EFFECTS OF LARGEST SHAREHOLDERS ON

DIVIDEND:

A STUDY ON MALAYSIAN FIRMS

YEO JENG FATT

Research report submitted in partial fulfilment of the requirements for the

Degree of Master of Business Administration

UNIVERSITI SAINS MALAYSIA

2015
 ACKNOWLEDGEMENT

First and foremost, I would like to express my deepest gratitude and greatest

appreciation to my supervisor, Professor Datin Dr. Ruhani Hj. Ali for her guidance,

patience, advice and encouragement throughout the entire research project. Secondly,

I would like to express my deepest appreciation to Dr. Teoh Ai Ping, the Program

Manager of Project Management for her help in sharing and solving the problems that

I face when taking this research project. I would also like to thank Poh Suan and

Mesyaira Rosihan for their help and assistance given to me all the while I am doing

my research project.

Last but not least. I am very grateful to my family members and colleagues for their

support and understanding throughout my master studies in University Sains

Malaysia.

i
 TABLE OF CONTENTS

ACKNOWLEDGEMENT ................................................................................................. i

TABLE OF CONTENTS ................................................................................................. ii

LIST OF TABLES ............................................................................................................ v

LIST OF FIGURES ......................................................................................................... vi

ABSTRACT ..................................................................................................................... vii

ABSTRAK ...................................................................................................................... viii

CHAPTER 1 INTRODUCTION .................................................................................... 1

1.1 Background of the Study ................................................................................. 1

1.2 Problem Statements ......................................................................................... 3

1.3 Research Objectives ........................................................................................ 7

1.4 Research Questions ......................................................................................... 7

1.5 Definition of Key Terms ................................................................................. 9

1.6 Significance of the Study .............................................................................. 10

1.7 Organization of Study ................................................................................... 11

CHAPTER 2 LITERATURE REVIEW ...................................................................... 12

2.1 Introduction ................................................................................................... 12

2.2 Definition of Dividend Policy ....................................................................... 13

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 2.2.1 Dividend Irrelevance Theories ............................................................... 15

2.2.2 Dividend Relevance Theories ................................................................ 16

2.3 Determinants of Dividend Policy .................................................................. 19

2.4 Type of Firm Ownership and Dividend Policy ............................................. 23

2.4.1 Corporation Owned (CO) Firms ............................................................ 23

2.4.2 Manager Owned (MO) Firms ................................................................ 24

2.5 Largest Shareholder and Dividend Policy .................................................... 25

2.5.1 Alignment Effect .................................................................................... 25

2.5.2 Effective Monitoring .............................................................................. 26

2.5.3 Second largest shareholder (LO2) and Dividend Policy........................ 31

2.6 Theoretical Framework ................................................................................. 33

2.7 Development of Hypotheses ......................................................................... 35

CHAPTER 3 RESEARCH DESIGN AND METHODOLOGY ................................ 38

3.1 Introduction ................................................................................................... 38

3.2 Research Design ............................................................................................ 39

3.3 Population and Sample Size .......................................................................... 41

3.4 Sample Data .................................................................................................. 42

3.4.1 Data Analysis ......................................................................................... 44

3.5 Multivariate Model ........................................................................................ 47

3.5.1 Dependent Variables .............................................................................. 47

3.5.2 Independent Variables ........................................................................... 48

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 3.5.3 Control Variable..................................................................................... 51

3.5.4 Summary of all the variables ................................................................. 61

CHAPTER 4 RESULT AND DATA ANALYSIS ....................................................... 63

4.1 Introduction ................................................................................................... 63

4.2 Descriptive Statistics ..................................................................................... 66

4.3 Empirical Results .......................................................................................... 73

4.3.1 Correlation Analysis .............................................................................. 73

4.3.2 Regression Analysis ............................................................................... 80

4.3.3 Additional Analyses ............................................................................... 91

CHAPTER 5 CONCLUSION ....................................................................................... 97

5.1 Research Discussion ...................................................................................... 97

5.2 Impact and Limitation of the Study ............................................................ 102

5.3 Suggestions for Future Research ................................................................. 103

5.4 Conclusion................................................................................................... 104

References ...................................................................................................................... 105

Appendix ........................................................................................................................ 112

iv
 LIST OF TABLES

Table 1 Summary of Variables pg 61

Table 2 Sample Composition pg 64

Table 3 Sample of MO and CO firms pg 64

Table 4 Descriptive Statistics pg 66

Table 5 Dividend per Share Payout of Malaysian listed Firms,

2008-2014 pg 70

Table 6 Dividend Paying Firms by the Type of Largest

Shareholder (LO) Ownership, 2008 – 2014 pg 71

Table 7 Correlation Coefficients pg 75

Table 8 Largest Shareholder and Dividends pg 84

Table 9 Type of Largest Shareholder and Dividends pg 87

Table 10 Summary of Results pg 91

Table 11 Largest Shareholder and Dividends assuming a

Non Linear Relation pg 92

Table 12 Type of Largest Shareholder and Dividends assuming

a Non Linear Relation pg 95

v
 LIST OF FIGURES

Figure 1 Theoretical Framework pg 34

Figure 2 Dividend Paying Firms by the Type of Largest

Shareholder (LO) Ownership, 2008 – 2014 pg 72

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 ABSTRACT

The purpose of this study is to identify the effects of the largest shareholder (LO) and

the second largest shareholder (LO2) on the dividend policy in Malaysian firms. The

sample consists of Malaysian firms listed on Bursa Malaysia over the period 2008 –

2014. Panel data set were gathered from Bursa Malaysia whereby the sample firms

consist of 762 firms for a period of seven years. The results show a statistically

significant positive relationship between the largest shareholder (LO) and dividend

pay-out for manager owned (MO) firms. As for the corporation owned (CO) firms,

this study do not find any significant relationship between the largest shareholder

(LO) and the dividend pay-out whilst for the second largest shareholder (LO2), this

study notice that there is no significant relationship with the dividend pay-out for both

MO firms and CO firms. Other factors which could affect the dividend pay-outs in

Malaysian firms are cash, profitability of the firm, firm’s size and firm’s leverage

level. Malaysian firms will have a higher dividend pay-outs when the amount of free

cash available in the firm is high and higher profitability of the firm is being recorded.

When taking the firm size into consideration, well established and large firms will

have a higher dividend pay-out compared to smaller firms. On the other hand, firm’s

leverage level shows a significant negative relation with the dividend pay-out. This

means that a firm with higher debt level will pay a lower dividends or may register a

zero dividend pay-out. In conclusion, if the type of firm is manager owned (MO) firm,

this study found that the largest shareholder do affect the firm’s dividend policy for

firms listed in Malaysia and as for corporation owned (CO) firms, this study found no

significant relation between the largest shareholder and the firm’s dividend policy.

vii
 ABSTRAK

Tujuan kajian ini adalah untuk mengenalpasti kesan daripada pemegang saham

terbesar dan pemegang saham kedua terbesar mengikut dasar dividen dalam syarikat

Malaysia. Sampel kajian terdiri daripada syarikat-syarikat Malaysia yang tersenarai di

Bursa Malaysia untuk tempoh 2008 - 2014. Panel set data dikumpulkan daripada 762

syarikat yang disenaraikan di Bursa Malaysia bagi tempoh tujuh tahun. Kajian ini

menunjukkan hubungan positif yang signifikan secara statistik di antara pemegang

saham yang terbesar dengan bayaran dividen bagi syarikat yang diklasifikasikan

sebagai syarikat pemilikan pengurus (MO firms). Bagi syarikat yang dimiliki oleh

syarikat lain (CO firms), kita tidak dapat mencari apa-apa hubungan yang signifikan

di antara pemegang saham terbesar dengan pembayaran dividen manakala bagi

pemegang saham kedua terbesar, kita juga mendapati bahawa tidak terdapat apa-apa

hubungan yang signifikan dengan pembayaran dividen bagi kedua-dua kategori

pemilikan syarikat (MO firms and CO firms). Faktor-faktor lain yang boleh

menjejaskan pembayaran dividen oleh syarikat-syarikat yang disenaraikan dalam

Bursa Malaysia adalah jumlah tunai, jumlah keuntungan yang diperolehi, saiz syarikat

dan leverage. Syarikat-syarikat di Malaysia akan membayar dividen yang lebih tinggi

apabila jumlah wang tunai yang terdapat di syarikat itu adalah tinggi dan syarikat

tersebut merakamkan keuntungan yang lebih tinggi. Apabila mengambil kira saiz

firma, syarikat yang besar dan mantap akan mempunyai pembayaran dividen yang

lebih tinggi berbanding dengan syarikat yang lebih kecil. Sebaliknya, leverage

menunjukkan hubungan negatif yang signifikan dengan pembayaran dividen. Ini

bermakna bahawa firma dengan tahap hutang yang lebih tinggi akan membayar

dividen yang lebih rendah ataupun tidak akan membayar dividen langsung.

Kesimpulannya, jenis pemegang saham terbesar sama ada ia adalah seorang pengurus

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firma memberi kesan kepada polisi dividen syarikat itu bagi syarikat-syarikat yang

disenaraikan di Bursa Malaysia manakala atau bagi syarikat yang dimiliki oleh firma

lain, kajian ini tidak menunjukkan apa-apa kesan.

ix
 CHAPTER 1

INTRODUCTION

1.1 Background of the Study

A dividend is defined as a payment made to its shareholders by a company listed on

the stock exchange. This dividend payment is also commonly known as the

distribution of the profits earned by the company to its shareholders. Starting from the

emergence of Miller and Modigliani (1961) irrelevance theory, dividend pay-out

question remains as a puzzle yet to be solved. Miller and Modigliani (1961) argued

that firms operating in a capital market in which it is perfect, the dividend decision is

not relevant since it is not able to affect the firms’ value. Instead, the firm’s earnings

and how the firm made their investment are the main determinants of the dividend

pay-out policy. This argument is rejected by financial practitioners as well as

academicians due to the existence of market imperfections. The market is considered

imperfect due to factors such as different taxation rates, asymmetries in the disclosure

of firm’s information, difference in interest between the firm’s managers and

shareholders and the illogical investor behaviour.

Since then, numerous studies have been done on the determinants of dividend policy

but these studies focused mainly on developed countries like the United States,

Germany and Japan. Besides that, past studies which aimed to examine the effect of

the largest shareholder on dividend policy are mostly specific country-based. The

1
findings from these developed countries may not be the same for other countries like

Malaysia with different corporate cultures, economic frameworks and regulations.

Holderness (2003) state that the role of largest shareholders is not well developed in

past literature. For example, in a study done by Claessens et al. (2002), the largest

shareholder of a firm is a special class of shareholder. The largest shareholder with

the highest voting power is able to affect the firm’s decisions by using their rights. If

the largest shareholder decision is in line with the firm managers’ decisions, there

would not be much problem. But unfortunately this is not the case, most firms’

managers do not act in line with what the largest shareholder have in mind and this is

known as agency conflict. Hence, there are costs or setbacks that a firm need to

consider with such a large shareholder in a firm not to forget the benefits arising from

having such large shareholder as the firms’ managers can tap into the influential

power that such shareholders exercise over the firm.

The largest shareholders can put in pressure on the firm’s management to implement

dividend policy that pays out all the profits earned to reduce or totally eliminate the

private consumption of the managers and ultimately reduce the agency conflict. On

the other hand, the largest shareholder can also implement a dividend policy that does

not pay out a single cent as dividends to the shareholders in order to maximize the

private benefits to themselves and neglecting the benefits for the minority

shareholders. This is known as expropriation.

2
Truong & Heaney (2007) found that firms and corporations are very likely to pay

good dividends when the largest shareholder is not an insider of the corporation. If the

largest shareholder does not have a huge interest in the company invested, there will

be a propensity for the shareholders to have continuous active monitoring on the

firm’s management continuously by external parties. This is similar with the past

agency theory which argued that ownership and dividends tend to provide substitute

monitoring devices (Easterbrook, 1984; Rozeff, 1982). Aoki (2014) used the same

method and divided the largest shareholder into two groups mainly corporation largest

shareholder and individual largest shareholder and found a U shaped relationship

between shareholding and dividend pay-outs.

In short, since dividend is one of the firm’s decision that strongly influenced by

corporate ownership structure, dividends can be used to solve agency problems in a

company and thus substituting the large ownership as a monitoring tool or it can

represent the severity of expropriation in a firm.

1.2 Problem Statements

This study is aimed to investigate how most corporation’s largest (LO) and second

largest shareholder (LO2) influence the payment of dividends to the firm’s

shareholders in Malaysia by examining the publicly listed firms on Bursa Malaysia

from years 2008 to 2014. Generally, ownership structure of firms in Malaysia are

concentrated with a few large shareholders having the total control of the firms and

these firms are classified as manager owned (MO) firms. Another common type of

firms’ ownership structure is known as corporation owned (CO) firms (Aoki, 2014).

3
Claessens et al. (2000) in their study has proven that a huge portion of the corporate

wealth in East Asia are in the hands of few individuals or family members who are

also part of the management of the firm and there is a high possibility for

expropriation to happen when the firm is being associated with a group of firms which

are controlled by the same large shareholder. Hence, the largest shareholder with

voting rights and being part of the management team can actually take the

opportunities to extract benefits at the expense of minority or other smaller

shareholders and this is known as expropriation. Holderness (2003) in his study on the

relationships between ownership and control stakes held by the largest shareholder for

publicly traded firms in East Asia found that the firm valuation increased with the

increase in ownership of the largest shareholder but they also found that an increase in

the control rights by the largest shareholder by being part of the management of the

firm will cause the firm’s value to decrease.

Studies by La Porta et al. (1999) observe that in most Asian countries, especially

Malaysia, the firms are closely owned by family members with the largest shareholder

having an active role in the firm’s management. With this, the monitoring duty has

been taken over by the firm’s manager instead of using the dividend to reduce the

agency conflict. Past studies done on firms in Malaysia did not touch on the aspects of

possible expropriation by the largest shareholder by studying the relationship between

the ownership structure and the dividend pay-outs. For example, Isa (1992) and

Kester and Isa (1996) found that firms in Malaysia tend to follow a steady dividend

policy by studying the relationship between P/E ratio and the dividend pay-out ratio.

4
Annuar and Shamsher (1993), Gupta and Lok (1995) and Pandey (2003) in their study

of firms listed in Bursa Malaysia found that the dividend pay-out of the firms are

positively related to the firm’s earnings which supported the Lintner’s model. Tam

and Tan (2007) found that Malaysian state firms have the highest ownership

concentration. This high level of ownership is expected to decrease the dividend pay-

outs for Malaysian firms as the largest shareholder will extract private benefits and

hoard the cash in the company for expropriation. Samuel et al. (2015) in their study

found that politically connected firms will prefer to pay a lower dividend whilst

corporation owned (CO) firms will demonstrate a higher dividend pay-outs.

Interestingly, Ramli (2010) found a different result in her study on how the largest

shareholder affect the dividend policy in Malaysian firms. Using panel data from year

2002 to 2006, the study done found that as the shareholding percentage of the largest

shareholder increase, the higher the dividend pay-outs will be. This is contrary with

the majority of the results obtained by studies done earlier whereby dividend tend to

fall with the increase in shareholding percentage of the largest shareholder due to

expropriation or due to the increase in corporate governance. Given that Malaysian

firms are generally owned by few individuals and are part of the firm’s top

management, these firm managers have absolute control of the firms in terms of

deciding the dividend policy (Claessens et al., 2002).

Ramli (2010) also shown that the dividend pay-out does not change when a

substantial second largest shareholder (LO2) exist in the firm without further

analysing the type of largest shareholder whether they are corporation largest

5
shareholder or individual largest shareholder and how it affect the dividend policy for

firms in Malaysia. Sun and Liu (2012) state that most literatures have commonly

emphasize on the dividend problems caused by concentrated ownership and have

ignored the differences in dividend policy when the large shareholders are actually

assuming a certain position in the firm.

Besides that, past studies on dividend pay-out for firms in Malaysia do not take into

consideration of all the firms listed on Bursa Malaysia. Ramli (2010) in her study of

dividend pay-outs for Malaysian firms applied a systematic random sampling

whereby one firm was chosen for every two firms in the sample population. With this,

a larger population sample size is thus needed to achieve a more accurate result of

dividend policy in Malaysia. Hence, a full understanding of how the type of largest

shareholder will affect the dividend policy in Malaysia need to be carried out.

In a summary, this study is aimed to find the impact of the largest (LO) and second

largest shareholder (LO2) on the firm’s dividend policy in the Malaysian context with

the firms listed on Malaysia’s main market being the main subject matter. This study

will be carried out by analyzing the 762 sample firms listed on the main market. With

this, a clear understanding on the role of the largest shareholder (LO) will be achieved

and subsequently the investors are able to predict how different type of largest

shareholder (LO) might react in setting the firms’ dividend policy.

6
1.3 Research Objectives

The objectives of this research are to study how dividends are related to the ownership

by the type or characteristics of the largest shareholder (LO) and to analyse the effect

of the second largest shareholder (LO2) on firm’s dividend policy under different type

of largest shareholder.

The research objectives are as follows;

1. This research will investigate the relationship between dividend pay-outs

among Malaysian firms and the characteristics of the firms’ largest ownership

whether it is manager-owned firms or corporation-owned firms.

2. This study will investigate the relationship between dividend pay-outs among

Malaysian firms and the ownership of the second largest shareholder (LO2)

given that the largest shareholder (LO) might be a firm manager or another

corporation.

1.4 Research Questions

DeAngelo and DeAngelo (2006) have explained that the optimum dividend pay-out is

determined by the requirement to distribute the profits or the free cash flow in the

firm. When a corporation or business earns a profit and there is a surplus in cash flow,

the business or corporation can re-invest the earning back into the business. Hence,

the firm can actually keep the earnings or allocate a part of this earnings to be given

out to their shareholders as dividends.

For this study, this study are interested in examining the kind of ownership for firms

in Malaysia. If the largest shareholder (LO) is a manager in the firm, the manager will

7
act as a governance mechanism. Any improvement in the aspect of efficiency of

corporate governance will shrink the role of dividends being an alternative monitoring

mechanism and subsequently lead to a decrease in the dividends pay-out. Dividends

can be made used by the largest shareholders to cancel off the minority shareholders’

concern in an environment where expropriation by the substantial shareholders

prevails (Faccio et al., 2001). Lower dividend payments will be expected when

dividends are no longer being required to work as an alternate agency control device

(Goergen et al., 2005).

On the other hand, a lower dividend can be expected and obtained due to the increase

in the probabilities that firm managers will hoard the cash for expropriation. Daniel

Wolfenzon (1999) and Claessens et al. (1999) in their study found that there is a high

possibility for expropriation to happen when the firm is being associated with a group

of firms and which are all controlled by the same large shareholder. The firm’s

wealth can be expropriated by the firm managers who have the power and rights to set

bias terms and conditions for intra-group sales and transfers of assets.

When the largest shareholder is another corporation, the dividend will be expected to

go up in order to reduce the agency conflict (Bohren et al., 2012). The largest

shareholder will force the managers to disgorge the extra cash available as dividend

pay-outs to improve the corporate governance as these corporations would not have

the time to monitor the firms. When the firms need a capital to work on new projects,

they will need to seek help from the capital markets and these capital markets will be

there to check on the firms’ financial condition.

8
The research questions are thus as follows;

1) Does the dividend pay-out of the firm increase with the largest shareholder (LO)

for MO firms?

2) Does the dividend pay-out of the firm decrease with the largest shareholder (LO)

for MO firms?

3) Does the dividend pay-out of the firm decrease with the largest shareholder (LO)

for CO firms?

4) Does the dividend pay-out of the firm increase with the largest shareholder (LO)

for CO firms?

5) Does the dividend pay-out of the firm increase with the increase in shareholdings

of the second largest shareholder (LO2)?

6) Does the dividend pay-out of the firm decrease with the increase in shareholdings

of the second largest shareholder (LO2)?

1.5 Definition of Key Terms

The independent variables are abbreviated as LO, LO2 and MAND. LO represents the

largest shareholder in the firm. LO2 refers to the second largest shareholder in the

firm while MAND is the abbreviation for manager owned firms’ dummy. Corporation-

owned firms are firms whose largest shareholder is another corporation or also known

as an outsider. It is being abbreviated as CO firms. Manager-owned firms, whose

largest shareholder is an internal firm manager is being abbreviated as MO firms.

DIVD, DIVY, DIVA and DIVS refers to the dividend dummy, dividend yield, dividend

to assets and dividend to sales respectively. These are the dependent variables in this

study. The control variables are abbreviated as LEV for the firm’s leverage level, ITA

9
for profitability of the firm, Tobin’s Ǫ for investment opportunities, SIZE for the book

value (BV) of the total assets, AGE for the firm’s age and CASH refers to the cash and

equivalents to total assets of the firm. Other terms include BV which means the book

value.

1.6 Significance of the Study

There are a few significant contributions that this paper aim to achieve. Firstly, this

study aimed to propose an explanation on how dividends are linked to the type of

largest shareholder in the context of Malaysian firms. The largest shareholder can be a

firm manager or another corporation. Different type of shareholder will affect the

dividend policy differently for certain reasons. For example, the amount of dividend

pay-out by the firms will be an indicator of whether the largest shareholder is using

the dividend payments as a monitoring and checking mechanism to ensure corporate

governance is in place or using the dividend payments as a mean to expropriate other

shareholders. The findings from this study can help the Malaysian regulators in

preventing expropriation, ensure that minority shareholders rights are not being

jeopardized, enhance the firms’ values and lastly protect all the shareholders’ interest.

The regulators can then promote and encourage the participations of foreign and

institutional investors. This study has explored on the relation between LO, the

percentage holdings of the largest shareholder and the amount of dividends being paid

out to understand whether the type of concentrated ownership or largest shareholder

have an effect on the dividends.

10
Next, this research will find out the interaction between the largest shareholder (LO)

and the second largest shareholder (LO2) in Malaysian firms. Second largest

shareholder (LO2) whom are normally outsiders have dissimilar dividend preferences

as compared to the largest manager shareholders whom are normally insiders of the

firm. Since the manager-owned firms and corporation-owned firms both have

different perception towards dividend pay-out, this study aimed to help investors to

decide wisely on which firms to invest if dividend pay-out is their primary concern for

firms listed on Bursa Malaysia. Besides that, investors who want to increase their

wealth through dividend payments will know what financial ratios that they should

look for in the firms. The financial indicators may be future investment opportunities,

firm’s leverage level, profitability of the firm, firm’s size, firm’s age and the firm’s

cash level.

1.7 Organization of Study

For this Chapter 1, background of the study will be introduced, the research problem

and issues are being identified and the significance of the study will be discussed. In

Chapter 2, the related theories will be identified, related literature will be reviewed

and appropriate models will be proposed for this study. The proposed research

framework and all the variables like the independent variables, dependent variables

and the control variables of this study will then be identified. Chapter 3 will mainly

focus on the design and methodology of the study followed by the method of analysis.

For Chapter 4, data analysis will be carried out and the results will be discussed. The

research hypothesis will be tested and explained. Lastly, Chapter 5 highlights the

research discussion, impact and limitations of the study, and concluded with

suggestion for future research.

11
 CHAPTER 2

LITERATURE REVIEW

2.1 Introduction

Black (1976) said in his research that “The dividend is like a jigsaw puzzle with

pieces that just not able to fit together”. Even after so many years have passed and lots

of studies have been carried out around the world, the dividend pay-outs decision is

still a subject of interest to financial analysts, academicians and researchers as nobody

has yet able to crack the code on dividend payments.

Dividend can be defined as a return from the money invested in the equity shares of a

firm. When the firm has made a profit and has the excess cash, it may retain the

earnings for future growth or distribute the profits and excess cash to the shareholders.

There are two ways that a manager can choose to pay this excess cash to the firm’s

owners. The first method commonly used by most firms is dividends pay-outs and the

second method which is less common is known as stock repurchases.

Up to today, firms in Malaysia still practice dividend payments as a way to attract the

investors and these firms are usually not binded under the regulation on the amount to

be given out as dividends. In other words, firms are free to choose the amount of

money to be given out as dividend to the shareholders and also free to decide on the

time to distribute the dividends. For example, a firm which has made a profit do not

necessary need to disburse the earnings immediately. The firm can delay the dividend

payments until the firm finds that it is suitable time for the firm to give it out.

12
Given that factors such as legal requirements, debt level, availability of cash and

many other factors may affect the decision on dividend payment, it is not abnormal to

see that there are variations in dividend behavior across firms, countries, time, size of

firm and the type of dividends being given out to the shareholders. Fama & French

(2001) noted the variation in dividend payment among firms and found that most

dividend paying firms in the US tend to be large firms and earning a profit while non-

paying dividend firms are typically small and less profitable. La Porta et al. (2000)

studied more than 4000 firms from 33 countries around the world found out a big

variation in the firms’ dividend policy.

The types of law being practiced by the countries also plays a role in affecting the

dividend policy. Common law countries have been proved to offer greater shareholder

protection compared to civil law countries (La Porta et al., 1998). Hence, common

law countries tend to give out higher dividend compared to firms operating in

countries with weak legal protection on the investors. Hence, this study can only say

that one factor which seem to be a primary factor in affecting the dividend policy may

not work on another firm or another country.

2.2 Definition of Dividend Policy

Dividend policy is a firm’s management long-term decision on how much to reinvest

in the business and how much money to be returned to the shareholders. Firms are

often in a dilemma when they are required to make a decision in between paying

dividends to the shareholders or reinvesting the profits made back into the business.

The amount of dividend to be paid out is an important decision that firms need to

13
consider carefully as the ultimate aim for the firms is to maximize the shareholders’

wealth and this is normally measured by the share price or refers to the capital gains

rather than the periodic payment of dividends only.

Some shareholders are not concerned with a firm’s dividend policy as they can sell off

their portfolio of shares if the shareholders need the cash. This is known as the

"dividend irrelevance theory" which essentially means that the amount of dividend

pay-out have little to no impact on the share price or the shareholders’ wealth. This

dividend irrelevance theory originated from Merton Miller and Franco Modigliani in

year 1961. They argued that a firm’s value is determined by its basic earning power

and its business risk in a perfect capital market with rational behavior and perfect

certainty. Dividend policy has no effect on the market value of the firm. With this, the

true value of the firm is mainly depend on the net income produced by its assets.

Another group of people is in support of dividend relevance theory. The supporters of

this theory argued that the dividend irrelevance theory is based on unrealistic

assumptions. The main argument is, periodic payment of dividends will have a

positive impact on the stock price of a firm, its market value and its weighted average

cost of capital. Many types of dividend policy theories are being used to explain the

rationale relating to the payment of dividends by public listed firms around the world

but unfortunately firms that ultimately pay dividends do not seem to have a stationary

formula in determining the dividend pay-out ratio. Firms that pay dividends may not

have a higher market value or higher stock price compared to non-paying firms and

14
on the other hand firms that pay dividends really do have a higher value compared to

other similar firms.

2.2.1 Dividend Irrelevance Theories

2.2.1.1 The Residual Theory

The residual theory states that dividends paid by firms are residual. This means that

firms will spend the money available on all available positive net present value

projects first and the amount of money remained will be given out as dividends.

Hence, firms will never forego desirable investment projects just to pay dividends to

the shareholders. This theory was trying to say that firms with good future investment

opportunities will not pay dividends. Firms will actually spend the money available

on projects hoping that it will create a higher future cash flows and subsequently lead

to capital appreciation of their stocks and higher dividends pay-outs. Based on this

theory, we would expect firms to reduce the dividend pay-outs when they have good

future investment opportunities and this is represented by the higher Tobin’s Ǫ value.

Smith (2009) in his study found a strong arguments exist to favour a residual dividend

policy as a method to optimize the usage efficiency of corporate resources.

2.2.1.2 The Modigliani and Miller Theory

The Modigliani and Miller Theory states that capital gains and dividends are

equivalent in the eyes of an investor. When the investment policy of a firm is held

constant and is known to all the investors, the dividend pay-out policy has no

consequences for shareholder wealth. The value of the firm is dependent on the firm’s

earnings which result from its investment policy and the industry background. Aretz

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and Bartram (2010) states that the market value of firms are not determined by the

dividend policies that they pursue. Instead, the firms’ investment policies are the ones

that really affect the firms’ market value. Firms can have a low earnings but having a

higher share price actually gained their firms’ value from future expansion

opportunities.

The wealth of the shareholders do not change if the firm decided to give out a higher

dividend pay-outs which will subsequently lower the retained earnings and capital

gains. With this, the total wealth of the shareholders remain unchanged no matter how

the dividend pay-outs changes. In this theory, the shareholders would not affect the

dividend policy as there is no direct benefit or setbacks by doing so since the total

wealth remained unchanged. Investors or shareholders can create their own cash

inflows from their shares according to their cash needs regardless of whether the firm

pay dividends or not. If a firm does not pay dividends, an investor who needs the cash

can simply sell his shares to meet his need for cash.

2.2.2 Dividend Relevance Theories

2.2.2.1 Signalling Theory

The dividend signalling theory arises from the unequal distribution of information

between the firm managers and the owners. The signalling theory states that the

dividend policy is able to communicate information about the existing or expected

level of earnings (Chen & Dhiensiri, 2009; Booth and Chang, 2011). For this theory

to hold, firm managers should firstly possess private information about a firm’s

prospects and need to have the incentives to convey this information to the market and

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secondly, if this signal is true, firms with poor performance should not be able to send

any false signals to the market such as increasing the dividend payments.

Changes in the share price is not caused by the dividend pay-out itself but it reflects

the future prospects of the firm. A reduction in dividend is viewed as poor

management of the firm and it reflects firms having less cash than it had in the past.

Fairchild (2010) found that dividends will increase the value of the firm by sending

out positive signals on the firm’s earnings. Hence, firms generally do not increase

their dividend or prefer not to give out dividends so as not to give a false signal to the

investors or shareholders when the firm reduce the dividends for the following year.

In order not to give out any false signals, Lintner (1956) found that firms will follow a

fixed dividend policy and gradually increase the dividend pay-out to achieve the

target pay-out ratio. Glen et al. (1995) find a substantial difference in dividend

policies of companies in developed and emerging markets like Malaysia. Their study

shows that companies in emerging markets follow a less stable or in other words

constant changing dividend policies although these firms do have a target pay-out

ratios. On the other hand, Isa (1992) find that firms in Malaysia follow a stable and

non-changing of dividend policies. Hence, firms which are in favour of no dividend or

tend to give out lower dividend pay-out are actually trying to avoid a negative

perception on the company management or financial condition according to the

signalling theory.

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2.2.2.2 Agency Theory

A well-known argument in favor of substantial dividend payments is based on the

agency theory of dividend. Jensen and Meckling (1976) states that agency conflicts

occur when there is a separation of ownership and control or a divergence of interests

between the firm’s managers and the external shareholders. The underlying

assumption is that managers, who is controlling the firm, may not necessarily always

act in line with maximizing the shareholders’ wealth. When the retained earnings are

high, managers may channel the extra funds into projects that do not increase the

shareholders wealth.

Easterbrook (1984), Jensen (1986), Myers (1998), Fluck (1999) and Gomes (2000) in

their studies state that dividend policies are able to address the agency problems

between corporate insiders and outside shareholders who are the investors and

shareholders of the firm. The firms’ profit can be diverted by the insiders who are the

firm managers for personal use or being invested in unprofitable projects that provide

private benefits for the insiders.

As a consequence, outside shareholders normally very inclined to choose dividends

rather than retained earnings. They tend to view the failure to disgorge the free cash

will lead to its diversion by certain insiders of the firm especially firm managers. The

managers are also seen to advance their own interests by investing in projects that are

linked to the managers. With this mindset, most shareholders would agree on a

generous dividend policy as this can reduce the amount of free cash flows in the firm.

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By paying dividends, the managers will return the corporate earnings to the investors

and are not able to use these earnings for their own benefits.

Unfortunately, there is not a fully satisfactory theoretical agency models of dividends

that can explain the dividend policies. Different models such as Gomes (2000) explain

different aspects of the dividend policies. Rozeff (1982) suggests that firms tend to

adopt an optimal monitoring system which acts to reduce the agency costs. Jensen

(1986) argues that a firm is more likely to share the profits with the shareholders

when the firm has a lower monitoring costs. As such, this study can say that the

dividend policy is a measure of the extent to which agency conflicts between existing

shareholders, managers, new investors and lenders that exist within the firm

(Easterbrook, 1984).

Bohren et al. (2012) in their study found a strong evidence that dividend payments are

able to reduce the agency conflicts in the firm especially among the stakeholders.

Farre Mensa et al. (2014) also found the same result and concluded that among all the

reasons like taxes and asymmetric information, the dividend pay-out was found to be

mostly affected by the agency conflict. On the other hand, Baker et al. (2011) found

mixed results when they studied the firms listed in the US and non-US market.

2.3 Determinants of Dividend Policy

There are two basic views that deal with dividend policy in the presence of market

imperfections which are “for” and “against”. Based on previous studies done,

dividend policy is not shaped just by considering the firm’s internal environment like

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the firms’ target dividend pay-out ratio, earnings, debt level and cash flows but also

external factors like the country’s governance rating, tax and legal system.

Other studies have been carried out to examine the relationship between dividends

and concentrated ownership as subject of corporate governance (Mitton; 2004,

Truong & Heaney 2007; Harada and Nguyen 2011). Mitton (2004) found that firms

with both country-level investor protection and strong corporate governance have

higher dividend pay-outs which is consistent with agency models of dividends. Fodil

and Walid (2010) in their study found that the shareholder rights policy to be the most

important determinant of dividend policy. Their results is in accordance with the

outcome model of dividends (La Porta et al., 2000) who suggest that when the

investors or shareholders’ rights are well protected, they can use their voting power to

pressure managers to pay higher dividends instead of spending the excess cash.

Corporate governance has become a major consideration for a lot of investors

especially after the Asian Economic Crisis that happened back in 1997 partly due to

the lack of governance mechanism. Both the government and the industry players had

since make changes to deal with the weakness to regain the investors' confidence in

the Malaysian capital market starting with the appointment of independent directors in

a firm. Nonetheless, Sing and Ling (2008) found that appointment of independent

directors in Malaysian firms is merely to fulfil the firm’s listing requirement rather

than as a measure to improve the transparency and efficiency of the corporate

governance. Besides having an independent director, Malaysia government has

established The Minority Shareholder Watchdog Group (MSWG) back in year 2000

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as part of a broader capital market framework to protect the interests of minority

shareholders. Its main role is to increase the market discipline by encouraging good

governance amongst public listed firms and raising the shareholder value over time.

Bancel et al. (2009) in their study found that the major factor influencing dividend

policy are similar across the countries studied and some country specific differences

exist due to the difference in the country’s legal structure. Da Silva et al. (2004) found

that the Anglo-American system tend to provide a higher investor protection while the

German or Continental European system allows firms to have a higher flexibility in

terms of their dividend policy. La Porta et al. (2000) in their study found that firms

operating or established in common law countries will pay higher dividends than

firms established in code law countries. Common law countries typically offer

superior protection on the minority shareholders.

Lintner (1956) in his research discovered that firms maintain a target dividend pay-out

ratio and these firms will adjust their dividend policy to meet this target. Firms pursue

a steady dividend policy initially and then gradually increase their dividends to

achieve the desired target pay-out ratio. Lintner’s study also stressed that investors

prefer to invest in firms with a steady dividend policy. Bulan and Hull (2013) study

strengthened the model further when the managers were reluctant to reduce the

dividend pay-out and prefer an uninterrupted dividend payments. An increase in

dividend pay-out will only be materialized when the stability of firm’s earnings has

been achieved.

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A number of studies have since been conducted around the world mostly on a specific

country using this Lintner's framework. It has been tested by Chateau (1979) in

Canada, Shevin (1982) in Australia, Leithner and Zimmermann (1993) in West

Germany, UK, France and Switzerland using this model and different results were

obtained.

In the 1990s and 2000s, Lintner’s dividend model performance degraded and no

longer can be used to study the dividend policy. It appears that dividends have

become less responsive to changes in the firms’ earnings due to the shift of pay-out

from cash dividends to share repurchases. Baker and Powell (2000) found that

determinants of dividends differ among industries based on their survey on New York

Stock Exchange listed firms and conclude that the expected future earnings are the

main determinant of dividend policy.

As for Malaysia, Pandey (2003) in his study of corporate dividend policy and

behaviour in Malaysia found that pay-out ratios varied from one industry to another.

His results of multi-nominal logit analysis proved that the dividends of companies

listed in KLSE are related to the changes in earnings which is in support of Lintner’s

model. Osobov and Denis (2007) found that the dividends pay-outs among the largest

and most profitable firms is primarily determined by the distribution of free cash flow

in the firm consistent with the lifecycle theory. Ajmi and Hussain (2011) also found

that life cycles theory is positively related to the firms’ dividend decisions in Saudi

Arabia.

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Nonetheless, this research is aimed to investigate and find out how a firm’s largest

shareholder (LO) will influence the payment of dividends to the shareholders in

Malaysia by taking into consideration of the firms’ financial background like the level

of leverage, the level of profitability of the firm, the future investment opportunities

available to the firm, the firm’s cash level, the firm’s size, the firm’s age as well as the

type and the concentration of ownership.

2.4 Type of Firm Ownership and Dividend Policy

The identity of the large shareholder may be important (Gugler & Yurtoglu, 2003).

The large shareholder may be an insider if the firm or a financial institution or a state.

Some shareholders are able to influence the firm’s policy and performance better than

other large shareholders. For this study, the types of large shareholders can be divided

into two groups mainly the manager owned (MO) large shareholders and corporation

owned (CO) large shareholders. Previous research on the relationship between

ownership structure and dividend policy has largely focused on companies in the US

and the UK as the markets are well regulated and the ownership is widely distributed

instead of in the hands of few large shareholders. Tirole (2006) state that US firms are

generally diffusely owned and US firms are more diffusely owned than comparable

firms elsewhere.

2.4.1 Corporation Owned (CO) Firms

Allen et al. (2000) found that financial institutions will find cash dividends attractive

for taxation reasons. Thus, firms will have higher tendency to pay dividends and will

actually pay more dividends when the large shareholder is a financial institution or

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also known as corporation owned (CO). A study on corporation owned firms done by

Barclay et al. (2009) found out that large shareholders who are financial firms tend to

give out higher dividend compared to non-financial firms. Short et al. (2002) found

that large shareholders like institutions have a preference for cash dividends over

retained earnings.

2.4.2 Manager Owned (MO) Firms

There are two different views on how the ownership concentration may affect the

dividend pay-out for manager owned (MO) large shareholders. Firstly, manager

owned (MO) large shareholders may increase the dividends to constrain or limit the

managerial opportunism. The dividends given out can be a sign of the severity of the

conflict between the large shareholder which is the controlling owner and the minority

outside shareholders. Manager owned (MO) firms may also increase the dividend

pay-out as a consequence of good corporate governance. Secondly, firms’ managers

are able to influence a firm’s policy easily compared to other shareholders. For

example, when the largest shareholder (LO) is an insider of the firm, the firm will

have a higher preference for retained earnings over giving out dividends due to

expropriation. The firm managers, being the largest shareholders may choose to

pursue their own interests at the expense of other small shareholders. Hence, large

shareholders tend to decrease the dividend pay-out.

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