Assignment of Fin-2206: Financial Management

Assignment of Fin-2206: Financial Management

A Report On Signaling Theory in Bangladesh

Submitted to Md. Omar Faruque Course Instructor/ Lecturer, Department of Finance, Faculty of Business Studies Jagannath University, Dhaka Submitted by Sultan Ahmed Khan Representative of the group Epimetheus BBA 3 rd Batch Department of Finance, Faculty of Business Studies Jagannath University, Dhaka.

Group Name: Epimetheus Group No: Name of the members of the group: Serial No: Name of the members of the group Roll Number 01 Sultan Ahmed Khan 091597 02 Md. Mynul Islam 091633 03 Mamunur Rashid 07882747 04 Md. Mofazzal Hossen 091615 05 Sharjil Ahmed 091623 06 Md. Anik Mahmud 091636 07 Protiva Talukder 091602 08 Md. Mehedi Hasan 091590 09 Mohammad Didarul Islam Khan 091613 Group Representative: Sultan Ahmed Khan. Group Coordinator Contact : Md. Mynul Islam. : epimetheus.jnu@gmail.com

July 19, 2011 The Course Instructor, Md. Omar Faruque, Lecturer, Department of Finance, Jagannath University, Dhaka. Sub: Thanks giving letter to the respective faculty member. Sir, We are the student of Department of Finance (3 rd batch) of Jagannath University, Dhaka & also from the group named Epimetheus. We are very much enthusiastic about our presentation. We are really happy to have such a presentation of challenging and interesting like this presentation & also thanks to you for making us worthy for corporate. Our presentation topic is Signaling Theory in Bangladesh. We have learned many things from this topic which will help us in future to conduct as an analyst of finance. There were some obstacles we have faced at the time of collecting data about our topic. But we have overcome all the obstacles by the endeavor effort by each member of our group and tried our best to give an overview of our topic. We the group Epimetheus tried our best to make this presentation attractive, impeccable, interesting, informative and enjoyable by the help of electronic and print media in association with our honorable teacher, mentor, counselor, instructor and advocate Md. Omar Faruque. We are really grateful to him. We had limitations at the time preparing presentation. So mistakes may occur in our demonstration of our presentation. We hope that, you will exempt our mistakes. Thanking in anticipation, Yours Fidel, Sultan Ahmed Khan Group Representative, Group- Epimetheus BBA 3 rd Batch Department of Finance Jagannath University,Dhaka.

First of all we would like to thank the Almighty for giving us the strength, and the aptitude to complete this report within due time. We are deeply indebted to our course teacher, mentor, and counselor, Md. Omar Faruque for assigning us such an interesting topic named Signaling Theory in Bangladesh. We also express the depth of my appreciation to our honorable course teacher for his suggestion and guidelines, which helped us in completing this report.

In economics, more precisely in contract theory, signaling is the idea that one party (termed the agent) credibly conveys some information about itself to another party (the principal). A theory that suggests company announcements of an increase in dividend payouts act as an indicator of the firm possessing strong future prospects. A manager who has good investment opportunities is more likely to "signal" than one who doesn't because it is in his or her best interest to do so. After completing this study we will learn about the signaling theory. We will show that dividend has no significant effect over the stock price in Bangladesh capital market. Although some banks did not allow dividend to the share holder but the stock price continued to rise. On the other hand some allowed dividend they also observed rising price of the stock. This is nothing but the normal pace of the capital market. Authority cannot overlook factor individually. We have found from the signaling theory of capital structure that investment opportunities in last few years in sound in Bangladesh. The trend of the growth of the EPS is fluctuates with the normal pace of the capital market. This study examines stock price reactions of listed Private Commercial Banks (PCBs) in Bangladesh surrounding 44 days of the dividend announcement dates. The major objective of this study is to identify whether dividend announcement convey any information to the DSE that results a price reaction for adjusting the dividend announcement information. A negative relationship between dividend announcement stock returns is expected due to tax effect, but researchers tended to relate the positive relationship between stock returns and dividend announcement with the information effect of dividend.

NAME Page no Executive Summary Introduction Chapter- 01 Introduction 01 Rational of the study 01 Objective of the study 02 Scope of the study 02 Methodology of the study 02 Limitations of the study 02 Body of the term paper Signaling Theory 03 Collection of Data 03 Uses of signaling theory 04 Signaling theory on dividend policy 04 Chapter- 02 Analysis 05 Comment 06 Signaling theory on capital structure 07 Analysis & Islami Bank Ltd. 07-08 Analysis & AB Bank Ltd. 09 Analysis & Trust Bank Ltd. 10 Chapter-03 Findings of the study 12 Conclusion 13 Bibliography 13

Contents of Tables, Graphs NAME Page No Graph of EPS 06 Islami Bank BD Ltd. at a glance 07 AB Bank Ltd. at a glance 09 Trust Bank Ltd. at a glance 10 Summary of EPS of sample banks 11

Chapter- 01 Introduction In economics, more precisely in contract theory, signaling is the idea that one party (termed the agent) credibly conveys some information about itself to another party (the principal). A theory that suggests company announcements of an increase in dividend payouts act as an indicator of the firm possessing strong future prospects. A manager who has good investment opportunities is more likely to "signal" than one who doesn't because it is in his or her best interest to do so. In this report we tried to show that how signaling theory works in the business organization by managers & whether it is important or not for determining the stock price in Bangladesh share markets like DSE & CSE. Rationale of the study The case study is assigned by our course teacher Md. Omar Faruque as a part of our Financial Management course. The topic of our case study is Signaling Theory in Bangladesh. By conducting this study we can enhance our knowledge and skill to apply various research methods in professional life on higher educational life. The report has given us a chance to raise our quality in developing research instrument and its applications. By doing so, we can boost our acceptability in job market and develop our real life knowledge. Objective of the Case Study Primary objective The main objective of the study is to know how the factors of signaling theory work in our capital market. Secondary objective: The case study has the following objectives: To know about signaling theory. How signaling theory fluctuate the share price. Relationship among signaling theory and stock price in Bangladesh. Causes behind the changing of share price and signaling theory.

Scope There were huge scopes to work in the area of this Report. Considering the dead line, and exposure of the paper has been wide-ranging. The study Signaling Theory in Bangladesh has covered overall scenario of capital market situation of Bangladesh. It has measured the living standard of mass people. We have a chance to work on the financial variable used in modern finance & business world. By doing the report, we are able to know that the importance of signaling theory to assess how the expert of the country using it. In the report we have showed how the signaling theory used to forecast & how much this is significant for determining the share price. Methodology We have used the concept of the course, information of the case study. Sources of Data Here the secondary sources of information were used. The secondary sources are: Books. Financial Reports. Website. Limitations While conducting the report on Signaling Theory in Bangladesh, some limitations were yet present there: Because of time shortage many related area can t be focused in depth. Website in different organization of Bangladesh contains poor information. Recent data and information on different activities was unavailable. Limited access to the information of the organizations.

Chapter-2 Signaling Theory Definition Signaling theory is a body of theoretical work examining communication between individuals. The central question is when organisms with conflicting interests should be expected to communicate "honestly". Mathematical models in which organisms signal their condition to other individuals as part of an evolutionarily stable strategy are the principal form of research in this field. In economics, more precisely in contract theory, signaling is the idea that one party (termed the agent) credibly conveys some information about itself to another party (the principal). We use the term signaling theory in the field of finance including the variable of financial statements to forecast the proper value maximization. Signaling Theory of Capital Structurean improvement on Tradeoff Theory: This is another modification of the theory of Miller Modigliani Capital Structure. Insiders (Managers and Owners) Know Better When Firm s Future genuinely looks Good (i.e. High forecasted Cash Flows, Earnings, NI, and ROE) then Managers will choose to raise financing through Debt (or Bonds or Loan) because they do not want to share the Financial Gain with More Shareholders. Rather They Prefer to Take on Debt and pay a small interest to the Debt Holders. There is almost no risk of Default. When Firm s Outlook looks bad, then Managers will choose to raise capital by Issuing Equity (or Stock) to be able to share the Likely Losses amongst more Shareholders (Owners). If they took Debt and couldn t repay it, they might Default and be forced to go Bankrupt. Collection of Data Here we have used all the listed banks (25) in DSE to measure the population of the market in Bangladesh (Banking sector) to determine the significance of the dividend on stock price as a part of signaling theory. As we know that signaling theory is used to forecast the future, so here the use of historic data is necessary to analyze the signal. Here we have used three banks as a sample data to measure the population of the market in Bangladesh (Banking sector) as a part of signaling theory. In this study we will see the change of Asset, Debt & Equity and its impact on dividend & EPS as a part of signaling theory.

Uses of signaling theory Here we have found that signaling theory is used in the two specific fields to forecast the organizations capital structure and earnings per share (EPS) after a period. The fields are given below: Uses of signaling theory Signaling theory on Dividend Policy Signaling theory on Capital Structure Chart: uses of signaling theory in financial market. Signaling theory on Dividend policy This study examines stock price reactions of listed Private Commercial Banks (PCBs) in Bangladesh surrounding 44 days of the dividend announcement dates. The major objective of this study is to identify whether dividend announcement convey any information to the DSE that results a price reaction for adjusting the dividend announcement information. A negative relationship between dividend announcement stock returns is expected due to tax effect, but researchers tended to relate the positive relationship between stock returns and dividend announcement with the information effect of dividend.

Analysis This is the analysis of the stock prices of 44 days when dividend was given. We measure the mean & standard deviation to prove the relevance theory or the signaling theory at DSE.

Comment Impact of dividend announcement on stock prices behavior of 25 selected private commercial banks has been analyzed. Dividend announcement generates a very low significant impact on the stock price movement. The adjusted mean return index of the stocks 30 days before dividend announcement is tk.98.28 whereas the adjusted mean return index in the price adjustment period (7 days after the no price limit date related to dividend announcement) is tk.100.09 and 7 days before the recode date is tk.105.25. In this case, stock price increases by 1.84% in the price adjustment period after the dividend announcement and 7.09% in the period when investors wishes to avail the dividend benefit (7 days before record date). Thus it is evident that dividend announcement has a very less significant impact on stock price changes in the price adjustment period. Findings also show that investors lost more value in the ex-dividend period than the value gained in the pre-dividend period. In academic literature, it was suggested that dividend payments have no impact on the shareholders value (Miller and Modigliani, 1961) in the absence of taxes and other market imperfections. A dividend payment provides cash flow to the shareholders but it reduces firm s recourses for investment. Hence, firms should not pay dividend if they have any positive net present value project in hand. Now it is proven that post dividend price of stock does not significantly affect the price. The little change of price of post dividend period at DSE is the response of the Giant investors those who manipulate the total market. Here we have found that mean and standard deviation of the banks in Bangladesh fluctuates with the normal flow of capital market. Some where the prices of the stock increase some where the prices of the stock decrease after the dividend announcement showed in the following figure. In a word signal of dividends are quit irrelevant at DSE as well as CSE. Graph of the data

Signaling theory on Capital Structure We use the term signaling theory in the field of finance including the variable of financial statements to forecast the proper value maximization. Signaling Theory of Capital Structurean improvement on Tradeoff Theory: This is another modification of the theory of Miller Modigliani Capital Structure. When Firm s Future genuinely looks Good (i.e. High forecasted Cash Flows, Earnings, NI, and ROE) then Managers will choose to raise financing through Debt (or Bonds or Loan) because they do not want to share the Financial Gain with More Shareholders. This is the signal to the share holders of the banks or financial corporations. Analysis Here we have used three banks as a sample data to measure the population of the market in Bangladesh (Banking sector). The sample data contains the following three banks. Islami Bank BD Ltd. Year Asset Liability Equity Retained earning Dividend EPS 2008 230,879,135,344 216,818,643,365 14,060,491,979 1,425,600,000 No data 43.3 2009 278,302,839,706 258,197,295,853 20,105,543,853 1,853,280,000 No data 55.1 2010 330,586,118,276 307,091,862,514 23,494,255,762 2,594,592,000 617,760,000 60.21

The analyzing of the information Due to raise of liability and equity every year there is also a raise in retained earnings, dividend & EPS. Because in that year 2008 2010 the rate of interest was lower so that the total industry has raised their liability. In those years investment opportunities was enough to invest the total retain earning. So the banks did not allow any dividend to the share holders. Although the dividend is lower but their stock price is continued rising because of the growth of the banks as well as economy. It provides a positive signal that here the corporation is maintaining a proper and effective capital structure. Now it is concluded that the investment in that year is safer in DSE.

AB Bank Limited Year Asset Liability Equity Retained earning Dividend EPS 2008 84053612585 77,331,107,238 6,722,505,347 1,789,769,440 No data 82.72 2009 106,912,312,383 96,825,789,451 10,086,522,932 3,541,969,135 334,467,810 104.91 2010 134,003,878,314 119,121,750,377 14,146,877,356 4,979,826,528 490,304,794 115.31 The analyzing of the information Due to raise of liability and equity every year there is also a raise in retained earnings, dividend & EPS. Because in that year 2008 2010 the rate of interest was lower so that the total industry has raised their liability. In those years investment opportunities was enough to invest the total retain earning. So the banks did not allow any dividend to the share holders in the year 2008. Because of higher level of income they forced to allow dividend During that year the banking industry continues to grow so that EPS continues to rise. It provides a positive signal that here the corporation is maintaining a proper and effective capital structure. Now it is concluded that the investment in that year is safer in DSE.

Trust Bank Limited Year Asset Liability Equity Retained earning Dividend EPS 2008 38,534,721,576 35,415,068,589 3,119,652,987 486,833,118 No data 31.96 2009 54,206,648,607 50,451,782,551 3,754,866,056 463,963,772 No data 33.06 2010 58,360,673,800 53,250,975,098 5,045,020,636 1,142,729,910 No data 57.48 The analyzing of the information Due to raise of liability and equity every year there is also a raise in retained earnings & EPS. Because in that year 2008 2010 the rate of interest was lower so that the total industry has raised their liability. In those years investment opportunities was enough to invest the total retain earning. So the banks did not allow any dividend to the share holders. Although the dividend is zero but their stock price is continued rising because of the growth of the banks as well as economy. It provides a positive signal that here the corporation is maintaining a proper and effective capital structure. Now it is concluded that the investment in that year is safer in DSE.

In a word we can conclude that We have come to this point after analyzing above banks as the sample of the population (Banking Industry). On those years investment opportunities was high enough and the growth of the industry is satisfactory. This is the reason that the market was profitable for the share holders. The following graph represents the word that EPS is raising through the period whereas the dividend is paid or not. Thus there is no significant effect on the EPS in Bangladesh for dividend announcement. Limitations of signaling theory We have found one limitation here. That is except numerical data nothing is counted here. Suppose hartals & riots cause a great loose in the economy but it cannot be measured under this theory.

Chapter-03 Findings and conclusion Findings of the study The intension of this study is to know how to work with digital information system. The major findings of the overall study are discussed below: Significance of signaling theory in Bangladesh. How far it is used in Bangladesh. Reason behind the factors of changing EPS. Historical trend of some banks collected as a sample to measure the population. The overall economic & financial scenario of Bangladesh.

Conclusion After completing this study we have learnt about the signaling theory. We have also leant that dividend has no significant effect over the stock price in Bangladesh capital market. Although some banks did not allow dividend to the share holder but the stock price continued to rise. On the other hand some allowed dividend they also observed rising price of the stock. This is nothing but the normal pace of the capital market. Authority cannot overlook factor individually. We have found from the signaling theory of capital structure that investment opportunities in last few years in sound in Bangladesh. Bibliography Books Scott Besley & Eugene F. Brigham; Essentials of Managerial Finance ; 13 th Edition. (South-Western: Thomson, 2010-2011). Financial Reports of the banks. Web Sites www.trustbank.com.bd www.abbank.com.bd http://www.islamibankbd.com http://www.dsebd.org