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IMPACT OF EARNINGS PER SHARE DIVIDEND AND PRICE EARNING RATIO ON SHARE MARKET PRICE MOVEMENTS
ABSTRACT
Despite years of theoretical and empirical research, dividend policy remains a source of controversy especially the aspect of the linkage between dividend policy and stock price. Its impact on shareholders wealth is still unresolved. This is in view of the fact that companies belong normally to different people or groups of people with individual views on the business and how to divide the firm’s profit which inturn affects how each of these diverse investors place value on the firm. Hence, this paper investigated the impact of dividend policy on the share price of selected quoted firms in Nigeria. Dividend relevance and irrelevance theories were introduced in the study to capture the divergent views on the impact of dividend policy on stock price. The study adopted time series research design and secondary data drawn from the fact book of the Nigerian stock exchange and annual report of ten (10) selected companies for the period covering 1997-2012 was used for the study. The sample selection is based on a number of criteria employed by previous studies on dividend policy. Such criteria includes firms with the financial and market information available in the summarized reports necessary to estimate the various pooled panel data models amongst others criteria. A linear regression model was developed and statistically tested using panel least square method. The result of the empirical study carried out revealed that the earning streams of companies in Nigeria have a greater impact than their dividend payouts in shaping the price of their shares in the market. The study therefore recommends that corporate managers should strive to maintain a steady increase in earnings by maximizing return on investment. The study further recommends that firms should maintain a stable dividend payout in order to increase internal finance available to pursue further profitable investments that will help increase earnings.
CHAPTER ONE
INTRODUCTION
BACKGROUND OF THE STUDY
The dividend policy of a company is a guideline that determines the proportion of earnings that is distributed to the shareholders by way of dividends, and the proportion that is ploughed back for reinvestment purposes. Dividend policy represents the payout policy, which managers pursue in deciding the size and pattern of cash distribution to shareholders over time (Davis, 2006). The main objective of financial management is to maximize the market value of equity shares, thus, one key area of study is the relationship between the dividend policy and market price of equity shares (Waithaka, Ngugi, Aiyabei, Itunga and Kirago, 2012). This objective translates into maximizing the value of the company as measured by the price of the company’s common stock which 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 (Black, 1976). There is a school of thought that advocates that the higher the dividend payout ratio, the more attractive the share is to shareholders (Gordon, 1959 cited in Al-Kuwari, 2009). This is not always true as some investors view firms that retained higher proportions of their profits as firms with strategic investment opportunities. In this vein, another school of thought emanated in the literature suggesting that those firms who have viable investment opportunities should retain their profits and invest in such opportunities (Modigliani and Miller, 1961; Nissim and Ziv, 2001; De-Angelo, De-Angelo and Stulz, 2006). This is based on the premise that when a firm declares cash dividends, it indicates the lack of such investment opportunities and could be considered negatively thereby resulting in negative abnormal returns in the market share (Abubakar, 2010).
Thus, dividends are more than just a means of distributing net profit. This is because the dividend policy of a firm has implication for investors, mangers and lenders and other stakeholders and variations in dividend payout ratio could affect share prices (Kapoor, 2012). For investors, dividends – whether declared today or accumulated and provided at a later date are not only a means of regular income, but also an important input in valuation of a firm. Similarly, managers’ flexibility to invest in projects is also dependent on the amount of dividend that they offer to shareholders as more dividends may mean fewer funds available for investment. Lenders may also have interest in the amount of dividend a firm declares, as more the dividend paid less would be the amount available for servicing and redemption of their claims. A firm should therefore endeavour to establish an optimal policy that will maximize the value of the firm (Waithaka et’al, 2012).
Statement of the Problem
There is no doubt that dividend policy is an integral part of the financial management decision of a business firm. Similarly, it is often said that the goal of any business is to earn profit and the division of this profit is an element of a firm’s financial strategy. However, today companies belong normally to different people or groups of people with individual views on the business and how to divide the firm’s profit between pay outs and retention. It, therefore, becomes difficult to make the most appropriate decision about the payout policy to be followed as it no doubt affects how each of the diverse investors place value on the firm. This poses a big problem for managers .For instance, some shareholders prefer to be paid dividends every year for investing in other profitable businesses while other shareholders would like to invest in the future and thus, prefer that the dividends be retained by the company for re-investment. Since firm’s management deals with competing interests of various shareholders, the kind of dividend policy they adopt may have either positive or negative effects on the share prices of the company. According to Miller and Modigliani (1961), the effect of a firm’s dividend policy on the current price of its shares is a matter of considerable importance, not only to management who must set the policy, but also to investors planning portfolios and to economists seeking to understand and appraise the functioning of the capital market. It is this basis that prompted the study.
Research Questions
This following research questions became relevant from the problem identified:
- Is there a statistically significant effect of dividend paid on market price of share?
- Is dividend payout the major determinant of share price?
- Does the impact of dividend policy on share price differ among the different sectors?
Objectives of the Study
The general objective of this study is to examine the impact that a firm’s dividend policy might have on its share price. However, the specific objectives of the study are to:
- Examine the effect of dividend paid on the share price of quoted firms in Nigeria.
- Ascertain if dividend paid is the major determinant of share price of quoted firms in Nigeria.
- Determine if impact of dividend on share price is sector specific.
Statement of Research Hypotheses
In line with the research questions, the following hypotheses were tested:
Ho1: Dividend paid has no statistically significant effect on the market price of shares of quoted companies in Nigeria.
Ho2: Dividend policy is not the major determining factor of the market price of shares of quoted companies in Nigeria.
Ho3: The impact of dividend policy on share price does not differ between different sectors of the economy.
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