SIGNALING EFFECT OF DIVIDEND DECISION ON THE MARKET PRICE OF SELECT LISTED COMPANIES THESIS DOCTOR OF PHILOSOPHY IN BUSINESS ADMINISTRATION

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1 SIGNALING EFFECT OF DIVIDEND DECISION ON THE MARKET PRICE OF SELECT LISTED COMPANIES THESIS SUBMITTED TO THE UNIVERSITY OF LUCKNOW FOR THE AWARD OF THE DEGREE OF DOCTOR OF PHILOSOPHY IN BUSINESS ADMINISTRATION SUBMITTED BY: VIJAY SHANKAR PANDEY Under the Supervision of Prof. J. K. SHARMA DEPARTMENT OF BUSINESS ADMINISTRATION UNIVERSITY OF LUCKNOW LUCKNOW 2015

2 DEPARTMENT OF BUSINESS ADMINISTRATION UNIVERSITY OF LUCKNOW Declaration I declare that this thesis titled Signaling Effect of Dividend Decision on the Market Price of Select listed Companies is my genuine and original work. It is being submitted in fulfilment for the award of Doctor of Philosophy in Business Administration, University of Lucknow. It is further declared that this thesis has not been submitted earlier for the award of any degree of diploma in this or any other university or any other institute. All the sources referred to in this dissertation have been duly cited. However, in pursuance of this research, two papers namely Dividend Signalling And Market Efficiency In Emerging Economy: A Study of Indian Stock Market published in International Journal of Finance & Accounting Studies ISSN and Effect of Dividend Initiation and Omission on Share Prices in Indian Stock Market presented and published in Advances in Economics and Business management (AEBM) print ISSN: ; Online ISSN: are associated with the topic of this Ph.D. thesis. Dated: Feb, 2015 Lucknow Countersigned Vijay Shankar Pandey Research Scholar This is to certify that the above declaration by the candidate is true to the best of my knowledge. Prof. J. K. Sharma Dated: Lucknow (Supervisor) i

3 Certificate This is to certify that thesis entitled Signaling Effect of Dividend Decision on the Market Price of Select listed Companies being submitted by Vijay Shankar Pandey for the award of degree of Doctor of Philosophy is a record of bonafide research carried out by him. He has worked under my guidance and supervision for submission of this thesis, which to my knowledge has reached the requisite standard. To the best of my knowledge, this thesis or any part thereof has not been submitted to any other university or Institution for the award of any degree. Date Place: Lucknow Prof. (Dr.) J. K. Sharma Department of Business Administration University of Lucknow, Lucknow ii

4 Acknowledgement This work is the outcome of constant thoughts and discussions with my research supervisor Professor J. K Sharma Sir, who evoked positivity and inspired me to work in the right direction to complete this work. It is privilege for me to be a student supervised by him. I am highly obliged and thankful for his contribution of time, ideas and dedication, to make my Ph. D experience stimulating and productive. The joy and enthusiasm endeavoured in me by his working style, made the long association with him a short journey. I am always indebted not only for his supervision of thesis work but also for taking care of me as his own son. I am also grateful to Professor Poonam Sharma Ma am, (Mathematics Department, University of Lucknow, Lucknow) who is a constant inspirational source for me by her dedication, humbleness, nurturing behaviour and continuous guidance to me. Her careful act towards me is not anything less than that of my own mother. This study would not have taken its present form without the support of teachers in the Faculty of Commerce particularly the teachers of the Department of Business Administration. I am very gratitude to Prof. Arvind Kumar (Dean, Faculty of Commerce), Mr. Sanjay Medhavi (Head, Department of Business Administration) Dr. Ritu Narang, Dr. Ajay Prakash, Mr. Rajeev Saxena, Dr. S. K. Kaushal, Dr. Mohd. Aneesh Dr. Nishant Kumar and Dr. Anu Kohli for their support and guidance to complete this thesis. I also grateful to all the staff members of the Faculty of Commerce especially staff members of Department of Business Administration for their support in completing this work. I am highly obliged to all the library and computer laboratory staff of IIM Lucknow, for their support in the collection of data through CMIE data base Prowess and literature. I am also very thankful to all my cliques, seniors and juniors who supported me to complete this work. I am also expressing a very humble gratitude to my late grandparents, parents, brothers and sisters and all my relatives for their continuous inspiration and encouragement in the direction of completing this thesis.i show my gratitude to all other peoples who I could not mentioned personally for helping me directly or indirectly in the completion of this thesis work. Last but not the least I bow my head to the ALL MIGHTY who has shown me the path, built patience in me and encouraged me when I was nervous in the my journey to reach this place. Vijay Shankar Pandey iii

5 CONTENTS Chapter No. Particulars Page No. 1 INTRODUCTION Introduction and Genesis of the Research Idea Aim and Objectives Research Methodology Procedure for Sample Selection Categorization of Events Hypothesis Data Collection Analytical tools For Event Study : GARCH Model Organization of the Study 5 2 LITERATURE REVIEW Introduction Dividend Signaling Theories 9 Bhattacharya s View on Dividend Signaling (1979) Miller and Rock s View on Dividend Signaling (1985) John and William s View on Dividend Signaling (1985) Recent Researches on Informational Content of Dividend Decision Information Asymmetry and Dividend Policy Dividend Announcement and Future earnings Dividend Announcement and Share Price Dividend and Stock Price in Emerging Markets Conclusion 43 3 RESEARCH METHDOLOGY Aims and Objective of Research Sample Selection Events Selection Event Window Selection Formulation of Hypothesis Event : Dividend Decision along with declaration 65 of financial results Event : Standalone dividend alone announcement Event : Dividend initiation Event : Dividend Omission iv

6 3.4 Data Collection Analytical tools For Event Study: GARCH Model Hypothesis Testing Tools 68 4 EVENT STUDY ANALYSIS OF DIVIDEND DECISIONS Event Dividend Increase/Decrease announcements 70 along with financial Results Event: Dividend Increase/Decrease Announcement 70 of 10 per cent along with Financial Results Event: Dividend Increase/Decrease Announcement 75 of 15 per cent along with Financial Results Event: Dividend Increase/Decrease Announcement 80 of 20 per cent along with Financial Results Event: Dividend Increase/Decrease Announcement 85 of 25 per cent along with Financial Results Event: Dividend Increase/Decrease Announcement of 50 per cent or more along with Financial Results 4.2 Event: Dividend Increase/Decrease announcement Event: Dividend Increase/Decrease announcement 96 of 10 per cent Event: Dividend Increase/Decrease announcement 99 of 15 per cent Event: Dividend Increase/Decrease announcement 102 of 20 per cent Event: Dividend Increase/Decrease announcement 106 of 25 per cent Event: Dividend Increase/Decrease announcement 110 of 50 per cent or more 4.3 Event: Dividend Initiation/Omission 114 Announcement 4.4 Analysis of 10-day Mean CAAR values for 119 dividend related events 10-Days Mean CAAR Values for Event Dividend Increase / Decrease of 10 per cent along with Financial Results 10-Days Mean CAAR Values for Event Dividend Increase / Decrease of 15 per cent along with Financial Results 10-Days Mean CAAR Values for Event Dividend Increase / Decrease of 20 per cent along with Financial Results Days Mean CAAR Values for Event Dividend 125 v

7 Increase / Decrease of 25 per cent along with Financial Results 10- Days Mean CAAR Values for Event Dividend Increase / Decrease of 50 per cent or more along with Financial Results Analysis of 10-day Mean CAAR for dividend increase /decrease 10-Days Mean CAAR Values for Event Dividend Increase / Decrease of 10 per cent 10-Days Mean CAAR Values for Event Dividend Increase / Decrease of 15 per cent 10-Days Mean CAAR Values for Event Dividend Increase / Decrease of 20 per cent 10-Days Mean CAAR Values for Event Dividend Increase / Decrease of 25 per cent 10-Days Mean CAAR Values for Event Dividend Increase / Decrease of 50 per cent or more 10-Days Mean CAAR Values for Event Dividend Initiation/Omission Announcement 5 FINDINGS AND DISCUSSIONS Findings Event dividend Increase/decrease along with announcement of financial results Dividend increase event along with announcement 140 of financial results Dividend decrease event along with announcement 142 of financial results Event Dividend Increase/Decrease announcement Event Dividend Increase Announcement Dividend Decrease Announcement Events Event Dividend Initiation/Omission 149 Announcement 6 CONCLUSIONS, POLICY IMPLICATIONS AND FUTURE RESEARCH DIRECTIONS vi Conclusions Signaling effect 153 Pronounced period of CAAR reflecting inefficiency in the Indian Stock market Empirical support to findings from other studies Level of Corporate Governance and market 158

8 efficiency in emerging economies 6.2 Policy implications Implications for corporates Regulatory Bodies Investors Limitations and directions for future research 162 REFERENCES APPENDICES vii

9 LIST OF TABLES Sr. No. Table No. Title of the Table Page No Summarization of Literature Review: Existing Stock Exchanges in India Summarizes stepwise sample selection procedure of companies Category wise- break-up of Selected Companies based on respective market capitalization Industry wise Classification of the selected companies and proportionate representation of industry to overall selected companies Total Events in the Period of 1 April 2001 to 31 March 2011 and the final event selected for the 56 study; Shows the number of different types of dividend 62 related events for the selected 103 companies. Number of isolated dividend events in the window period of 61 days Capitalization based percentage changes in 64 dividends Summarization of Proposed Hypotheses Details of dividend events analysed Test of hypotheses at 5 % level of significance for 10% dividend change announcement along with financial results Positive and Pronounced periods of significant CAAR values at 5% level of significance during sixty- one day event period for the event 10 per cent change in dividend along with financial results Test of hypotheses at 5 % significance level for 15% dividend change announcement along with financial results Pronounced periods of significant CAAR values at 5% level of significance during sixty- one day viii

10 event period for the event 15 per cent change in dividend along with financial results Test of hypotheses at 5 % significance level for 20% dividend change announcement along with financial results Pronounced periods of significant CAAR values at 5% level of significance during sixty- one day event period for the event 20 per cent change in dividend along with financial results Test of hypotheses at 5 % significance level for 25% dividend change announcement along with financial results Pronounced periods of significant CAAR values at 5% level of significance during sixty- one day event period for the event 25 per cent change in dividend along with financial results Test of hypotheses at 5 % significance level for 50% dividend change announcement along with financial results: Pronounced periods of significant CAAR values at 5% level of significance during sixty- one day event period for the event 50 per cent change in dividend along with financial results Test of hypotheses at 5 % significance level for 10% dividend change announcement Pronounced periods of significant CAAR values at 5% level of significance during sixty- one day event period for the event 10 per cent change in dividend Test of hypotheses at 5 % significance level for 15% dividend alone change announcement: Pronounced periods of significant CAAR values at 5% level of significant during sixty- one day event period for the event 15 per cent change in dividend alone Test of hypotheses at 5 % significance level for 20% dividend alone change announcement: Pronounced periods of significant CAAR values at 5% level of significance during sixty- one day event period for the event 20 per cent change in dividend alone ix

11 Test of hypotheses at 5 % significance level for % dividend alone change announcement Pronounced periods of significant CAAR values at 5% level of significance during sixty- one day 109 event period for the event 25 per cent change in dividend alone Test of hypotheses at 5 % significance level for % dividend change announcement Pronounced periods of significant CAAR values at 5% level of significance during sixty- one day 113 event period for the event 50 per cent change in dividend Test of hypotheses at 5 % significance level for event dividend initiation/omission announcement Pronounced periods of significant CAAR values at 5% level of significance during sixty- one day event period for the event dividend initiation/ omission The analysis of different rates of dividend changes made simultaneously with declaration of financial results by large cap, mid-cap and small cap companies respectively in the sample based on daily ARR and CAAR movements as well as 10- day mean CAAR trends The analysis of different rates of dividend changes made by large cap, mid-cap and small cap companies in the sample based on daily ARR and CAAR movements as well as 10 day mean CAAR trends The analysis of different rates of initiation and omission made by large cap, mid-cap and small cap companies in the sample based on daily ARR and CAAR movements as well as 10 day mean CAAR trends x

12 LIST OF FIGURES Sr. Figure No. No Panel Title of the Figure Event Window and Duration of Event Number of Different type of Dividend Related Events: Number of Isolated Dividend Events in the Window Period of 61 Days Figure of calculated AAR and CAAR values for the event dividend increase/decrease announcement of 10 per cent along with financial results. Page No Panel 4.2 Figure of calculated AAR and CAAR values for the event dividend increase/decrease announcement of 15 per cent along with financial results 76 6 Panel 4.3 Figure of calculated AAR and CAAR values for the event dividend increase/decrease announcement of 20 per cent along with financial results Panel 4.4 Figure of calculated AAR and CAAR values for the event dividend increase/decrease announcement of 25 per cent along with financial results 86 8 Panel 4.5 Figure of calculated AAR and CAAR values for the event dividend increase/decrease announcement of 50 per cent along with financial results Panel 4.6 Panel 4.7 Figure of calculated AAR and CAAR values for the event dividend increase/decrease announcement of 10 per cent. Figure of calculated AAR and CAAR values for the event dividend increase/decrease announcement of 15 per cent alone xi

13 11 12 Panel 4.8 Panel 4.9 Figure of calculated AAR and CAAR values for the event dividend increase/decrease announcement of 20 per cent. Figure of calculated AAR and CAAR values for the event dividend increase/decrease announcement of 25 per cent alone Panel 4.10 Panel 4.11 Figure of calculated AAR and CAAR values for the event dividend increase/decrease announcement of 50 per cent or more Figure of calculated AAR and CAAR values for the events dividend Initiation and Omission announcement Panel 4.12 Panel 4.13 Figure of calculated 10 days mean CAAR values for the event dividend increase/decrease announcement of 10 per cent along with financial Figure of calculated 10 days mean CAAR values for the event dividend increase/decrease announcement of 15 per cent along with financial results Panel 4.14 Figure of calculated 10 days mean CAAR values for the event dividend increase/decrease announcement of 20 per cent along with financial results Panel 4.15 Figure of calculated 10 days mean CAAR values for the event dividend increase/decrease announcement of 25 per cent along with financial results Panel 4.16 Panel 4.17 Panel 4.18 Figure of calculated 10-days mean CAAR values for the event dividend increase/decrease announcement of 50 per cent or more along with financial results. Figure of calculated 10-days mean CAAR values for the event dividend increase/decrease announcement of 10 per cent alone. Figure of calculated 10-days mean CAAR for the event dividend increase/decrease announcement of 15 per cent xii

14 22 23 Panel 4.19 Panel 4.20 Figure of calculated 10-days mean CAAR values for the event dividend increase/decrease announcement of 20 per cent Figure of calculated 10-days mean CAAR values for the event dividend increase/decrease announcement of 25 per cent Panel 4.21 Panel 4.22 Figure of calculated 10-days mean CAAR values for the event dividend increase/decrease announcement of 50 per cent or more. Figure of calculated 10-days mean CAAR values for the events dividend Initiation and Omission announcement xiii

15 Sr. Appendix No. No LIST OF APPENDICES Title of the Appendices The category wise break-up into Large Cap, Mid cap and small cap of these 627 companies Lists of the break up of the 103 selected companies into respective market cap category along with Industry representation Category wise changes in dividends for all the selected companies in Large cap Category wise changes in dividends for all the selected companies in Mid cap Category wise changes in dividends for all the selected companies in Small cap Calculated AAR and CAAR values for the event dividend increase/decrease announcement of 10 per cent along with financial results Calculated AAR and CAAR values for the event dividend increase/decrease announcement of 15 per cent along with financial results Calculated AAR and CAAR values for the event dividend increase/decrease announcement of 20 per cent along with financial results Calculated AAR and CAAR values for the event dividend increase/decrease announcement of 25 per cent along with financial results Page No Calculated AAR and CAAR values for the event dividend increase/decrease announcement of 50 per cent along with financial results Calculated AAR and CAAR values for the event dividend increase/decrease announcement of 10 per cent Calculated AAR and CAAR values for the event dividend increase/decrease xiv

16 announcement of 15 per cent alone Calculated AAR and CAAR values for the event dividend increase/decrease 247 announcement of 20 per cent Calculated AAR and CAAR values for the event dividend increase/decrease 251 announcement of 25 per cent alone Calculated AAR and CAAR values for the event dividend increase/decrease 255 announcement of 50 per cent or more Calculated AAR and CAAR values for the events dividend Initiation and Omission 161 announcement 10-Days Mean CAAR Values for Event 4.12 A, B, 17 Dividend Increase / Decrease along with 267 C Financial Results for Large cap, Mid cap and Small cap companies 4.13 A, B, 10-Days Mean CAAR Values for Event 18 Dividend Increase / Decrease for Large cap, 275 C Mid cap and Small cap companies 10-Days Mean CAAR Values for Event Dividend Initiation / Omission for Large cap, 282 Mid cap and Small cap companies Major scams in Indian Capital/Stock Market Initiative towards Corporate Governance in Indian 286 xv

17 INTRODUCTION CHAPTER 1 INTRODUCTION 1.1 Introduction and Genesis of The Research Idea Corporate finance focuses on decisions aimed at maximization of shareholders wealth. In the long term perspective, the decisions related to investment, financing as well as dividends are expected to create value. One of the measures of value being market capitalization is influenced by share price value attached by the market. The performance, growth prospects, strategic direction and potential for long term sustainable results affects the share prices. The returns to shareholders simply depend upon capital appreciation in the holdings as well as dividends over the period. The changes in market prices reflect the perceived changes in the value of the shares of the company amidst changing environment and in response to make-up of the company including relations with shareholders in terms of dividends as well as additions to market value of shares as an outcome of company s quality of decisions. The market reaction to changes in share prices is affected not only by company s performance and growth potential but also by the nature of market. Markets tend to be driven by the informational content of events in the external environment as well as information communicated by the company through its various decisions. One of the such decisions is the dividend related decision which has been a subject matter of interest for researchers all over the world as to its signalling effect. Existence of differences in signalling effect of dividend related events in different economies of the world characterised by respective nature and level of market efficiency have been observed. Indian stock market has evolved over a period of time to emerge as one of the most prominent ones. India being a prominent emerging economy with a highest 1

18 INTRODUCTION number of transactions amongst all the stock exchanges of the world (World Federation of Exchanges, 2013) thus provides a good example to examine if signalling theory holds and comment upon relative efficiency of the market. 1.2 Aim and Objectives This research primarily aims to study the signalling effect of dividend decisions on the market price of companies listed on stock market in India. Incidental to the study it is necessary to understand whether the efficiency level of the Indian stock market has any role in affecting the changes in share prices due to dividend related events. The companies listed on the stock market are diverse in terms of the industry, market capitalization and performance. They also exhibit different types of dividend decisions viz. cash or stock and indirectly repurchase of shares. The dividend change decisions can be grouped in to various event categories such as dividend omission, initiation, increase or decrease. Accordingly, the following objectives of the study have been formulated: i) To identify and analyze the different types of dividend related events and their signalling effect if any on the share price of listed companies in India. ii) To analyze whether the signalling effect is consistent for all the events or it varies with market capitalization or industry representation of the company. iii) To test the market efficiency of the Indian Stock Market in relation to dividend related announcements. 1.3 Research Methodology Procedure for Sample Selection There are twenty five stock exchanges operating in India. Out of these twenty one operate at regional level and only four are working at national level. Only Bombay 2

19 INTRODUCTION Stock Exchange (BSE), National Stock Exchange (NSE), Over the Counter Stock Exchange (OTC) and Multiple Commodity Index (MCX) are operational at national level. The MCX is trading in commodities and falls within the regulatory purview of Forward Market Commission of India; while OTC is the market for non-listed medium size companies, only BSE (Bombay Stock Exchange) and NSE (National Stock Exchange) deal in majority of the companies listed on the Indian Stock Market. Due to their size in terms of number of listings as well as turnover, BSE and NSE have been considered as representative of. Indian Stock Market for identification of companies and selection of events. The selections of companies in the sample are based on non-probability purposive sampling (Stepwise sampling). Time span of 10 year from financial year to financial year has been taken for the study. The final selection of companies is based on the criteria of regular announcement of dividend and active trading in the stated stock exchanges (e.g. BSE and NSE) during the span of time taken for the study. Listed companies on NSE and BSE exchanges were scanned for such companies which are common to both the exchanges. Amongst the ones which were found to be common, those companies which had at least ten dividend events including interim and final dividend over the ten-year period from Financial year to were identified and categorized into into Large Cap, Mid Cap and Small Cap companies based on their respective market capitalization bases to constitute the sample for event study analysis. The sample constitutes 103 companies and 872 events related to them over a span of 10 year period from FY 2001 to FY Categorization of Events As the study focusses on signaling effect of dividend decisions in the Indian Stock listed companies, the dividends related decisions have been categorized into following broad groups: 1. Dividend alone 2. Dividend along with financial results 3. Dividend along with other events except financial results 3

20 INTRODUCTION 4. Dividend along with financial results and other events In order to perform event study analysis it is necessary to exclude such cases where other events are announced during the window period. The number of isolated dividend related events falling in the window period of 61 days is arrived to be 725 with break-up different types of isolated dividend events such as 152 dividend alone events, 522 dividend along with financial results, 16 dividend and other events except of financial results and 29 of dividend along with financial results and other events Hypothesis: The following hypotheses have been formulated to study the effect of change in dividend on the respective share prices of the selected companies: i. H 0 : There is no relationship between dividend change announcement (both increase or decrease) on the share prices of the Indian Stock market listed companies when dividend announcement is made along with declaration of financial results.. ii. H 0 : There is no relationship between standalone t dividend change announcements on the share prices of the Indian Stock Market listed companies. iii. H 0 : There is no relationship between dividend initiation announcements on the share prices of the Indian Stock Market listed companies. iv. H 0 : There is no relationship between dividend omission announcements on the share prices of the Indian Stock Market listed companies Data Collection: This study used CMIE data base for the collection of data with the help of software called PROWESS. As claimed by organization itself Prowess is a database of the financial performance of Indian companies. Annual Reports of 4

21 INTRODUCTION individual companies are the principal source of this database. The database covers listed and unlisted companies. For listed companies, the database includes data sourced from the stock exchanges. Prowess contains time-series data from onwards. It is updated continuously. Therefore Prowess database has been used for the collection of data for the period of 10 years from FY to FY Data collected from Prowess 3.1 includes dividend rate, dividend announcement date, closing prices of the selected companies for sampled companies Analytical tools For Event Study : GARCH Model To examine the impact of any dividend related event on share price, abnormal returns have been calculated using GARCH (p, q) model as given by Bollerslev (1987). The decision to apply GARCH (p, q) model for the estimation of abnormal return over simple OLS model is based on resolution of concerns regarding autocorrelation and heteroskadasticity in residuals as advocated by Serra (May 2002) and Pynnonen (2005). 1.4 ORGANISATION OF THE STUDY The study has been organised in six chapters. i) Chapter I is Introductory and summarizes the approach related to signaling theory. ii) Comprehensive Literature review related to dividend signaling has been carried out in Chapter II. As there have been large number of studies all over the world pertaining to different markets and having divergent views on signaling, detailed review of dividend theories to understand the theoretical framework and evolving thoughts related to signaling have been studied. Empirical studies on dividend and information asymmetry, relationship between dividend announcement and future earnings and share 5

22 INTRODUCTION iii) iv) prices and dividend related studies particularly pertaining to emerging market economies have been reviewed.. Chapter III is devoted to Research Methodology adopted by the researcher in terms of aims and objective of research, sample selection, events selection, selection of event window, formulation of hypothesis, procedure of data collection, analytical tools for empirical study: Garch Model and hypothesis testing tools. The analysis of testing of hypotheses appears in Chapter IV. Share price reaction to changes in dividends have been analyzed for +/-10%, +/-15%, +/-20%, +/-25% and +/-50% changes both when made along with announcement of financial results or in isolation. These have been done for large cap, mid cap as well as small cap companies separately. In addition, events of dividend initiation as well omission have also been analyzed for the three categories of companies. Apart from testing for signalling effect, pronounced period of CAAR in share price movement have been examined to comment on the nature of Indian Stock market in terms of its efficiency. v) Findings and discussion have been presented in Chapter V to draw inferences about the signaling effect for the respective categories of events on share price movement as well as the relative efficiency of the stock market. vi) Chapter VI is devoted to the conclusions and policy implications for company management, board, regulators as well as investors. 6

23 LITERATURE REVIEW CHAPTER 2 LITERATURE REVIEW 2.1 Introduction The dividend decision is one of the three basic decisions, which a financial manager is required to take, the other two being the investment and financing decisions. The dividend decision is recommended by the Board of Directors at the annual general meeting. The Board of Directors is faced with the challenge of reconciling the need for financing future growth, maintaining adequate liquidity, satisfying the expectations of shareholders. Accordingly the decisions on extent of retention of profits, cash or stock dividend, repurchase of shares from market and the amount as well as timing of dividend are required to be made. Therefore in arriving at an appropriate dividend policy, managers not only look at the current year s profit but also at expected future earnings and the ability of the company to maintain a stable rate of dividend, taking into consideration the systematic growth. The amount of dividend is therefore dependent upon the percentage of profits any company would like to part for distribution to shareholders which in turn is governed by several considerations. Laws in all countries prohibit distribution of dividend out of capital as part of meeting the conditions of maintaining minimum legal capital. The distribution of profits as dividend is also subject to various statutory requirement s to transfer some of the profits as reserves. Similarly, bond indentures or contracts also often prevent companies from increasing the proportion of cash dividend beyond a certain level in order to secure the rights of bondholders (Black and Cox, 1976). Based on above-mentioned accounts, dividend policy has drawn attention of several researchers from time to time. There are several schools of thought in the 7

24 LITERATURE REVIEW area. Miller and Modigliani s (1961), asserted that dividend policy is not important because it has no effect on the value of the firm and thus does not affect a firm owner s wealth. This school assumes that companies follow a residual dividend Policy which is based on reinvestment of profits to avail investment opportunities with a positive net present value (Saxena 1999, Baker 2009, Chen and Dhiensiri 2009) and after that the firms distribute the surplus as a cash dividend to the shareholders. Partington (1985) claimed that in real practice companies do not follow the residual dividend policy as dividend decisions are taken independently from the investment policy. Bhattacharya (1979), John and Williams (1985) and Miller and Rock (1985) have gone through all the dividend related school of thoughts and found a gap in practicing of dividend related policies and its impact on the shareholders. This gap they attribute to asymmetric information and the resulting impact on the shares prices and ultimately on the wealth of shareholders. Thus there seems to be consensus that dividend provide financial signal. The signaling effect of dividend decision depends on many factors of which prominently one is the level of perfection of the market. As markets in different countries are at varying levels of perfection and efficiency, the effect of dividend decision accordingly must be viewed in the context of the specific market. India being in transitory state of financial market and is gradually evolving and getting integrated with global markets, the study of signaling effect on dividend decisions thus assumes importance considering the size of the equity market in India. This chapter confines the review of literature to dividend signaling hypothesis, which considered being as one of the most important aspects in dividend decisions. Therefore, we have covered main aspects related to dividend policy, which starts by brief introduction of the models related to dividend signaling and the relevant empirical works done in this domain from time to time. The empirical work we intent to develop in our thesis, is comprised of sub sections on signaling effect of dividend decision since they directly relate to the purpose of our study. 8

25 LITERATURE REVIEW We conclude this part by inferences from the study of relevant literature related to dividend decisions and signaling impact of dividend decision Dividend Signaling Theories: Miller and Modigliani (1961) hypothesized irrelevancy proposition based on the assumptions of perfect market due to symmetric information available to all interested groups. Based on this assumption everyone have symmetric ability to understand and analyze the available information. Therefore, the investors have the same outlook concern about the company as managers have. They also assumed that investors and managers have the same information and expectations about the company s future growth. But in the imperfect world, available information is asymmetrically distributed among groups (Dewenter and Warther, 1998), so the investors have different expectations and information about company's future profits and risks as compared to managers. Managers have better, accurate information and expectations than external investors regarding the company s profits and performance. Managers use the change in the dividends rate and amount as a way to deliver such information to investors to reduce the information gap between managers and investors, thereby influencing the company s market value and shareholders wealth. Latter Miller and Modigliani (1961) pointed out that to informational content of dividend decision. Investors accordingly are likely to interpret a change in the dividend rate as a change in management s views of future prospects for the firm. Ross, Westerfield and Jaffe (1990) also contend that dividend policy can provide information to stockholders concerning the firm s performance. Thus, market could interpret a change in dividend as an attempt on the part of company to convey information on a firm s future prospects to outsiders. Bhattacharya (1979), John and Williams (1985) and Miller and Rock (1985) developed the models based on the information asymmetry hypothesis and called it signaling theory. They showed that, in a world of imperfection, insiders use dividends as a costly signal to convey their firm s future prospect to less informed 9

26 LITERATURE REVIEW outsiders. Thus, an increase in dividend signals prospects of better future performance, while on the contrary a decrease suggests a worsening of its future prospects. Bhattacharya s (1979) views closely related to the Ross (1977) views. Assuming that outsiders have asymmetric information about a firm s profitability, therefore dividend announcements is a better way of conveying information. Miller and Rock (1985) also suggested that managers have more information than shareholders about a firm s current and future earnings and they transmit this information through dividend announcement. They further argued that firms whose shares react more to the information conveyed to the market, have a stronger information asymmetry. John and Williams (1985) empirically observed positive relationship between profitability and dividend yield is due to both information effect and to taxes. The signaling models of dividends constitute an important understanding the way the dividend announcements convey information about firms to the market, while empirical studies done in this domain allow us to analyze the impact of dividend change announcements on share prices. Signaling models predict a positive correlation between dividend change announcements and share price reactions along with future earning changes Bhattacharya s Views on Dividend signaling (1979): Bhattacharya (1979) developed a model to explaining the motive of firms paying the dividends to its shareholders. He developed a model, in which managers take decisions in the interest of shareholders. The model assumes that at time zero, managers adopt a specific dividend policy; at the end of the period, the firm follows same dividend policy set at time zero to distribute dividend to shareholders. If cash flows generated in the period are not enough to pay the dividends, the firm should use outside financing, even with transaction costs, to pay the dividend, which has been set in, time period zero. In his model he assumes that firm s dividends paying policy is not affected even when dividends are taxed 10

27 LITERATURE REVIEW at higher rate than capital gain tax and also when dividends and share repurchases are perfect substitutes to each other. As dividends are taxed at higher rate than capital gain and firms still pay dividend despite the tax disadvantage, this itself explains that dividends function as signals. This was a significant step in dividend policy research area and in the development of signaling models Miller and Rock s View on Dividend Signaling (1985): Miller and Rock (1985) analyzed the impact of dividend announcement and its consequences under conditions of asymmetric information. Their two period model is marginally different to Bhattacharya s (1979) model. They base their work on the premise that a firm in time zero makes investment in a project and generates cash flow, which is used to pay dividends and to reinvest in new potential projects. They assume that managers (insiders) have some specific private information about firms future prospects, which is not known to outsiders. This information gap affects the perception that each of the parties has about the firm s value and future prospects due to the fact that while evaluating the firm s current as well as future potential, managers not only consider the dividend announcements, but also other non-disclosed earnings. This is based on the rationale that market behaves rationally and evaluates the company in the same manner as it is done by managers. According to Miller and Rock s (1985) dividend declaration is considered as a signal of good news but not bad. The good performing firms have good news to convey to the market while for non-performers giving false signal to the market may prove to be costly, as it does not justify earnings potential. Introducing the asymmetry of information hypothesis in their model, they showed that the impact of dividend announcement on share prices depends upon unanticipated operational cash flow changes. This information conveyed through unanticipated dividend changes will be similar to unexpected earnings changes. Firms anticipating higher potential to generate higher cash flow would therefore contemplate higher 11

28 LITERATURE REVIEW dividends payout ratios. Firms would not like to reduce investment to maintain same dividend amount. They concluded that in asymmetric information context a signaling equilibrium is a position, where dividends convey information about future prospects John and William s View on Dividend Signaling (1985) John and Williams (1985) developed a model that identifies the personal taxation and its impact on dividend. While Miller and Rock (1985) discuss earnings effect on dividend, John and Williams developed their model with the help of an equilibrium dividend-signaling model where taxable dividends and share repurchases are not related, unlike their predecessors Bhattacharya (1979), Miller, and Rock (1985), who considered same as being perfect substitutes. The assumptions by John and Williams (1985) include no tax except on dividend income, uniform tax rate for all shareholders, no transaction costs on issue, trading or retirement of shares. Besides, firm s all sources and uses of funds are fully observable by outsiders through costless public audits, management can issue shares to meet cash requirements and that it has better information about firms future potential, expected cash flows and investment opportunities available than investors (outsiders), who are exposed to asymmetric information. Their work is based on Riley s (1979) findings that firms which have better future prospects are rewarded by market through premium on shares with higher dividends which compensates for additional taxes paid by shareholders. They argue that if dividends have a significant cost, only firms with good performances will be compensated for incurring such costs. In equilibrium, managers (insiders) have more valuable future cash inflows information, distribute larger amount as dividends, and consequently are able to command higher market prices for company s shares. The summary of above discussions is as under: 12

29 LITERATURE REVIEW Under signaling equilibrium model, firms expecting larger future cash flows pay higher dividends, anticipating share prices to increase in future; The smooth dividends associated with optimal dividend policy require operational cash flows to occur in such way that dividend changes have a lagged relation with cash flow changes; Firms which pay dividend have clientele effect and therefore need liquidity to meet expectations of regular dividend; and Higher dividends change are associated, ceteris paribus, with higher changes in share prices while smaller dividends changes are associated with smaller changes in share prices However, these models support the smooth dividend hypothesis, proposed by Lintner (1956), and others, like Fama and Babiak (1968). In summary, these theoretical models suggest that dividend is potentially useful as signal for the future earnings potential of the firm. 2.3 Recent Researches on Informational Content of Dividend decision: Ever since Miller and Modigliani (1961) proposed informational content of dividend, there have been many empirical studies in the direction. The empirical studies under this sub section are broadly classified into two different views as under: i) Bhattacharya s (1979) view that dividends could be used as a future cash flows signal, ii) View of Miller and Rock (1985), who consider that dividends could provide information concerning earnings and future potential. From theoretical perspective it is seen that in general, the market reacts positively to dividend increase announcements and negatively to their decrease announcements. This phenomenon has been analyzed by many researchers and 13

30 LITERATURE REVIEW academicians, such as Pettit (1972), Charest (1978), Aharony and Swary (1980), Healy and Palepu (1988) and Michaely, Thaler and Womack (1995) Their findings are consistent with the view that managers have more information than external investors, and dividends provide information on future cash flows. Before going to analyze signaling effect of dividend change announcement, we present below the results of some empirical tests, organized in agreement with the implications of the dividend information content referred to above Information Asymmetry and Dividend Policy Security market information broadly relates to economy, industry structure and company related information. The decision makers at the macro level policy making are concerned with general trends in the economy such as budgetary deficits, price level, demand and supply position of various inputs, money supply, foreign exchange position, contribution of various sectors to the aggregate economic indicators and sustainable growth rate. Information related to economy therefore, is a necessary and important component of the investor s decisionmaking. Most of the investors and brokers interpret what is happening in the market by looking at the market indices and announcement made by any organization relevant to them. Information related to industry is necessary for the understanding of the general trend of events in that industry. The investors analysis of the state of the industry forms a base for performance evaluation of individual firms. Information related to the management, raw material source, products and market share performance record of the firms etc. enable the potential investor to form opinion about the firm and its value (Nwezeaku and Okpara, 2010). Based on this theoretical mindset various empirical studies have been carried out. The conclusions of some relevant studies are discussed below: Hasbrouck (1991) empirical analysis presented is motivated by theoretical models, which suggested that the response of security prices to trading activities is a consequence of asymmetric information. Commenting on the usefulness of 14

31 LITERATURE REVIEW theoretical model author argued that the principal difficulty in making this concept operational is that the actual mechanism linking trades and quote responses is complicated by deviations from the idealized theoretical constructs. By considering the persistent impact of the innovation, he concentrated on the information ultimately impounded in the price after transient liquidity effects have died out. The following conclusions have been made by the author: i. The full impact of a trade on the security price is not felt instantaneously but with a protracted lag. ii. As a function of trade, innovation, size, the ultimate impact of the innovation on the quote is nonlinear, positive, and increasing, but concave. iii. The order flow is affected by prior quote revisions: there is Granger-Sims causality running from quote revisions to trades. iv. Spread size exhibits a response to trading activity. Large trades in particular are associated with a widening of the bid-ask spread. This finding is consistent with a market-maker who infers from a large trade an increased likelihood that an information event, has occurred. v. Trades which occur in the face of a relatively wide spread have a larger price impact than those which occur when the spreads are narrow. vi. Across firms, the price impact and (by implication) the extent of the information asymmetry appears more significant for firms with smaller market values. From the above mentioned point this can be inferred that the large trades lead to large price impacts but also induce an increase in the spread consistent with a perceived increase in the extent of the information asymmetry, implying that subsequent trades will have larger price impacts. Brioa, Miguel, and Perote (2002) analyzed both the profitability and the information content of insider trading in Spanish stock markets. Their results suggest that the strong form of the EMH does not hold, since insiders earn returns that exceed risk-adjusted benchmarks. In fact, the picture emerging is a semistrong efficient market, where insiders are able to beat the market by using their 15

32 LITERATURE REVIEW private information on a firm s prospects, while outsiders cannot earn abnormal profits by using the publicly available information. Therefore, on their results they recommend a regulatory change in Spanish laws so as to outlaw fraud in security trading. Brio and Miguel (2010) have examined the new evidence on the multiplesignal cash flow theory of dividends by testing it in a European Market. They also incorporated analysis of decreases and increases in current dividends, rather than focusing only on dividend initiations. From their findings, they concluded that the results indicate the cash flow signaling theory alone seems insufficient in explaining the information effects of dividend announcements. They inferred that quite often insiders signal a firm s future prospects by altering their ownership stakes, rather than by disclosing changes in dividend payouts. The secondary result, suggests that earnings information is not fully impounded in prices when the dividend signal reaches the market. Okpara (2010) showed that in the long run dividend policy is positively and significantly related to information asymmetry. The study investigated the relationship between asymmetric information and dividend policy in Nigeria. To carry out the research work, the researcher employed the unit root test using the augmented Dickey Fuller test, the Johanson cointegration test and then vector error correction model to ascertain the long-run relationship between the variables. Granger causality test was also used. The researcher found supportive evidence for the dividend signaling theory. Thus, there is a positive and significant relationship between dividend policy and asymmetric information Dividend Announcement and Future earnings: Under this sub heading, the researcher has grouped the literature related to studies on dividend changes followed by subsequent earnings changes, in the same direction. Studies in this direction provide evidence that dividend changes convey significant information about the future prospects of the firm i.e there is merit in recognizing existence of dividend informational content. 16

33 LITERATURE REVIEW Makhija and Thompson (1986) suggest that dividends can serve to signal the profitability of a cross section of firms, provided the least profitable and the most profitable firm are properly characterized. Additionally, they have shown that the relation between dividends and earnings is likely to be nonlinear. David, Diane, Denis and Sarin (1994) arrived at results that seek to explain the positive association between dividend change announcements and stock price reactions. Their investigation is motivated by linking Tobin's Q and dividend yield. They argue that the negative relation between Tobin's Q and dividend yield may lead to a spurious correlation between Q and excess returns around dividend announcements. This can lead to biased inferences regarding the relative importance of the cash flow signaling, overinvestment, and dividend clientele hypotheses. The authors went on to clarify that the cash flow signaling, overinvestment, and dividend clientele effect are not mutually exclusive and therefore justify to be integrated into a single testing framework. The conclusions drawn point out implications of the cash flow signaling and dividend clientele effect. Bernheim and Wantz (1995) observe that the dividend signaling hypothesis implies that abnormal returns should be more sensitive to the magnitude of announced dividend changes when observable factors (such as tax rates, bond ratings, and capacity utilization) suggest that the marginal costs of dividends are high. Their empirical investigation reveals that the interest generated by dividend announcements rises with the decline in dividend tax rate, falls with the rise in bond rating, and rises with increase capacity utilization. Daniels, Shain and Lee (1997) showed how dividends caused permanent earnings for half the sample, while the causality study from dividend to current earnings failed to detect a causal relationship for more than eighty per cent of the sample. They attribute the enhanced performance of analysis of the hypothesis at a firm level as a better proxy of the future earnings. Benartzi, Michaely, and Thaler (1997) have adopted a systematic attempt to discover whether the information content of a dividend announcement has something to do with future earnings. Consistent with the early findings of Watts (1973), they are unable to find any evidence to support the view that changes in dividends have information content about future earnings changes. 17

34 LITERATURE REVIEW While there is a strong past and concurrent link between earnings and dividend changes, the predictive value of changes in dividends seems minimal. They also find some evidence that dividend-increasing firms are less likely to have subsequent earnings decreases than firms that do not change their dividend despite similar earnings growth. In this sense, changes in dividends do signal something about the present provided that the current increase in earnings is permanent. Brook, William Jr., and Hendershott (1998) are of the opinion that dividend policy is used by managers to signal future cash flow increases. From their samples they found that firms used dividend as signal to show their cash flow increases. They also found that these firms also earn significantly positive abnormal stock return. From these findings, they suggested that as higher cash flow is realized, positive abnormal return continue. Dhillon, Raman, and Ramirez (2003) have indicated that actual dividend increases (decreases) computed using the naive dividend method do not necessarily reflect favourable (unfavourable) information. It is dividend surprise that becomes relevant which conveys new information to financial markets. In an informationally efficient market, announcements of no dividend changes can be informative when analysts revise their expectations. Using regression analysis, the authors were able to document a significant positive relationship between dividend surprises and contemporaneous as well as future earnings changes. Koch and Sun (2004) suggested that dividend changes that confirm prior earnings news, have a positive statistical relation between the market reaction around the announcement of the dividend change and the prior earnings change. For dividend changes that contradict prior earnings news, they found a negative statistical relation between the market reaction surrounding the dividend change announcement and the prior earnings change. Grullon, Michaely, Benartzi and Thaler (2005) found that dividend changes are uncorrelated with future earnings changes when one controls for the well-known nonlinearities in the earnings process. They also find that, regardless of the model of earnings expectations, models that include dividend changes do not outperform those that do not include dividend changes in out-of-sample tests. Some of their results even suggest that investors may be better off not using dividend changes 18

35 LITERATURE REVIEW when they forecast earnings changes. Based on their work it may be concluded that changes in dividends are not useful in predicting future changes in earnings. By using several different estimation methods and various measures of profitability, they found that the association between dividend changes and future profitability is not consistent with the predictions of the signaling hypothesis. They do not rule out that dividend increases signal something, but that something is neither abnormal increases in future earnings nor abnormal increases in future profitability. They attribute the motive for paying dividends, and the market reaction to it, as lie elsewhere. Wann & Long (2009) established a strong relationship between aggregate dividends and aggregate earnings, implying that aggregation filters out firm-specific earnings information and signifies macroeconomic trends. Using macroeconomic data provided, they showed that changes in aggregate payout ratios, driven by positive liquidity shocks, do have information content about aggregate future earnings growth for horizons up to 3 years. Fuller and Benjamin (2010) state that firms pay dividends to signal future earnings or to disburse excess cash flows or both. They classified firms into three observationally distinct groups using their prior performance, so that signaling occurs only within each group and not across groups.they also found that firms that have low or high prior performance display little heterogeneity in future earnings, while firms with intermediate prior performance have high future and past earnings heterogeneity and have the highest heterogeneity in current dividend payments. Finally, firms with intermediate prior performance have the highest abnormal stock price reaction to a dividend change. They contend that the nonmonotonic relationship between firm quality and dividend is the possible explanation of the weakness of the empirical support for dividend signaling hypothesis Dividend Announcement and Share Price: There are a number of factors affecting the dividend policy decisions of a firm. These factors include amongst others clientele effect, earnings, investment 19

36 LITERATURE REVIEW opportunities annual vs. target capital structure, flotation costs, signaling aspect, dividend smoothening and Government policies such as legal constraint, taxation and provision about insider trading etc. As in real world asymmetric information exist among insiders and outsiders, signaling are one of the crucial factors used by managers that influence the market. Dividends may have informational content which is conveyed by managers about the firms, so it suggests the possibility of its influence on the stock market and consequently on share prices. Paying large dividends reduces risk, thus influence stock price (Gordon, (1963)) and is a proxy for the future earnings (Baskin, 1989). In general, the underlying hypothesis to be studied under this domain is that unexpected dividend changes should be positively associated with share price changes, providing evidence that financial markets interpret correctly dividend changes. So many empirical tests carried out with the purpose of analyzing the effect caused by dividend change announcements on share prices established a positive relationship between dividend change announcements and change in share prices. The empirical studies in this direction have been commented below: Luab (1976) considerably support the signaling hypothesis that dividend announcement conveys information about future earnings prospects that is not inherent in the past time series of future earnings. Fama (1970) suggests that, the theory of efficient markets is concerned with whether prices at any point in time "fully reflect" available information. The theory only has empirical content, however, within the context of a more specific model of market equilibrium. Fama, Fisher, Jensen and Roll (1969) argued that stock splits have very often been associated with substantial dividend increases. They argued that this evidence indicate that the market realizes this and uses the announcement of a split to reevaluate the stream of expected income from the shares and led them to thus conclude that the stock market is "efficient" in the sense that that stock prices adjust very rapidly to new information. The findings of Shillers (1981) found a very strong stock price volatility to the extent of five to thirteen times. The author 20

37 LITERATURE REVIEW observed that not only the unexpected dividend but also the unexpected real interest rate affects the shares prices of the companies. Asquith and Mullins, Jr. (1983) investigated the impact of dividends on stockholders wealth by analyzing 168 US listed firms that either paid first dividend in their corporate history or initiated dividend after a ten-year gap. The results suggest a positive impact on the wealth of shareholders implying that dividends convey unique and valuable information to investors. Kane, Lee, and Marcus (1984) examined the US markets for corroborative relationship between earnings and dividend announcements. The empirical results suggest the existence of a corroborative relationship between the two announcements and more credence given by investors to unanticipated dividend increases or decreases when earnings are also above or below expectations, and vice versa. Stephens and Proffitt (1988) based on examination of payment of stable amount per share, constant percentage of income per share and residual amount per share polices reveal that market response to unanticipated dividend announcements is a function of dividend policy. Ariff and Finn (1989) through their study of the Singapore Equity Market suggest that that for the "good news" announcement, that is earnings and dividends increases and capitalization changes, prices react quickly, in that there are essentially zero excess returns after the announcement. For the "bad news" announcements, that is earnings and dividends decreases, there is some appearance of slower price adjustment, perhaps extending for some months after the announcements. Wansley, Sirmans, Shilling and Lee (1991) examined the announcement effects of changes in regular quarterly dividends and its impact through asymmetric information models and concluded that dividend decreases are viewed by the market as containing more information than dividend increases. Their findings 21

38 LITERATURE REVIEW also suggest that firms with more positive information to release to the market appear to do so by making larger percentage changes to their dividend yield. Akhigbe, Borde and Madura (1993) indicated that signal to the market can be measured by the share price response to dividend changes. They found that share price response for insurers that increased their dividends was positive and significant. Kao and Wu (1994) estimated the relation between unexpected changes in the dividend and earnings for the companies from S & P 500 index. The results support the contention that dividend changes reflect both expected and unexpected permanent earnings changes. Further, the effectiveness of dividend signaling depends on firm specific characteristics and it can be claimed that the information content hypothesis have the signaling power that is positively taken by the market. The results of Peterson and Salandro (1994) indicate that managers signal earnings information via a noisy dividend announcement, which results in sub optimal investment levels. For this suboptimal decision they argued that managers compensation depends upon the value of the firm so they use dividend as a signal to promote the value of the firm. Iqbal and Rahman (2002) on their study of data from Standard & Poor s Research Insight databases, indicate that a dividend cut may not be an effective signal of poor future performance under all circumstances. When a dividend reduction accompanies other operational actions, managers are less likely sending a signal that poor performance is forthcoming. Conroy, Eades, and Harris (2000) findings based on Japanse experience suggest that earnings variables are more dominating in their ability to explain share price movements. They found, that current dividend effects is never significantly related to announcement returns and management forecast of next year s dividend has a small but significant effect on the stock price. 22

39 LITERATURE REVIEW Ryan, Besley and Lee (2000) found a very strong support for signaling hypothesis in the explanation of dividend changes for NASDAQ firms. Results show a strong support for the dividend-signaling hypothesis, and limited support for the free cash flow argument. Crawford and Franz (2001) analyzed the signaling effect due to stock distribution and share split on the share price. Their empirical findings suggest that both the anticipation and credibility of signaling effects are present in the sample of stock distributions examined. A positive response of the market to the announcement of a stock distribution is partly due to real cash flow benefits to investors from returning the share price to its optimal trading range. Gunasekarage and Power (2002) analyzed the market-adjusted excess returns for three periods around the announcement and then examined the financial performance in the year of the announcement and in the subsequent five-year period. The findings of the study are inconclusive about the validity of the dividend-signalling hypothesis. By examining the event windows of 3-day, 21-day and 61-day to capture the reactions of the markets over the period, Adelegan (2003) found negative excess returns for the dividend paying samples for pre-announcement period and positive excess return after the announcement date. Further, significant excess returns and the cumulative excess returns for 30 days before and until 25 days after dividend announcements for dividend paying firms were observed to conclude semi-strong efficient nature of the Nigerian stock market. Due to the drift in prices until 25 days after the announcement date, the author did not rule out the effect of insider trading. By analyzing the nature stockholding, Amihud and Li (2006) viewed that dividend announcements are becoming less informative due to the increase in stockholdings by institutional investors who are more sophisticated and informed than average individual investors. They also observe that institutional investors increase their holdings in firms that subsequently raise dividends even two quarters before the 23

40 LITERATURE REVIEW announcement but stop doing so after the dividend announcement. Firms with high institutional holdings are less likely to raise their dividends. Analysis shows that the disappearance of dividends reflects the declining role of dividends as a means to convey information, which is a result of the increase in institutional holdings. Vieira and Raposo (2007) found different results in different markets. While abnormal returns for the three-day announcement period only support the dividend content hypothesis for the dividend increase events in the UK market, no significant market reaction to dividend change announcements was found for Portuguese and French markets. In many cases reverse relationship was also observed between dividend change announcements and share price reaction. Bulan, Subramanian and Tanlu (2007) suggested that dividend initiators are large and stable firms with relatively high profitability and cash balances, and low growth rates. Their findings show mixed evidence that a firm's propensity to initiate dividends is affected by the market sentiment for dividends. Papasyriopoulos, Koulakiotis, Papadimitriou, and Kalimeris (2007) examined the effect of acquisition announcements on the abnormal returns of six Greek industrial and constructing firms in the time of They calculated the average and cumulative average abnormal returns using the Market model in combination with the event study methodology. The OLS parameters (α and β) of the model were calculated from the estimation period -211, -11 and were applied for the calculation of AAR and CAAR of period -211, +10. They found the AAR and CAAR for the period -211, +10. Firstly, results show that, the announcement (t = 0) of an acquisition does not significantly affect the AAR and CAAR. Although AAR is positive on day 0, it begins to decline right after that. Apart from that, CAAR is positive between days -120 and way after the announcement day. More generally, it seems that both AAR and CAAR on day t = 0 are statistically and economically insignificant, that is, they do not seem to have a great effect on abnormal returns on that particular day. Secondly, they used the Exponential GARCH model technique to find if there is any correlation between 24

41 LITERATURE REVIEW the current return and the future volatility. They included 2 dummy variables in our estimation, namely D1 and D2, which measured the effect of good and bad news on abnormal returns respectively. Results from the E-GARCH model show that the presence of good news positively affects the average abnormal returns in the pre-announcement period -211, -1, while the presence of bad news has a slight negative effect. Wann, Long, Pearson, and Wann (2008) hypothesized that investor expectations regarding dividend changes are conditioned by growth opportunities, as proxied by the market-to-book ratio. Using the traditional event study approach, they examined the implications of signaling theory and agency theory on investor reaction to changes in dividend payments (i.e. increases and decreases) by high and low growth opportunity firms. In particular, low growth opportunity firms experience more pronounced excess abnormal returns in response to large dividend changes according to the agency theory. The presence of large positive cash shocks tends to dissipate the differences in excess abnormal returns found between high and low growth opportunity firms. However, low growth opportunity firms that decrease dividends following negative cash shocks experience significantly larger negative stock returns than do high growth opportunity firms. Thus, it appears that the agency theory predictions are more severe for low growth opportunity firms. Further, dividend decreases made by low growth firms following negative liquidity shock events result in significantly larger negative abnormal and cumulative abnormal returns than do regular dividend decreases. The empirical study by Howatta, Zuberb, Gandarc and Lambd (2009) shows positive increases in real dividends that associated with declines in profitability. When compared to non-dividend paying firms, real dividend decreases also exhibit a direct relationship with decreases in earning per share. Findings are consistent with the dividend signaling theory. Anderson (2009) used friction modeling, a procedure using maximum likelihood estimation to replace both the market model and restricted least-squares regression 25

42 LITERATURE REVIEW in event studies where there are two quantifiable variables and a number of possible interaction effects associated with the news that constitutes the study s event. From the findings, they suggest that the dividend signal can be separated from the earnings signal. Hussainey (2009) tested the issues of the effects of dividend payment status and the increase in dividends over time on the relation between current stock returns and future earnings. This paper evidence that firms that pay dividends or that increase dividends levels exhibit higher levels of share price anticipation of earnings than non-dividend-paying (non- increasers) firms. It also provides evidence that the association of dividend with share price anticipation of earnings is statistically significant for loss-making firms and insignificant for profitable firms. From findings, suggest that loss making firms use dividends as to signal their future prospects to the stock market participants. Using a sample of 477 large companies Bouwman (2010) examined whether announcement effects triggered by dividend changes are affected by the presence of optimistic CEOs in the companies based on the premise that an optimistic manager has an upward bias in own assessment of a private signal about future earnings, such that dividend change on an average embeds more good news for the market than an equal-sized dividend change announced by a rational manager. As the market cannot perfectly distinguish between optimistic and rational managers, there is favourable market response to dividend changes announced by optimistic managers (controlling for other factors, including the size of the dividend change) than to those announced by rational managers. The results reinforce the existing evidence that dividend changes generate abnormal price reactions, and yet provide little information about future earnings. Westfall (2010) tested the efficient market hypothesis by assessing the investor s ability to earn an above normal return in the short run by acting on stock split announcements. This study used the standard risk adjusted event study methodology with the market model and an appropriate statistical test for significance was conducted. Results show a positive market reaction prior to the 26

43 LITERATURE REVIEW firms announcement of regular two for one stock splits. The results from this study support efficient market theory at the semi-strong form level as documented by Fama (1970). Dasilasa (2011) examined the reaction of dividend change announcements effect on stock market as well as the trading volume for a sample of firms listed on the Athens Stock Exchange and found significant market reaction on the dividend announcement day. Andres, Betzer, Bongard, Haesner, and Theissen (2011) analyzed dividend announcements made by German firms in the period from 1996 to They performed a standard event study and then used random effects panel models to analyze the determinants of the cumulative abnormal returns. The results show that share prices react to the surprise in the dividend announcement, not to a dividend change per se. Their results also suggest that, when dividend and earnings announcements are made on the same day, the dividend surprise has, if anything, higher explanatory power for the share price reaction than the earnings surprise. Salameh and Albahsh (2011) findings reject the null hypothesis that there is no difference between the average abnormal return and zero; this indicates that Palestine market is inefficient at the semi strong level and that information is gradually reflected in stock prices. They claimed that the market is still an emerging one. Many other developments are needed to enhance the desired turns in the market; in the internal market level or in the external economic and legal environment. They suggested that more attention should be given on studying the efficiency of the Palestine stock exchange PEX at the weak form and on the impact of other events. 27

44 LITERATURE REVIEW Dividend and Stock Price in Emerging Markets: Emerging economies are the fastest growing economies of the world. They are in the transition phase in their development process. India is one of the emerging economies. The Indian stock market as most of the other emerging economies stock markets is growing rapidly and exhibits volatility die to growth prospects. The empirical studies of signaling theories on these countries provide different results. Discussion on these studies follows: Chen, Firth and Gao (2002) while studying Chinese market observed a positive relationship between changes in profits and stock returns measured over short intervals of time. Further, they realized that the signaling effect of dividend announcements along with earnings embellish the signal from earnings. Abdullah, Rashid and Ibrahim (2004) explained the market reaction to the dividend announcements for the period of 1996 to 1999 in Kuala Lumpur Stock Exchange (KLSE). The findings do not support the signaling hypothesis. By investigating the semi-strong form of market efficiency of stock prices to dividend announcements using event study methodology, Akbar and Baig (2004) analysed cash, stock, and simultaneous cash and stock dividend announcements of 79 companies listed on the Karachi Stock Exchange for the period July 2004 to June Their findings suggest that the reaction of stock prices to cash dividend announcements is statistically insignificant. They also suggested that the returns are mostly negative for the 41-day window, which they attribute to the tax effect of cash dividends. Thirumalvalavan and Sunitha (2006) observed significant abnormal returns around the divided announcement date. However, this positive signaling existed only for a day after the announcements, after which the extent of positive reaction started decreasing suggesting that the market reaction in the Indian market to events or announcements such as stock repurchases and dividends was complete within a day or two. 28

45 LITERATURE REVIEW Study on Dhaka Stock Exchange by Hossain, Siddiquee and Rahman (2006) pertaining to four years ( ) shows a rise in the average abnormal return (AAR) one day before the dividend announcement and falling sharply after the dividend announcement. The cumulative abnormal return (CAR) of almost all the companies around the study period, which increased just before the dividend announcement date, did not sustain in the ex-dividend period. The sensitivity is prominent on the day after or the day before the declaration instead on the declaration day. They justify the findings due to leakage of significant information before the dividend announcement. Thus their study is supportive of signaling theory. Cooray and Wickremasing (2007) used The Augmented Dickey Fuller (ADF- 1979, 1981), the Phillips-Perron (PP-1988), the Dicky-Fuller Generalized Least Square (DF-GLS-1996) and Elliot-Rothenberg-Stock (ERS ) tests to examine stock market efficiency in India, Sri Lanka, Pakistan and Bangladesh. The findings support weak- form efficiency for all four countries. Chander, Sharma and Mehta (2007) analyzed the impact of dividend announcement considering 188 events of dividends announcement for Group A listed stocks of the Bombay Stock Exchange during the period from January 2004 through December 2005 by using the event study methodology. The results show consistent incidences of average abnormal returns around the dividend announcement, indicating over expectation of investors regarding dividend announcement in the information leakage phase, which subsided considerably with new information disclosure. The study broadly endorses the market efficiency in these markets however goes on to conclude that dividend being marginal portion of return does not inspire over enthused investors in rising markets. Hong kong being characterized as asymmetric market environment due to concentrated shareholding patterns provides a good example due to limited disclosure of information to investors. Due to dividends being important source of information, Cheng, Fung and Leung (2007) support the signaling hypothesis that 29

46 LITERATURE REVIEW dividend changes reflect profitability and cash flow for firms with unexpected earnings increases. On the other hand study on Amman Stock Exchange for the period 1996 to 2002 by Nobanee, Hadda, Alshattarat and Alshattarat (2009) showed that the market reacted negatively to dividend increase and decrease samples, and the same result was obtained for the dividend no change sample leading no support for dividend signaling consistent with the results of Mollah (2001). At the same time study by Chen, Nieh, Chen and Tang (2009) while analyzing the effect of cash dividend changes on the share prices for the period 2000 to 2004 for Chinese Stock Market found that share prices react significantly positive to both cash dividend increases and cash dividend decreases. While applying event study method, Chen, Liu, and Huang (2009) investigated the impact of cash dividend changes on share prices and simultaneously examined whether the dividend-signaling hypothesis holds in China s stock markets. Their results half support the signaling hypothesis. The reaction of dividend decrease is more pronounced than for dividend increase. Chakraborty and Mukhopadhyay (2010) took six different sub-categories of 125 events for the period of 1996 to The empirical study indicates that the Indian stock market conforms to the Efficient Market Hypothesis (EMH) whereby the investors exhibit an informed and rational behavior. Study by Karamjeet and Balwinder (2010) reports positive reaction of stock market to the announcements of share buy-backs in India particularly on the announcement date showing abnormal returns of 2.22% per cent for share buybacks with 72.28% events generating positive returns on announcement day (0). Using event study for Karachi Stock Exchange Index (KSE-30), Chughtai (2010) found that an average stocks start showing positive abnormal returns seven to eight days before announcement date due to leakage of information regarding announcement raising questions on corporate credibility in emerging markets. 30

47 LITERATURE REVIEW Mandal and Rao (2010) findings provide enough evidence to support that both the announcements of dividend initiation and dividend omission carry some new value relevant information to the investors implying signaling by management to shareholders. The impact of dividend omission was found to be greater than for initiation. Mohammad and Chowdhury (2010) also used event study methodology to investigate the effect of dividend announcement on stock price and found no strong evidence that stock price reacts significantly on the announcement of dividend. They attribute this due to insider trading in the market in insiders, brokers and the exchange employees act as informed speculators for short-term gain thus making dividend information ineffective. In view of this, a dividend announcement does not generate significant impact on the movement of stock prices. Study on Indian market by Sharma (2011) suggests that the dividend announcements do not result in any non-random behaviour in the stock return series surrounding the announcement day and no investor could earn significant abnormal returns by strategizing his/her investment policy surrounded by these announcements days as informational content got embedded in the share prices. Overall results by Aamir and Shah (2011) indicate that impact of dividend on dividend announcement date and few days after were positive thereby making a strong argument that dividend distribution is relevant for future price determination. Taneem, and Yuce (2011) analyzed results of 82 BSE enlisted companies, which announced dividends during the financial years claim that investors have a favourable reaction towards companies that increased their dividends and the vice versa for companies that declared a decrease in dividend. They thus conclude that dividend announcements have information content and induce share price adjustments. The result showed higher abnormal return and higher cumulative abnormal return for companies that increased their dividend amounts. They make strong support to the signaling hypothesis in explaining the positive price reactions in the direction of dividend change. 31

48 LITERATURE REVIEW By taking the sample of 55 dividend-paying companies listed at Karachi Stock Exchange for the period of 2001 to 2010, Khan, Aamir, Qayyum, Nasir and Khan (2011) found that dividend yield to be positively related while retention ratio being negatively related to Stock Prices. The authors found significant fixed as well as random effect in variations in the stock prices. Kumar, Mahadevan and Gunasekar (2012) observed that information is reflected in stock prices very quickly such that even the published data tells nothing to the investor about the likely hood of change in stock prices. Therefore the study leads to conclude that announcement of corporate dividend result does not have any impact on the stock return behavior. Maitra and Dey (2012) observed that there are significant abnormal returns (positive or negative or both) upon dividend announcement which is more evident under the CAPM model. They suggest that although abnormal returns are found significant even before the announcement of dividend both under the market model and the CAPM model, still more cumulative average abnormal returns are not found significant well before the announcement under the CAPM model while it becomes faster during the post- announcement period. Under the market model, no significant difference between positive and negative average abnormal return is observed which is suggestive of no signaling effect whereas application of CAPM model suggests signaling. The difference in results seems to be due to difference in calculating returns. The literature review carried out has been summarized as under: 32

49 LITERATURE REVIEW Table 2.1: Summarization of Literature Review: Srl. No. Author/Authors Period of Study Country of Study Direction of findigs Information Asymmetry and Dividend Policy 1 Hasbrouck (1991) 62 trading days in the first quarter of 1989 US Dividend has signaling effect due to asymmetric information. 2 Brioa, Miguel, and Perote (2002) Spain Dividend has signaling effect due to asymmetric information. 3 Brio and Miguel (2010) European Market Dividend has signaling effect due to asymmetric information Dividend Announcement and Future Earnings: 5 David, Diane, Denis and Sarin (1994) US Dividend information is used to convey future earnings prospects 6 Bernheim and Wantz (1995) US Dividend information is used to convey future earnings prospects 33

50 LITERATURE REVIEW 7 Dhillon, Raman, and Ramirez (2003) US Dividend information is used to convey future earnings prospects 8 Benartzi, Michaely, and Thaler (1997) US No evidence to reflect effect on future earnings due to conveyed dividend announcement. 9 Daniels, Shain and Lee (1997) US No evidence to reflect effect on future earnings due to conveyed dividend announcement. 10 Brook, William Jr., and Hendershott (1998) 4 year data till 1992 Data from Compustat tapes Dividend information is used to convey future earnings prospects 11 Koch and Sun (2004) US Due to decrease in earnings no effect of positive dividend signaling was substantiated. 12 Grullon, Michaely, Benartzi and Thaler (2005) US No evidence to reflect effect on future earnings due to conveyed dividend announcement. 13 Wann & Long (2009) 1952 Q Q3 US Dividend information is used to convey future earnings prospects 14 Fuller and Benjamin (2010) US Dividend information is used to convey future earnings prospects 34

51 LITERATURE REVIEW Dividend Announcement and Share Price: 15 Luab (1976) US Evidence of positive relationship between dividend announcement and share price 16 Fama, Fisher, Jensen and Roll (1969) US Evidence of positive relationship between dividend announcement and share price 17 Stephens and Proffitt (1988) COMPUSTAT Research file Evidence of positive relationship between dividend announcement and share price 18 Shillers (1981) US Evidence of positive relationship between dividend announcement and share price 20 Asquith and Mullins, Jr. (1983) US Evidence of positive relationship between dividend announcement and share price 21 Kane, Lee, and Marcus (1984) US Evidence of positive relationship between dividend announcement and share price 22 Wansley, Sirmans, Shilling and Lee (1991) US Evidence of positive relationship between dividend announcement and share price 35

52 LITERATURE REVIEW 23 Akhigbe, Borde and Madura (1993) US Evidence of positive relationship between dividend announcement and share price 24 Kao and Wu (1994) COMPUSTAT Evidence of positive relationship between dividend announcement and share price 25 Salandro (1994) 15 period asset double auction with five minute trading period in 1994 US Evidence of positive relationship between dividend announcement and share price 26 Bouwman (2010) US Evidence of positive relationship between dividend announcement and share price 27 Michaely, Thaler, and Womack (1995) US Evidence of positive relationship between dividend announcement and share price 28 Iqbal and Rahman (2002) US No relationship between dividend announcement and change in share price 30 Ryan, Besley and Lee (2000) US Evidence of positive relationship between dividend announcement and share price 36

53 LITERATURE REVIEW 31 CRAWFORD and Franz (2001) US Evidence of positive relationship between dividend announcement and share price 36 Amihud and Li (2006) starting in July 1962 US No relationship between dividend announcement and change in share price 38 Bulan, Subramanian and Tanlu (2007) US Evidence of positive as well as negative relationship between dividend announcement and share price found 40 Wann, Long, Pearson, and Wann (2008) US Evidence of positive relationship between dividend announcement and share price 41 Howatt, Zuberb, Gandarc and Lambd (2009) US Evidence of positive relationship between dividend announcement and share price 44 Westfall (2010) US Evidence of positive relationship between dividend announcement and share price 37 Andres, Betzer, Bongard, Haesner, and Theissen (2011) German Evidence of positive relationship between dividend announcement and share price 35 Dasilasa (2011) Greece Evidence of positive relationship between 37

54 LITERATURE REVIEW dividend announcement and share price 39 Papasyriopoulos, Koulakiotis, Papadimitriou, and Kalimeris (2007) Greece Evidence of positive relationship between dividend announcement and share price 19 Ariff and Finn (1989) Singapore Evidence of positive relationship between dividend announcement and share price 42 Anderson (2009) New Zealand Evidence of positive relationship between dividend announcement and share price 29 Conroy, Eades, and Harris (2000) Japan Evidence of positive relationship between dividend announcement and share price 43 Hussainey (2009) UK Evidence of positive relationship between dividend announcement and share price 32 Gunasekarage and Power (2002 ) UK Evidence of positive relationship between dividend announcement and share price 33 Vieira and Raposo (2007) UK, French Portuguese and No relationship between dividend announcement and change in share price 38

55 LITERATURE REVIEW 45 Salameh and Albahsh (2011) May.2006 Oct.2006 Palestine No relationship between dividend announcement and change in share price 4 Makhija and Thampson (1986) India Dividend information is used to convey future earnings prospects Dividend and Stock Price in Emerging Markets: 46 Chen, Firth and Gao (2002) China No relationship between dividend announcement and change in share price 48 Chen, Nieh, Chen and Tang (2009) China Evidence of positive relationship between dividend announcement and share price 57 Chen, Liu, and Huang (2009) China Evidence of positive relationship between dividend announcement and share price 55 Cheng, Fung and Leung (2007) Hong Kong Evidence of positive relationship between dividend announcement and share price 50 Abdullah, Rashid and Ibrahim (2004) Malaysia No relationship between dividend announcement and change in share price 39

56 LITERATURE REVIEW 51 Akbar and Baig (2004) Pakistan No relationship between dividend announcement and change in share price 59 Chughtai (2010) Pakistan Evidence of positive relationship between dividend announcement and share price 63 Aamir and Shah (2011) Pakistan Evidence of positive relationship between dividend announcement and share price 65 Khan, Aamir, Qayyum, Nasir and Khan (2011) Pakistan Evidence of positive relationship between dividend announcement and share price 52 Hossain, Siddiquee and Rahman (2006) Bangladesh Evidence of positive relationship between dividend announcement and share price 61 Mohammad and Chowdhury (2010) Jan.2008-Sep Bangladesh Evidence of positive relationship between dividend announcement and share price 56 Nobanee, Hadda, Alshattarat and Alshattarat (2009) Amman No relationship between dividend announcement and change in share price 53 Cooray and Wickremasing (2007) India, Sri Lanka, Pakistan and Evidence of positive relationship between dividend announcement and share price 40

57 LITERATURE REVIEW Bangladesh 49 Thirumalvalavan and Sunitha (2006) India Evidence of positive relationship between dividend announcement and share price 54 Chander, Sharma and Mehta (2007) India Evidence of positive relationship between dividend announcement and share price 47 Chakraborty and Mukhopadhyay (2010) India Evidence of positive relationship between dividend announcement and share price 58 Karamjeet and Balwinder (2010) India Evidence of positive relationship between dividend announcement and share price 60 Mandal and Rao (2010) India Evidence of positive relationship between dividend announcement and share price 64 Taneem, and Yuce (2011) India Evidence of positive relationship between dividend announcement and share price 66 Kumar, Mahadevan and Gunasekar (2012) India Evidence of positive relationship between dividend announcement and share price 62 Sharma (2011) India No relationship between dividend announcement 41

58 LITERATURE REVIEW and change in share price 67 Maitra and Dey (2012) India No relationship between dividend announcement and change in share price 42

59 LITERATURE REVIEW 2.4. Conclusion: Based on the literature review, it is seen that the various studies fall into four distinct areas, those related to asymmetric information, dividend announcement and future earnings, dividend and its impact on share prices and finally dividend announcement and signaling reactions in share price of the stocks in emerging economies. Part one of the literature reviewed, examined studies related to information asymmetry among stakeholders. The managers (insiders) are using dividend and other important information to signal outsider about the potential of the companies to enhance the value of the firm and by this way they try to safeguard managerial interest in the companies. The second part of the literature review related to dividend announcement and future earnings. The results are mixed with some of the studies support dividends to convey future prospects. Most of the studies support the viewpoint only if there are potential real earnings in the long run then dividend announcement really acts as signals otherwise not. At the same time some of the studies do not find support that dividend conveys future potential earnings. In third part of the literature review, we analyzed the impact of dividend on share price reaction has been covered suggest that dividend and share prices are positively correlated. While some of the studies found signaling effect and inverse relationship between dividend announcement and share prices, others did not find any relationship at all. The literature is also abound with studies showing mixed results depending upon dividend related events and the event periods chosen for the respective studies. Studies on dividend signaling in the context of emerging economies by and large do not show clear evidence of signaling effect. The reason for this has been attributed to low level of market efficiency. 43

60 LITERATURE REVIEW The literature also points out that the methodology adopted and models used to analyse signaling effect also affect the outcome of the results.the theoretical and empirical works reviewed in the literature show various type of results for different markets. The different results from large number of empirical studies and the evidence of a significant percentage of cases where the market reaction to dividend change announcements is opposite to the expected reaction leads us to draw that the debate over the empirical validity of the dividend-signaling hypothesis remains inclusive. However, different results in different markets also prompt one to explore the cause and effect relationship with the characteristics of the dividend related events as well as the nature of market. Taking the clues from literature review carried out in the preceding sections, the following salient points emerge which can be provide a basis for formulating the aims and objectives of the study as under: i) The relationship between dividend changes announcements and subsequent changes in share prices of the firms are not always consistent with the signaling theory and the information meant to be conveyed to the market through dividend decision is not always related to future earnings, growth or cash flow; ii) The empirical evidence in developed countries predominately support the positive relationship between dividend change announcements and the subsequent change in share prices while in developing counties the same is not supported either due imperfections or inefficiencies in the market. The evidence of negative relationship between dividend change announcements and changes in share prices may also be attributed to investors perceived behavior for future earnings and growth. 44

61 RESEARCH METHODOLOGY CHAPTER: 3 RESEARCH METHDOLOGY 3.1 Aims and Objective of Research This research primarily aims to study the signaling effect of dividend decisions on the market price of companies listed on stock market in India. Incidental to the study it is necessary to understand whether the efficiency level of the Indian stock market has any role in affecting the changes in share prices due to dividend related events. The companies listed on the stock market are diverse in terms of the industry, market capitalization and performance. They also exhibit different types of dividend decisions viz. cash or stock and indirectly repurchase of shares. The dividend change decisions can be grouped in to various event categories such as dividend omission, initiation, increase or decrease. Accordingly, the following objectives of the study have been formulated: i) To identify and analyze the different types of dividend related events and their signaling effect if any on the share price of listed companies in India. ii) To analyze whether the signaling effect is consistent for all the above events or it varies with market capitalization or industry representation of the company. iii) To test the market efficiency of the Indian Stock Market in relation to dividend related announcements. On the basis of the above objectives, the researcher intends to contribute to the resolution of the debate on signaling effect of dividend decisions particularly in the context of transient and emerging economy- India. 45

62 RESEARCH METHODOLOGY 3.2 Sample Selection: There are twenty five stock exchanges operating in India as shown in the Table 3.1. Out of these twenty one operate at regional level and only four are working at national level. Only eight stock exchanges have permanent license amongst which namely Bombay Stock Exchange (BSE), National Stock Exchange (NSE), Over the Counter Stock Exchange (OTC) and Multiple Commodity Index (MCX) are operational at national level. The MCX is trading in commodities and falls within the regulatory purview of Forward Market Commission of India; while OTC is the market for non-listed medium size companies, only BSE (Bombay Stock Exchange) and NSE (National Stock Exchange) deal in majority of the companies listed on the Indian Stock Market. Due to their size in terms of number of listings as well as turnover, BSE and NSE have been considered as representative of. Indian Stock Market for identification of companies and selection of events. 46

63 RESEARCH METHODOLOGY Table 3.1: Existing Stock Exchanges in India Srl. No. Name of Stock Exchange Foundatio n Location Working Status (National/ Regional) No. of Listed Com. (as on Dec. 2011) Market Capitalization 1 Bombay Stock Exchange 1875 Mumbai, India National 5,133 US $ 1 trillion (Dec. 2011) 2 Ahmedabad Stock Exchange 1894 Ahmedabad, India Regional 3 Calcutta Stock Exchange 1908 Kolkata, India Regional 2,700 4 Madhya Pradesh Stock Exchange 1919 Indore, India Regional Madras Stock Exchange 1937 Chennai, India Regional Hyderabad Stock Exchange (dereconized by SEBI) 1941 Hyderabad, India Regional 7 Delhi Stock Exchange Association 1947 New Delhi, India Regional 3,000 8 Banglore Stock Exchange 1963 Banglore, India Regional Cochin Stock Exchange 1978 Kochi India Regional Ludhiana Stock Exchange 1981 Ludhiana, India Regional 11 Pune Stock Exchange 1982 Pune, India Regional 12 UP Stock Exchange 1982 Kanpur, India Regional 13 Guwahati Stock Exchange 1983 Guwahati, India Regional Manglore Stock Exchange (dereconized by SEBI) 1984 Manglore, India Regional 15 Magadh Stock Exchange Association (dereconized by SEBI) 1986 Patna, India Regional 16 Bhubaneshwar Stock Exchange 1989 Bhubaneshwar, Regional India 17 Jaipur Stock Exchange 1989 Jaipur, India Regional Saurashtra Kutch Stock Exchange (dereconized by EBI) 1989 Saurashtra, India Regional 19 OTC Exchange of India 1990 Mumbai, India National Vadodara Stock Exchange 1990 Vadodara, India Regional National Stock Exchange 1992 Mumbai, India National 1,646 US $ 1 trillion (Jul. 2012) 22 Coimbatore Stock Exchange 1996 Coimbatore, India Regional 23 Inter-connected Stock Exchange of India 1998 Mumbai, India MCX Stock Exchange Ltd 2008 Mumbai, India National 25 United Stock Exchange 2010 Mumbai, India Source:

64 RESEARCH METHODOLOGY The selections of companies in the sample are based on non-probability purposive sampling (Stepwise sampling). Time span of 10 year from financial year to financial year has been taken for the study. The final selection of companies is based on the criteria of regular announcement of dividend and active trading in the stated stock exchanges (e.g. BSE and NSE) during the span of time taken for the study. Table 3.2 Summarizes stepwise sample selection procedure of companies Steps Procedure and criterion of selection of companies No. of companies and events selected (as on June 2011) NSE BSE Step 1 Start with all the listed companies on NSE and BSE Step 2 Step 3 Step 4 Step 5 Identification of companies which have at least ten dividend events including interim and final dividend over the ten-year period from Financial year to Identify those dividend paying companies which are 627 common to NSE as well as BSE stock exchanges. Categorize companies identified in step 3 into Large 627 Cap, Mid Cap and Small Cap Select companies from each category for event 103 selection if they are in respective Indices of BSE as well as NSE Total number of companies selected 103 Source: Computed from Prowess 3.1data Companies which exhibited at least ten dividend events including interim as well as final dividend in all the ten years covered in the study have been identified adopting the above procedure. The researcher analyzed the dividend history of all 1963 companies (816 NSE listed plus 1147 BSE listed companies). By observation of the dividend history and identifying only those companies which had at least ten dividend related events over the period FY , the list was narrowed down to 627 companies. The category wise break-up 48

65 RESEARCH METHODOLOGY into Large Cap, Mid cap and small cap of these 627 companies appears in Appendix 3.1 adopting the criteria The above 627 companies were further screened for their representation in both NSE as well as BSE indices. The list of companies fulfilling the criteria comprised of 103 actively traded companies, had ten dividend related events over ten year period and were represented in both NSE and BSE indices. The criteria adopted for inclusion of companies in the respective large cap, midcap and small cap categories BSE Indices Source bseindia.com/indices) is as under: i) The average market capitalization aggregating 98.5% of the universe constitutes the eligible universe of companies ii) The large cap companies category includes those company scripts which are traded on 60% of the trading days in the last three months and together cover 80% of the average market capitalization of the eligible universe of companies. iii) Mid- cap companies includes those company scripts which are traded on 60% of the trading days in the last three months and together cover 15% of the average market capitalization of the eligible universe of companies. iv) Small - cap companies includes those company scripts which are traded on 60% of the trading days in the last three months and together cover 5% of the average market capitalization of the eligible universe of companies. Appendix 3.2 lists the break up of the 103 selected companies into respective market cap category along with Industry representation. For brevity, the category wise- break-up appears in the Table

66 RESEARCH METHODOLOGY Table 3.3 Break-up of selected companies based on respective market capitalization Sensex/Nifty 50 BSE- Mid Cap/ S&P NSE Mid Cap BSE- Small Cap S&P NSE Small Cap TOTAL 50

67 RESEARCH METHODOLOGY Table 3.4: Industry wise Classification of the selected companies and proportionate representation of industry to overall selected companies Srl. No. Industry No. of Large Cap companies in sample % of large cap companies in sample No. of Mid- Cap companies in sample % of Mid cap companies in sample No. of Small Cap companies in sample % of Small cap companies in sample Industry wise Total No of companies in sample 1 Auto Ancillary Automobile Banking & Financial Services Cement Chemicals & Pharmaceuticals Construction & Real Estate Diversified Electrical Machinery Electricity Electronics Machinery Ferrous Metal Food & Beverage Gems & Jewellery Health Services Hospitality & Recreational Services 16 Information Technology & Telecommunication Services Industry wise % of companies in sample 51

68 RESEARCH METHODOLOGY 17 Mining Misc. Manufacturing Misc. services Non - Electrical Machinery Non - Ferrous Metal Non - Metalic Mineral Product Textile Industry Transport & Logistic Services Whole Sale & Retail Trading Total Source: Computed from Prowess

69 RESEARCH METHODOLOGY Events Selection: Gurgul et al. (2003) and Apostolos Dasilas (2011), in the study on events study defined the events announcement date as very first official statement on dividends of the executive board of the analyzed company. The Prowess 3.1 data has been used to identify the events announced for Indian Stock Market. On the basis of decisions in the Prowess data base, the following types of events were observed: 1. Interim Dividend (IDIV) 2. Preference Dividend (PDIV) 3. Dividend (DIV) 4. Bonus Shares (BON) 5. Buy Back of Shares (BUY) 6. Split of Shares (SPLIT) 7. Quarterly Result (QTR) 8. Half Yearly Results (HYR) 9. Advance Corporate Tax (ACT) 10. Annual Audited results (AU) 11. New Issue 12. Right Issue (RTS) 13. Issue of Securities in Foreign Market & Currency 14. Merger 15. Acquisition (ACQS) 16. Strategic Business Restructuring 17. Expansion Plan 18. Public Premise Liability (PPL) 19. Listing (LISTG) 20. Delisting (DLISTING) AS the study focusses on signaling effect of dividend decisions in the Indian Stock listed companies, the dividends related decisions have been categorized into following broad groups: 1. Dividend alone 53

70 RESEARCH METHODOLOGY 2. Dividend along with financial results 3. Dividend along with other events except financial results 4. Dividend along with financial results and other events Event Window Selection: The literatures also provides input for the study of events that one must decide the event window.different researchers have defined different time frames for the event window such as 21 days (Apostolos Dasilas (2011), 41 days (Dar-Hsin Chen (2009 ), 71 days (E.B. Del Brio et al. (2002. From all these studies it is clear that there is no consistency in the selection of the period of event window. India being a developing country with evolving capital market, it is characterized by volatility in short span of time. The transparency of the corporate world is questionable and there appears to be large scale insider trading before the announcement of any event. Therefore the researcher has chosen a 61 days period as the event window for the study of signaling impact of dividend announcement. This 61 days is total of event date which is defined 0-days (the date on which event is publically announced) and -30 to +30 days (the date 30 days previous from event date and 30 days post event dates) for the study. This study is associated with the study the stock price behavior surrounding the announcement date and therefore labelled as event study. The methodology of event study is associated with Efficient Market Hypothesis developed by E. F. Fama (1970), to understand the adjustment of stock prices to new information. The methodology is commonly referred to Fama Fisher Jensen and Ross (1969) methodology of event study. The steps followed to study the events are as follows; Step1: Identify the events to be studied and pinpoint the date (t=0) on which the events are announced. 54

71 RESEARCH METHODOLOGY Step2: Take the decision for the event window (ensure that during this period no other important event has been announced). The event window id dividend as t=0 ( Event date) and a period of -30 days previous to event date and +30 days after the event date which is shown below with the help of graph. Figure 3.1: Event Window and Duration of Event t = Source: Edwin J. Elton and Martin J. Gruber, book Modern Portfolio Theory analysis and Investment Analysis. In this figure t=0 is shown as event announcement date and respective effect of this announcement on share prices are calculated for the period of -30 days to +30 days to know if there is any impact of such announcement and for how many days it persists. Table 3.5 presents of the company wise break of dividend events captured for the period of ten years covering FY to FY for the sampled companies. 55

72 RESEARCH METHODOLOGY Table 3.5: Total Events in the Period of 1 April 2000 to 31 March 2011 and the final event selected for the study: COMPANY: EVENTS: Total Event Total EVENTS DIV DIV with Alone RE DIV with Any Oth Ev Exc. RE DIV with RE and any othr Ev Oth Ev Without DIV Selected Events Total EV Sel for Study DIV Alone Sel for study DIV with RE Sel For Study DIV with Any oth Ev Exc.RE Sel for Final Study DIV with RE and Any oth Ev Sel for Final Study Aban Offshore Akzo Nobel India Alok Industries Apollo Hospitals Enterprise Apollo Tyres B E M L B O C India Bajaj Hindusthan Bata India Berger Paints India Bharat Heavy Electricals Bhushan Steel Birla Corporation Oth Ev Without DIV Sel for Study 56

73 RESEARCH METHODOLOGY Blue Dart Express C E S C C M C Carborundum Universal Chambal Fertilisers & Chemicals Cipla City Union Bank Clariant Chemicals (India) Coal India Coromandel International Crisil Deepak Fertilisers & Petrochemicals Corpn. E I D-Parry (India) Eicher Motors F A G Bearings India F D C Federal Bank Finolex Industries G A I L (India) Geodesic Glenmark Pharmaceuticals 57

74 RESEARCH METHODOLOGY Godfrey Phillips India Godrej Industries Graphite India Gujarat Gas Co Gujarat Mineral Devp. Corpn Gujarat State Fertilizers & Chemicals Hero Motocorp Hexaware Technologies Hindalco Industries Hindustan Construction Co. Hindustan Oil Exploration Co Hindustan Unilever Honeywell Automation India Housing Development Finance Corpn I C I C I Bank I T C Infosys Infotech Enterprises Ipca Laboratories J M Financial

75 RESEARCH METHODOLOGY Jindal Stainless Jindal Steel & Power Jubilant Life Sciences K P I T Cummins Info systems Kansai Nerolac Paints Karnataka Bank Karuturi Global Lakshmi Machine Works Larsen & Toubro M R F Magma Fincorp Maharashtra Seamless Mahindra & Mahindra Marico Mercator Monnet Ispat & Energy Motherson Sumi Systems N T P C Nava Bharat Ventures Oil & Natural Gas Corpn

76 RESEARCH METHODOLOGY Orchid Chemicals & Pharmaceuticals Pantaloon Retail (India) Pidilite Industries Praj Industries Prism Cement Rallis India Reliance Industrial Infrastructure Reliance Industries Ruchi Soya Inds S K F India S R F Shree Cement Sintex Industries South Indian Bank State Bank Of India Sterlite Industries (India) Strides Arcolab Sun Pharmaceutical Inds Supreme Industries Tata Consultancy Services Tata Investment Corpn Tata Motors

77 RESEARCH METHODOLOGY Tata Power Co Tata Steel Texmaco Thermax Torrent Pharmaceuticals Trent Tube Investments Of India TOTAL Source: Computed from on Prowess

78 RESEARCH METHODOLOGY Table 3.6 shows the number of different types of dividend related events for the selected 103 companies. Table 3.6: Number of different types of dividend related events: Total No. of Companies Selected Total No. of dividend related Events announced from FY to Standalo ne Dividen d Events Dividend Along with Financial Results Dividend announcement along with and other Events excluding declaration of Financial Results Dividend along with declaratio n of financial Results and other Events In order to perform event study analysis it is necessary to exclude such cases where other events are announced during the window period. The number of isolated dividend related events falling in the window period of 61 days is arrived to be 872 with break-up different types of isolated dividend events appearing in Table 3.7. Table3.7: Number of isolated dividend events in the window period of 61 days. Total No. Dividen Dividend Dividend and Dividend Total No. of d Alone Along with Other Events along with of Events Companie Events Financial Except of financial Relevant s Selected Results Financial Results and for Study Results Other Events Figure3.2and 3.3 showing the total number of events and isolated final selected events are shown with the help of pie chart as under: 62

79 RESEARCH METHODOLOGY Figure3.2: Number of Different type of Dividend Related Events Number of different types of dividend related events Standalone Dividend Events Dividend Along with Financial Results 878 Dividend announcement along with and other Events excluding declaration of Financial Results Dividend along with declaration of financial Results and other Events Figure 3.3: Number of Isolated Dividend Events in the Window Period of 61 Days Number of isolated dividend events in the window period of 61 days Dividend alone event Dividend Along with financial results Dividend with other event except financial results 619 Dividend with financial results alon with other events 63