A Report On Impacts of Dividend On Stock Price
A Report On Impacts of Dividend On Stock Price
A Report On Impacts of Dividend On Stock Price
On
Prepared for
Shah Ridwan Chowdhury
Assistant professor
Department of Management
Faculty of Business Studies
University of Dhaka
Prepared by
Group-21
Future Entrepreneurs
02 May, 2016
Group Profile
Future Entrepreneurs
ID Name Remarks
02 May, 2016
Assistant professor
Department of Management
University of Dhaka
Dear Sir,
According to your direction and the requirement of Financial Management (Mgt-303) course, a
report is made on “Impacts of Dividend policy on Stock price”. As this process is for learning,
we request you to accept this report with considering our all limitations.
Thanking
Future Entrepreneurs
Table of Contents
1 Executive summary 1
2 Introduction 2
3 Literature review 3
7 Conclusion 11
Executive Summary
How dividend policy decisions affect a firm’s stock price, is a widely researched topic in the
field of investments and finance but still it remains a mystery that whether dividend policy
affects the stock prices or not. There are those who suggest that dividend policy is irrelevant
because they argue a firm’s value should be determine by the basic earning power and business
risk of the firm, in which case value depends only on the income (cash) produced, not on how the
income is split between dividends and retained earnings and opponents of this statement called
dividend is irrelevance, that investors care only about the total returns they receive, not whether
they receive those returns in the form of dividends, capital gains or both. The results of
researches conducted in various stock markets are different. There are many internal and external
factors, which simultaneously affect stock prices and it is almost impossible to segregate the
effect of each so the variations remain. Attempts are made to examine, what kind of relationship
exists between dividend policy and stock market returns of private commercial banks in
Bangladesh. Overall results of this study indicate that Dividend Policy has significant positive
effect on Stock Prices. It is very difficult to come to a decision that dividend actually influences
market price of stock in Bangladeshi stock market because of the greatest fall of the market in
the recent past. Stock price is also affected by some other reasons and that’s why to conclude the
decision is very tough as stock price is affected by dividend policy of the companies like banks
of Bangladesh. According to the analysis of this paper and with the calculation of company’s
data, stock price is highly correlated with dividend policy of company.
Introduction
Dividend policy is a major financing decision that involves with the payment to shareholders in
return of their investments. Every firm operating in a given industry follows some sort of
dividend payment pattern or dividend policy and obviously it is a financial indicator of the firm.
Thus, demand of the firms share should to some extent, dependent on the firm`s dividend policy.
Dividend policy is one of the most widely researched topics in the field of finance but the
question is whether dividend policy affects stock prices still remain debatable among managers,
policy makers and researchers for many years. Dividend policy is important for managers,
investors, lenders and for other stockholders. It is important for investors because investors
consider not only the sources of income but also a way to assess the firms from investment point
of view. It is the way of assessing whether the company could generate cash or not. Many
investors like to watch the dividend yield, which is calculated as the annual dividend income per
share divided by the current share price. The dividend yield measures the amount of income
received in proportion to the share price. If a company has a low dividend yield compared to
other companies in its sector, it can means two thing: (1) the share price is high because the
market reckons the company has impressive prospects and isn`t overly worried about the
company`s dividend payments, or (2) the company is in trouble and cannot afford to pay
reasonable dividends. At the same time however a high dividend yield can signal a sick company
with a depressed share price. Dividend yield is of little importance for growth companies
because, retained earnings will be reinvested in expansion opportunities, giving shareholders
profits in the form of capital gains.
Selecting a dividend policy is important for the bank 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 to pay off their obligation. So,
the study will investigate the relationship between dividend policy and its impact on market
performance of the share. In this report, we will examine with some real life sample (commercial
banks) that whether the dividend policy has any effect on the firm`s share price. We just focus on
the specific factor; the dividend policy.
Literature Review
(Miller & Modigliani, 1961) proposed irrelevance theory suggesting that the wealth of the
shareholders is not affected by dividend policy. It is argued in their theory that the value of the
firm is subjected to the firm’s earning, which comes from company’s investment policy. The
literature proposed that dividend does not affect the shareholders’ value in the world without
taxes and market imperfections. They argued that dividend and capital gain is two main ways
that can contribute profits of firm to shareholders. When a firm chooses to distribute its profits as
dividends to its shareholders, then the stock price will be reduced automatically by the amount of
a dividend per share on the ex-dividend date. So, they proposed that in a perfect market, dividend
policy does not affect the shareholder’s return.
(Baskin, 1989) used a different method and examined the association between dividend policy
and stock price volatility rather than returns. He added some control variables for examining the
association between share price volatility and dividend yield. These control variables are earning
volatility, firm’s size, debt and growth. These control variables do not only have clear effect on
stock price volatility but they also affect dividend yield. For instance, the earning volatility has
effect on share price volatility and it affects the optimal dividend policy for corporations.
Moreover, with assumption that the operating risk is constant, the level of debt might have
positive effect on dividend yield. Size of firm would be expected that affect share price volatility
as well. That is, the share price of large firms is more stable than those of small firms as the large
firm tend to be more diversified. Furthermore, small firms have limited public information and
this issue can lead to irrationally react of their investors. (Baskin, 1989)’s work was based on
following fundamental models that connect dividends to risk of stock. The models are the
duration effect, the rate of return effect, the arbitrage pricing effect and the information effect.
(Baskin, 1989) proposed that fluctuation in the discount rate has less impact on high dividend
yield stocks because high dividend yield can be a signal of more near-term cash flow so the firm
with high dividend yield would be expected to have less volatility in share price. This is then
being named as duration effect. (Baskin, 1989) used the Gordon growth model for demonstrating
this effect. Moreover, he explained that based on the rate of return effect, it is possible that firms
with low dividend yield and low pay out to be assessed more valuable than their assets in place
due to their growth opportunities. Since forecasts of earning from growth opportunity have more
error than prediction of earning from assets in place, companies with low pay out and low
dividend yield are expected to have more volatility in their share price. He also proposed that
higher dividend yield will lead to higher arbitrage profit because the excess return is subordinate
of dividend yield and price discount rate. Baskin also argued that managers can control the stock
price volatility and stock risk by dividend policy and Distribution of dividend at the time of
earning announcement may be interpreted as signal about stability of firm.
The dividend discount model posits that the current stock price is equal to the present value of all future
dividend payments. As the present value increases, stock prices rise. Thus, higher dividends translate directly
into higher stock prices. There are problems with the model, however. It doesn’t explain the prices of non-
dividend stocks, and it expects that the rate of capital gains growth will always be steady and not exceed
investors' required rate of return, which is known as the cost of capital.
Modigliani-Miller Theorem
The Modigliani-Miller Theorem states that shareholders are indifferent to the division of retained earnings into
dividends and new investments. If correct, it predicts that the amount of retained earnings spent on dividends,
which raise stock prices, is offset by the effect of issuing new stock to replace the money spent on dividends,
which lowers stock prices. The model doesn’t consider the use of debt instead of new stock issuance. The M-
M Theorem concludes that dividend policy does not affect stock price.
Clientele Effect
The clientele effect is an acknowledgment that income-oriented investors are drawn to dividend-paying stock,
while those who are less risk-adverse prefer capital gains. Thus, if a company makes substantial changes to its
dividend policy, some shareholders will approve and may buy additional shares, while other shareholders will
sell their shares and find others that are more to their liking.
Signaling Effect
This theory states that an increase in the dividend rate should be viewed as a vote of confidence by the
corporation board about the company’s prospects to increase growth and earnings. If the board thought that the
firm would be short of funds, it would cut dividends rather than raise them. Since board directors know the
most about the company, the positive signals it sends should be viewed by investors as a reason to buy shares
and thus raise share prices.
If a company reduces the dividend it pays on its stock, the stock becomes less attractive to
investors. That means that the price of the stock will drop. If you own this stock, you will not
only receive a lower dividend, but you will also watch your share prices fall. The market reacts
very quickly to dividend changes, so even a hint of a dividend reduction can cause your stock to
go down in price.
When Dividends Go Up
When dividends go up, the stock becomes more attractive to buyers. That increased demand will
cause sellers to raise the price to gain more profits. If you hold this dividend stock, the share
price will go up as the dividend rises. Investors generally consider rising dividends a sign of a
company's good health. Always make sure the company that issues the dividend stock reports
growing profits along with the increased dividend. Avoid companies that raise their dividends
without increased profits to make their stock look more attractive, because those companies may
not be able to pay the increased dividend over time.
Company Signals
You can anticipate changes in dividends by going on the company's website, reading the annual
report, participating in quarterly calls and paying close attention to any press releases issued by
the company regarding dividend changes. The stock price will react before the actual dividend
change based on company news. Your stock price will also rise or fall based on profit and sales
projections, because these tend to be leading indicators of a coming change in dividends.
You should also pay attention to many non-company indicators so you can anticipate changes in
dividends. Keep up with analyst ratings and expectations, news headlines and industry
announcements that could affect the particular company that issues your stock. Use such market
signals to determine whether the dividend is likely to rise or fall so you can make buying and
selling decisions long before any announcement of a reduced or increased dividend.
When a company goes through the process of issuing a dividend, the company’s stock price can
potentially be impacted in two different ways:
1. If the company declares a dividend payment that’s higher or lower than expected, market
sentiment may shift causing the stock price to rise or drop accordingly.
2. An expected change in price occurs on the ex-dividend date when the company decreases
its market cap by the declared shareholder payout.
When a company declares a dividend amount that’s higher or lower than expected, the
company’s stock price can fluctuate in response to the declaration. Let’s consider two examples.
Let’s say company XYZ typically pays a dividend of $0.50 per share and has stuck to that
amount for the last 5 years. Then, XYZ declares a dividend amount of only $0.04 per share.
In this case, the market sentiment around company XYZ may cause its stock price to drop as
investors speculate as to the reasons why the dividend amount was lower than normal.
When a company issues a dividend, the cash that makes up the dividend payment no longer
belongs to the company. Because this is transferred to shareholders, the company’s share price is
reduced by the amount of the dividend payment on the ex-dividend date.
For stocks with small dividend payments, you may not even notice the decrease; one or two
cents per share may look like normal trading activity. Bigger dividend payouts, however, can be
more noticeable. In 2004, the share price of one stock dropped by more than $2.00 per share
when a company paid out dividends.
The principal objective of the study is to evaluate the effect of dividend policy on share price of
some selected listed companies in Bangladesh. To accomplish this objective following specific
objectives have covered:
To examine the relationship between dividend per share and share Price.
To evaluate the dependency of dividend per share and retained earnings on share price.
To draw inferences on the basis of analysis.
a) Secondary sources: Annual report of IBBL-2013, Annual report of IFIC bank-2014, Annual
report of Marchentile bank Ltd.-2014, Annual report of Prime bank Ltd.-2014.
b) Data is analyzed by following the formula of statistics.
Correlation between dividend percentage and stock price of Marchentile bank ltd. is moderately
positive that is 0.4586 which indicates that stock price is significantly influenced by declared
dividend.
Prime Bank
Particulars Arithmetic Mean S.D. C.V.
Market value/share 27.47 8.81 0.32
Dividend percentage 15.83 3.82 0.24
P/E ratio 11.95 3.17 0.27
EPS 2.33 0.55 0.24
Correlation between dividend percentage declared by the company and market price of share is
0.9988 that indicates a highly positive correlation between share price and dividend declared by
the company.
IFIC Bank
Particulars Arithmetic Mean S.D. C.V.
Market value/share 32.20 5.37 0.17
Dividend percentage 13.33 2.89 0.22
P/E ratio 10.34 2.64 0.26
EPS 3.17 0.32 0.10
The stock price and dividend of IFIC bank is highly correlated with r = 0.98406. It means that
stock price of IFIC bank is significantly dominated by dividend payout ratio.
Testing hypothesis
As the dividend percentage declared by the commercial banks impacts the stock price
significantly according to the analysis of gathered data, there is no reason to accept our null
hypothesis and that’s why alternative hypothesis is accepted at 95% level of significance.
Conclusion
After the study based on the collected data it is clear that dividend has a significant impact on
stock price of commercial banks and that’s why there is no reason to accept null hypothesis
rather alternative hypothesis. Stock price can be influenced by so many factors. That’s why to
conclude with this decision that only dividend policy impacts the stock price is not worthy.
Dividend policy can be an accelerator of stock price. On the other hand unexpected dividend can
do fall in stock price. But one thing is clear enough that dividend policy impacts the stock price
of commercial banks and it is highly correlated.