.
• Dividend: This is the sum of money paid regularly by a company to its shareholders out of its profits.
• Dividend Policy: This is the regulations and guidelines that companies develop and implement as the means of arranging to make dividend payments to the shareholders.
• Equity Capital: The part of the share capital of a company owned by ordinary shareholders.
• Retained Earnings: This refers to the portion of net income, which is retained by the corporation rather than distributed to its owners as dividends.