THE IMPACT OF DIVIDEND AND CORPORATE EARNINGS ON STOCK PRICES

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THE IMPACT OF DIVIDEND AND CORPORATE EARNINGS ON STOCK PRICES

ABSTRACT

This study was carried out to determine effects of dividends and earnings on stock price movement in Nigeria. This was done by examining the significance of cash dividend and corporate earnings on stock prices in the Nigerian Stock Exchange for a period of ten years from 1999 – 2008. The data sourced from Nigeria Stock Exchange reports and the company annual reports were analyzed using the regression tool. After the process of experimentation using this regression tool, the researcher observed that stock price movement is more significantly related to dividend than corporate earnings. Secondly, the optimization of corporate earnings influences positively stock price movement as many investors look at it as a significant factor for their choice for stock investment. This drive for such stock and the market price adherence to the law of demand and supply influences the stock price. Nevertheless, it is also observed that there is an autocorrelationship of the three variables, dividend, earnings per share and stock price in choice of stocks for investment. It is recommended, therefore, that Management should optimize their corporate earnings and derive a dividend and retention policy decision in an optimum manner to achieve the objective of maximizing the wealth of shareholders since the interrelationship of there decision have a significant impact/effect on equity share price.

It is also recommended that further works on this should be carried out in order to improve the body of existing knowledge in those areas in addition to a longitudinal study that will cover a time horizon of more than ten years should be conducted as this may enable a proper test on dividends and earnings. Management of this kind of investors should develop policies that will satisfy the investors and thus, enhance their firm’s value.

There should be a dividend pay out ratio that companies need to maintain so that they can enhance the value of their firms. Nevertheless, the study brings to the knowledge of all and sundry that investors in Nigeria are dividend driven and would therefore be willing to pay higher prices for stock that pay more dividend.

Finally, although factors like efficient market hypothesis, volume of equity, traded law of demand and supply etc influence investors decisions, but, suffice it to say that with available evidence, Nigeria investors are dividend driven as shown in the stock price movement/trend over the years.

TABLE OF CONTENTS

Title Page i

Certification ii

Approval iii

Dedication vi

Acknowledgements v

Abstract vi

CHAPTER ONE – INTRODUCTION

Background of the Study 1

Statement of the Problem

Objectives of the Study 4

Research Questions 5

Hypotheses of the Study

Significance of the Study 5

Scope and limitations of study 6

Operational Definition of Terms 7

References 9

CHAPTER TWO – REVIEW OF RELATED LITERATURES

2.1 The Concept of Investment 11

2.2 The Nigeria Capital Market 12

2.3 The Stock Market 15

2.3.1 Trading 15

2.3.2 Importance of Stock Market 16

2.3.3 The Behaviour of Stock Market 17

2.4 The Stock Exchange 20

2.4.1 The Nigeria Stock Exchange 22

2.4.2 The Stock Exchange and Capital Formation in Nigeria 24

2.4.3 Broadening Ownership 25

2.4.4 Institutional Framework 26

2.4.5 Legal and Regulatory Environment 26

2.4.6 Savings Structure 27

2.5 The Stock Prices 27

2.5.1 Dividend Policy 30

2.5.2 Types of Dividend 31

2.5.3 Dividend Theories 32

2.5.4 Dividend Relevant Theories 32

2.5.5 Walter’s Model 33

2.5.6 Gordons Model 34

2.5.7 Bird in Hand Argument 34

2.5.8Dividend Irrelevance 35

2.5.9 Modigliani and Millers Hypothesis of Dividend 35

2.5.10 Methodology of Dividend Payment 38

2.6 Factors Determining Dividend Policy 40

2.6.1 Level of Profit 40

2.6.2 Perceived Further Profit 41

2.6.3 Existence of Profitable Investment Opportunities 41

2.6.4 Shareholders Preference 42

2.6.5 Liquidity 42

2.6.6 Available Sources of Fund 43

2.6.7 Existence of Legal Restriction 43

2.6.8 Perceived Impact of Dividend on Share Price 43

2.7 Information Content of Dividend 44

2.8 Relation of Stock Prices to Corporate Earnings 49

2.8.1 Stock Prices and Dividend 51

2.8.2 Growth Earnings and Dividend Distribution Policy 54

2.8.3 Linkages between Share Price, Earnings and Dividend 57

References 58

CHAPTER THREE – RESEARCH METHODOLOGY

3.1 Research Design 61

3.2 Nature and Sources of Data 61

3.3 Techniques of Data Collection 61

3.4 Population and Sample 62

3.5 Models 62

3.6 Analytical Techniques 63

References 64

CHAPTER FOUR – DATA PRESENTATION AND ANALYSIS

4.1 Introduction 65

4.2 Data Presentation 65

4.3 Data Analysis 67

CHAPTER FIVE – SUMMARY, CONCLUSION AND RECOMMENDATIONS

5.1 Summary of Findings and conclusion 78

5.2 Recommendations 79

Appendix 80

Bibliography 97

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

In a competitive economy, it is clear that investments are undertaken due to the available benefits perceived or which they provide to the investors. Investment in securities are for the purpose of earning income which could be in form of dividends, profits or/capital gains. With this in mind, it could be said that no right thinking investor will put his funds if he does not expect some form of returns. Apart from the above reasons, prestige, power, control etc. could also be adduced, but primarily, the motive is to earn some form of returns.

Stocks or securities are documentary evidence of ownership or entitlement to claim upon the income and the assets of the issuing organization, which may be a publicly or privately owned institution. Investments in securities are carried out through a market known as the stock market, commonly referred to as the stock exchange, an example of which is the Nigerian stock exchange and it is the centre point of the Nigerian Capital Market (NCM).

The stock exchange as the hallmark constituency of the capital market is many things at the same time. It is a place where debt and equity securities of varying types are traded transparently. It is a market that facilitates capital mobilization and allocation, as both governments and companies can raise funds through the market on long and most prudent terms through the offer of shares (by companies) and bonds (by companies and governments)

The Securities and Exchange Commission (SEC) is the apex regulatory institution of the Nigerian capital market and is charged among other things with the responsibility of approving the price at which securities of all companies quoted on the stock market are to be listed. The principal objective of vesting this role on the SEC is to protect the generality of the investing public who are unsophisticated and therefore cannot understand the nature and operation of companies sufficiently to be able to appropriate value on their securities.

Economic analysts have discovered a number of factors affecting stock prices on the stock market. Among the factors affecting stock prices are:

Dividend policy of a company

Corporate earnings and

Volume of equity traded.

There has been a long standing controversy in academic circles as to which has greater impact/ influence on security prices. The dividend payment ratio is a major aspect of the dividend policy of the firm, which affects the value of the firm to the stock holders. The classical school of thought holds this view and they believe that dividends are paid to influence their share prices and furthermore, they believe that market price of an equity is a representation of the present value of estimated cash dividends that can be generated by the equity. The new classical schools of thought on the other hand, believe that the price of equity is a function of the earnings of the company. They believe that dividend payout is in no way relevant to evaluating the worth of an equity. What matters, they said is earnings.

Retained earnings provide funds to finance the firms long – term growth. It is the most significant source of financing a firm’s investment. Dividends on the other hand are paid in cash, thus the distribution of earnings utilizes the available cash of the company. When the firm increases the retained portion of net earnings, shareholders’ current income in the form of dividends decreases, but the use of retained earnings to finance profitable investments is expected to increase future earnings on the other hand, when dividends are increased, shareholders current income will increase but the firm may be unable to retain earnings and thus relinquish possible investment opportunities and thus future earnings.

Management therefore is in a dilemma to device a dividend and retention policy that divides the corporate earnings into dividend and retained earnings in an optimum manner to achieve the objective of maximizing the wealth of shareholders. The interrelation of these decisions and the impact/effect they have on equity share prices in the Nigerian capital market is the focus of this paper.

Attempts will also be made to explain movement of stock prices through a third approach known as “Efficient Market Hypothesis”. This hypothesis seeks to explain that security prices adjust to new information released to the market. Taking into consideration the basic assumption that the market is very rapidly processed so that securities are properly priced at a given time. An important premise of an efficient market is that a large number of profit maximizing participants are concerned with the analysis and valuation of securities. The hypothesis assumes that no stock price can be in disequilibrium or improperly priced for a very long time. There is almost instantaneous adjustment to new information. The hypothesis applies most directly to large firms trading on the major security exchange. It further assumes that information travels in a random, independent fashion and that prices are an unbiased reflection of all currently available information.

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