Analysis and Contrast of Dividend Policies of Indian Companies

Analysis and Contrast of dividend Policies of Indian Companies

Chapter 1


1.1 Introduction

The Sub-continent has become the prime target for foreign direct investment. India ranks 6th among the top 10 countries for Foreign direct investment. Although not in the front line, it has become an attractive destination for foreign investment. India’s economic policies are tailored to attract substantial capital inflows and to sustain such inflows of capital. Policy initiatives taken over a period of years have resulted in significant capital inflows of foreign investment in all areas of economy including the public sector. This paper analysis the structure of economic reforms during the pre- independence and post independence era in the context of growth of foreign direct investment and the risks posed by the political, economic and social conditions for foreign investors. Essentially, this research seeks to analyze and understand the economics and politics of India’s progressive integration with the global economy.

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Prior to understanding the economic progress of India, it is vital to first identify the current economic status of India so that it is easy to retrace the process leading to the current status. India presently enjoys the status of an attractive emerging market. However, this status has been the result of numerous economic reforms adopted over the years. India intent to open its markets to foreign investment can be traced back to the economic reforms adopted during two prime periods- pre- independence and post independence.

Pre- independence, industrialised economies of India was the supplier of foodstuff and raw materials to the of the world and was the exporter of finished products- the economy lacked the skill and means to convert raw materials to finished products.Post independence with the advent of economic planning and reforms in 1951, the traditional role played changes and there was remarkable economic growth and development. International trade grew with the establishment of the WTO. India is now a part of the global economy. Outside world is now linked with india either through direct involvement in international trade or through direct linkages with export and economic transaction.

Consequently economic reforms were introduced initially on a moderate scale and controls on industries were substantially reduced by 1985 industrial policy. This set the trend for more innovative economic reforms and they got a boost with the announcement of the landmark economic reforms in 1991. After nearly five decades of insulation from world markets, state controls and slow growth, India in 1991 embarked on an accelerated process of liberalization. The 1991 reforms ensured that the way for India to progress will be through globalization, privatisation, and liberalisation. In this new regime, the government is now assuming the role of facilitator and catalyst agent instead of the regulator and controller of economic activities.

India has a number of advantages which make it an attractive market for foreign capital namely, political stability in democratic polity, steady and sustained economic growth and development, significantly huge domestic market, access to skilled and technical manpower at competitive rates, fairly well developed infrastructure. FDI has attained the status of being of global importance because of its beneficial use as an instrument for global economic integration.








Now the market is further divided into PRIMARY MARKET and SECONDARY MARKET.


Deals with the new issues of securities.


Deals with outstanding securities.

Also known as “STOCK MARKET”.












Stock exchanges



Depositories and their participants

Securities and Exchange Board of India (SEBI)


Stock market indices are the indicators of the stock market.

Some of the market indices types are BSE SENSEX, NSE-50 etc.

Their usefulness:

Board trends of the market can be recognize by indices.

The funds are rationally allocated by the investors among stock by using indices.

Future market can be predict by analyst using indices.

The general economy report can be made on the basis of indices.


Possible reasons for the increment and decrement of rising prices:

Company News.

Country News.

Foreign Exchange rate .

Depends upon the market forces i.e demand and supply of stock.

1.4 Research Aims

The primary aim of this research is to develop an elaborate discussion on how Stock market works and to give the main concepts of Stock market and give the technical analysis of Indian stock market and shares.

1.5 Research Objectives

The following will be the objectives of the study:

1) To describe the Trends of Stock market of India,

2) To identify the Stock behaviour at various time slots,

3) To examine and analyse strategies adopted to make money in Stock market,

4) To identify the role of market activities on economy,

1.6 Research Questions

The following are the research questions of the study:

1). How many Exchanges are there in India?

2). what is an Index & How does one execute an order?

3).Why Stock market is so volatile?

4). Computation of Stock Index?

5). Shareholder Protection and Stock Market Development?

1.7 A selective review of the literature

There has been considerable research that seeks to identify the determinants of corporate Dividend policy. One branch of this literature has focused on an agency-related rationale for paying dividends. It is based on the idea that monitoring of the firm and its management is helpful in reducing agency conflicts and in convincing the market that the managers are not in a position to abuse their position. Some shareholders may be monitoring manage rs, but the problem of collective action results in too little monitoring taking place. Thus Easterbrook (1984) suggests that one way of solving this problem is by increasing the payout ratio. When the firm increases its dividend payment, assuming it wishes to proceed with planned investment, it is forced to go to the capital market to raise additional finance. This induces monitoring by potential investors of the firm and its management, thus reducing agency problems. Rozeff (1982) develops a model that underpins this theory, called the cost minimisation model. The model combines the transaction costs that may be controlled by limiting the payout ratio, with the agency costs that may be controlled by raising the payout ratio. The central idea on which the model rests is that the optimal payout ratio is at the level where the sum of these two types of costs is minimized.

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Thus Rozeff’s cost minimisation model is a regression of the firm target payout ratio on five variables that proxy for agency and transaction costs. Transaction costs in the model are represented by three variables that proxy for the firm’s historic and predicted growth rates and risk. High growth and high risk imply greater dependency on external finance due to investment needs, and in order to honor financial obligations, respectively. This, in turn, means, that the firm raises external finance more frequently, hence bears higher transaction costs that are associated with raising external finance. The model captures agency costs with two proxies. First, the fraction of the firm owned by insiders is a proxy for insider ownership and is expected to be negatively related to the target payout ratio. As insiders hold more of a firm’s equity, the need to monitor their actions is reduced because the incentive for managers to misuse corporate resources falls. Second, the natural logarithm of the number of outside shareholders is a proxy for ownership dispersion. It is expected to be positively related to the target payout ratio because the greater the dispersion, the more severe is the collective action problem of monitoring. Indeed results from an Ordinary Least Squares (OLSQ) cross sectional regression using 1981 data on 1000 US firms, support the theory put forward. Thus the model provides good fit and consequently has attracted the attention of subsequent studies.

Llyod, Jahera and Page (1985) is one of the first studies to modify Rozeff’s cost

minimisation model by adding a size variable. An OLSQ cross sectional regression is applied to 1984 data on 957 US firms, and the results provide support for the cost

minimisation model and show that firm size is an important explanatory variable. Likewise Schooley and Barney (1994) add a squared measure for insider ownership, arguing that the relationship between dividend and insider ownership may be non-monotonic. Indeed the results from an OLSQ cross sectional regression, using 1980 data on 235 industrial US firms, provide further support for Rozeff’s model in general and for the hypothesis put forward in particular.

More support and further contribution to the agency theory of dividend debate, is provided by Moh’d, Perry and Rimbey (1995). These authors introduce a number of modifications to the cost minimisation model including industry dummies, institutional holdings and a lagged dependent variable to the RHS of the equation to address possible dynamics. The results of a Weighted Least Squares regression, employing panel data on 341 US firms over 18 years from 1972 to 1989 support the view that the dividend process is of a dynamic nature. The estimated coefficient on the institutional ownership variable is positive and significant, which is in line with tax explanations but contradicts the idea about the monitoring function of institutions.

Holder, Langrehr and Hexter (1998) extend the cost minimisation model further by considering conflicts between the firm and its non-equity stakeholders and by introducing free cash flow as an additional agency variable. The study utilises panel data on 477 US firms each with 8 years of observations, from 1983 to 1990. The results show a positive relation between the dependent variable and the free cash flow variable, which is consistent with Jensen (1986). Likewise the estimated coefficient on the stakeholder theory variable is shown to be significant and negative as predicted. The estimated coefficients on all the other explanatory variables are also shown to be statistically significant and to bear the hypothesized signs.

Hansen, Kumar and Shome (1994) also take a broader view of what constitutes agency costs, and applies a variant of the cost minimisation model to the regulated electric utility industry. The prediction is that the agency rationale for dividend should be particularly applicable in the case of regulated firms because agency costs in these firms extend to conflicts of interests between shareholders and regulators. Results of cross sectional OLSQ regression for a sample of 81 US utilities and for the period ending 1985 support the cost minimisation model and the contribution of regulation to agency conflicts in the firm.

Another innovative approach to Rozeff’s cost minimisation model is offered in Rao and White (1994) who apply it to 66 private US firms. Using a limited dependent variable,

Maximum Likelihood (ML) technique, the study shows that an agency rationale for dividends applies even to private firms that do not participate in the capital market. The authors note that perhaps by paying dividends, private firms can still induce monitoring by bankers, Accountants and tax authorities.

To summarize, the agency theory of dividend in general, and the cost minimization model in particular, appear to offer a good description of how dividend policies are determined. The variables in the original cost minimisation model remain significant with consistently signed estimated coefficients, across the other six models reviewed above.

Specifically, the constant is, without exception, positively related to the dividend policy decision, while the agency costs variable, the fraction of insider ownership, is consistently negatively related to the firms’ dividend policy. The latter is with exception of the study by Schooley and Barney (1994) where the relationship is found to be of a parabolic nature.

Similarly, the agency cost variable, ownership dispersion, is consistently positively related to the firm’s dividend policy, while the transaction cost variable, risk, is consistently negatively related to the firm’s dividend policy regardless of the precise proxy used. The other transaction cost proxies, the growth variables, are also mainly significant and negatively related to the firm’s dividend policy, although past growth appears to be a less stable measure than future growth.

However, in spite of the apparent goodness of fit of the cost minimisation model to

US data, its applicability to the Indian case may be challenged. Indeed, Samuel (1996)

hypothesises that agency problems are less severe in India compared with the US. In contrast, it may be argued that some aspects of the Indian economy imply a particular suitability of the agency theory, and of the cost minimisation model, to this economy.

Notably, as explained in Haque (1999), many developing countries, including India,established state-centred regimes following their independence. These regimes drew their ideology from socialist and Soviet ideas and were accompanied by highly centralized economic policies, which may increase agency costs in at least three ways as follows.

First, such policies may increase managers’ agency behavior per se. Indeed Joshi and Little (1997) note that when domestic firms enjoy subsidies or a policy of protectionism, the pressure on managers to become more efficient is relaxed. Second, high state intervention means an extension of agency problems to shareholder-administrator conflicts.

Indeed, Hansen, Kumar and Shome (1994) show that the degree of industry regulation enters the dividend policy decision. Third, to the extent that management of the economy is based on social philosophies of protecting the weaker sectors such as employees or poorer customers, this may influence managers to consider the interests of non-equity stakeholders.

This implies that stakeholder theory should be particularly relevant to the Indian case, and, as shown by Holder, Langrehr and Hexter (1998) this may lead to a downward pressure on dividend levels. However, the relevance of stakeholder theory to the Indian case also implies enlargement of agency problems to conflicts of interests among capital holders and other shareholders, increasing the need for shareholders to monitor management behaviour.

It is thus the case that on the one hand stands the prediction by Samuel (1996) that agency costs should be lower in the Indian business environment. This implies that the agency rationale for dividends should be less applicable in the case of India. To contrast this, the agency rationale for dividends is predicted to become particularly applicable to India, due to the extension of agency conflicts on at least three accounts as explained above. An empirical procedure is the natural way to settle these differences and it is to this task that we now turn.

1.8 Overview of the Dissertation

Chapter 1 is a general summary and a brief introduction of the study. It mapped out the research aims, research objectives and research questions. It also suggests topics for complementing research, and an overview of the dissertation. Chapter 2 will be the review of the related literature that will put the study in context with the research aims. It will proceed with addressing the research objectives, thereby meeting the research aims. Chapter 3 will present a detailed picture of the methodology. Chapter 4 will expound on the discussions of the study and the final chapter shall present the conclusions and recommendations of the study.

1.9 Conclusion

The study develops an elaborate discussion on how to effectively be in the Stock market and a brief discussion on Stock market of India such that results favourable to it will commence using empirical data from secondary documents.

Chapter 2

Dividend behaviour of Indian firms after share split


As we have to discussed in this section about the dividend behaviour so it can be discussed,dividend policy remains a source of prolonged public disagreement despite years of theoretical and practical research, one aspect of dividend policy is the link between dividend policy and stock price risk . Risk can be reduced by paying large dividends (Golin 1986) and is a proxy for the later on earnings (Basken, 1990). Many theoretical mechanisms have been given advice that cause dividend policy and payout rolls to vary directly with common stock volatility. These are the effect of duration, effect of rate of return , pricing effect and information effect. Duration effect complies that high dividend rolls give more near the amount of money being transferred. If dividend policy is stably high dividend stocks will have a shorter time. Gordon john Model can be used to suggest so that high-dividend will be less intensive to Rise and fall irregularly in number or amount in discount rates and thus ought to show higher price volatility.

Now we can also take a look on some agency type reports being played in stock market agency cost argument, as developed by Johnson and Micken (1970), that is payment of dividends people motivates managers to remove sediment cash which is invested below at the cost of capital or waste on it on organizational capabilities (Roeff, 1991 and Eastrbrook 1990). Many authors have pressure the importance of facts content of dividend (Daneial and Thomsan, 1989; Bern, Mosey 1989). Diller and Reck (1986) suggested that dividend announces provide the missing cuts of

Facts and figures about the firm and allows the market to tell about the firm’s current savings. Investors may have greater trust on that reported earnings reflect economic profits and loss statements when announcements are as a companion or escort by sample dividends. If investors are more certain in their suggestion, they may ereact less to questionable sources of facts and figures and their main theme value may be insulated from irrational development, or behaviour.

The best discussion be made on this topic can be emphasized as rate and effect of market rate of return effect, as discussed by Gordin (1967), is that a firm with low payroll and high dividend interest may tend to be valued more in terms of future investment chances (Dinldson, 1965). As a result, its stock price may be more intensive to changing rates of return over rare time intervals. Exhibit price stability thus expanding firms although may have lower payout ratio and dividend yield. This may be because dividend yields and payroll ratio serves as proxy for the amount of projected growth opportunities. If forecasts of profits and loss from growth chances are less reliable than forecasts of returns on assets in place, firms with low payout and low dividend yield may have greater price volatility. This study seeks to examine the volatility of the spot market due to the derivatives market. Whether the volatility of the spot market has increased,decreased or remained the same. If increased then, what extent it is due to futures market. We use Autoregressive framework to model returns volatility. To measure

volatility in the markets, the VIX (Volatility Index) computed by the National Stock

Exchange is used. To eliminate the effect of factors other than stock index futures

(i.e., the macroeconomic factors) determining the changes in volatility in the post

derivative period, the model is used for estimation after adjusting the stock return

equation for market factors.

Volatility Index is a major tool of measuring market’s expectation of volatility over the next term.Volatility is often described as the “rate and magnitude of changes in prices” and in stock often suggest to as risk. Volatility Index is a measure, of the amount by which an Index is expected to change over the time, in the next term, (calculated as analyzed volatility, denoted in percentage e.g. 40%) based on the order book of the index options. Fama (1992) and Fames and French (1995) focus on dividends and other cash flow variables such as accounting earnings, investment, industrial production etc to explain stock returns. Baskin (1989) takes a slightly different approach and examines the influence of dividend policy on stock price volatility, as opposed to returns. The difficulty in any empirical work examining the linkage between dividend policy and stock volatility or returns lies in the setting up of adequate controls for the other factors. Baskin (1989) suggests the use of the following control variables in testing the significance of the relationship between dividend yield and price volatility: operating earnings, size of the firm, level of debt financing, payout ratio and level of growth. These variables have a clear impact on stock returns but also impact on dividend yield.

Karachi Stock Exchange (KSE) is an important emerging market of the region among the developing countries. KSE is termed as high-risk high return market where investors seek high-risk premium (Nishat, 1999). Few studies have attempted to analyse the long run behaviour of the market and related issues (Nishat, 1991, 1992 1995, 1999, 2001; Nishat and Bilgrami, 1994) but no work has been done to explore role of dividend yield and payout ratio in affecting the share prices. It is also important to study its role in the Pakistani context after the introduction of reforms during 1990s, which emphasized more towards openness to foreign investor, and competition, which led to, increased volatility in the market (Nishat, 1999) and has reduced the responsiveness of share price volatility to fundamental factors (Irfan and Nishat. 2003). Reforms in Pakistan in general and specific to dividend policy are; tax sealing on cash dividend, exemption of right and bonus shares from tax, pattern shifting from cash to share dividend and government policy of easing restrictions on transfer of market profits etc. The objective of this study is to find the role of dividend policy measures i.e. dividend yield and payout ratio on share price changes in the long run. It also attempts to assess the pattern of relationship during pre reform (1981-1990) and reform (1991-2000) periods.


2.2(a) Control variables:

Share price volatility should be related to the basic risks encountered in the firm’s product markets. Market risk may also have impact on the firm’s dividend policy. We therefore include a control variable to account for the variability in the firm’s earnings stream. Volatility Index is a good indicator of the investors’ behaviour on how markets are expected to be changed in the next term. Usually, during periods of market volatility, market moves steeply up or down

and the volatility index tends to rise. As volatility subsides, option prices tend to

decline, which in turn causes volatility index to decline. The market in the stocks of small listed firms could conceivably be less informed, more illiquid, and as a consequence subject to greater price volatility. Baskin (1989) suggests that firms with a more dispersed body of shareholders may be more disposed towards using dividend policy as a signaling device. The latter may also be a function of size and thus a size control was required.

A value of 2 indicates there appears to be no autocorrelation. Small values of d indicate successive error terms are, on average, close in value to one another, or positively correlated .It is also possible that systematic differences in market conditions, cost structures, regulatory restrictions etc. May lead to differences in dividend policy. These also have impact on price volatility.

2.2(b) Variable definition

Price volatility (PV)

The policy of central planning adopted by the government sought to ensure that the government laid down marked goals to be achieved by the economy thereby establishing a regime of checks and balances. The government also encouraged self sufficiency with the intent to encourage the domestic industries and enterprises, thereby reducing the dependence on foreign trade. Although, initially these policies were extremely successful as the economy did have a steady economic growth and development, they weren’t sustained. These average measures of variance for all available years can be transformed to a standard deviation by using a square root transformation. Parkinson (1980) describes how this method is far superior to the traditional method of estimation, which uses closing and opening prices only.

2.2(c) Dividend yield (DY)

The variable was calculated by summing all the annual cash dividends paid to common stock holders and then dividing this sum by the average market value of the stock in the year. The government approached the World Bank and the IMF for funding. In keeping with their policies there was expectation of devaluation of the rupee. This lead to a lack of confidence in the investors and foreign exchange reserves declined.

2.2(d) Earning volatility (EV)

In order to develop this variable, the first step is to obtain an average of available years of the ratio of operating earnings (before taxes and interest) to total assets. In order to compare the shocks to US markets over countries and the sample period, it is

necessary to impart shocks of the “same magnitude”. Since financial markets are volatile, it

would be misleading to compare shocks of the same nominal magnitude across different

periods of time. Thus, the responses of the Asian markets have been tracked to a one standard

deviation shock in the US variable.

2.2(e) Payout Ratio (POR)

To begin, total cumulative individual company earnings and dividends were calculated for all years. Payout is the ratio of total dividends to total earnings. The use of this procedure controls the problem of extreme values in individual years attributable to low or possibly negative net income. The payout ratio is set to one in cases where a total dividend exceeds total cumulative profits.

2.2(f) Size (SZ)

The variable size was constructed in a form that reflects the order of magnitude in real terms. The variable was constructed by taking the average market value of common stocks. The value of real size (Rs. million) was averaged over the period

2.2(g) Long-term Debt (DA)

The ratio of the sum of all the long-term debt (debt with maturity more than a year) to total assets is taken. An average is taken over all available years.

2.2(h) Growth in Assets (ASg)

The yearly growth rate was calculated by taking the ratio of the change in total assets in a year. Then the ratio was averaged over the years.

2.3 Conclusion

In this chapter Present day India enjoys the status of an emerging market. Skilled and managerial labor and technical man-power are such as that they match the best available in the world. A combination of these factors contributes to India having a distinct and a cutting edge in the globe. India has been termed as the ‘stealth’ miracle economy of the new millennium. We observe a common pattern of triggered by changes in the market and technological environment. Changes adopts in the form of innovation, avoidance and of regulation.


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