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Impact of dividend announcements on stock prices with special reference to

Banking Companies in India

Dr. Thejo Jose,

Assistant professor, FISAT Business School, Hormis Nagar, Mookkannoor PO, Angamaly-683577
Ms.Tiya George,
FISAT Business School, Hormis Nagar, Mookkannoor PO, Angamaly-683577

Dividend policy decision is a major constituent in framing the financial policy of a firm and it is
expected to play a major role in the value maximization of a firm. Itbasically deals with whether the
current year and accumulated profits are to be distributed as dividends or to be retained for future
growth and development of the firm.Companies normally estimate that declaration of dividend will
have a direct and positive impact on the share prices. According to Efficient Market Hypothesis, the
stock prices always reflect their fair values on stock exchanges and always incorporate and reflect all
relevant information. Hence it is interesting to study how stock prices move in relation to the dividend
declaration dates. This study attempts to analyse the stock price reaction to dividend announcements
(dividend increase) by 12 banks, listed on NSE Bank Nifty Index and BSE Bankex, during the period
2009-2013.The analysis had been undertaken using Event study methodology. The abnormal returns
and cumulative abnormal returns have been found out to understand the effect of dividend
announcement on the share price. The study exposed the fact that stock prices do react to increase in
dividend announcements and that the Indian stock markets are efficient.

1. Introduction
Banks are the backbone of any economy especially for a developing economy like India as they cater
the ever growing demand for finance to oil the economic growth and development. Banks needs to
raise funds from the general public for meeting the capital requirements of the economy through issue
of shares which are going to be traded on stock exchanges globally. To support this cause banks should
try to increase the value of shares which is influenced by many factors including profitability, spread,
track record, expected growth and financial soundness which is communicated to shareholders mainly
through the dividend paid by the organization. Hence the impact of dividend policy of the company on
the share price is certainly a major financial policy decision for a Bank. There has been a debate
between the academicians as and practitioners regarding the relevance of dividend on the share prices.
For a well-informed investor, they may be indifferent about the payment of dividend or retention and
hence is an irrelevant decision as per Modigliani and Miller (1961). But the dividend signaling theories
projected by Bhattacharya (1979)and Miller and Rock (1985)states that changes in dividend conveys
information about changes in future cash flows and hence there may be an increase(decrease) in share
prices when there is a rise(fall) in dividend payment.
Hence it will be interesting to check how dividend payment of banks affects the share prices. The
dividend policy of banks may vary according to the business cycle and features. A new bank requiring
funds for expansion may go for a no dividend or low dividend policy while an established one may go
for a stable or regular dividend. An irregular dividend pattern will be followed by banks depending on
their changing profitability and requirement of funds.

2. Literature Review
Dividend itself is an important financial decision even when it is considered as an important
determinant in the financing decision. There has been a lot of research connecting the dividend
declaration and share prices. Two school of thoughts existed regarding the impact of dividend on  >  RJCBS:  Volume:  04,  Number:  08,  June-­‐2015                                                                                                                  Page  1  

market value of shares: theory of relevance and irrelevance. But researches across the world indicate a
positive impact of dividend on stock price movements.
The irrelevance theory of dividend by Modigliani and Miller (1961) states that dividend policy may
have no influence on market price of shares under conditions of perfect capital market, rationally
behaving investors, absence of tax discrimination between dividend income and capital appreciation
and firm’s given investment policy. Even if the value of firm increases due to the payment of dividend,
it will be offset by the decline in the market price of shares because of external financing and there will
be no change in the total wealth of the shareholders.
Lintner (1956), prior to irrelevance theory, suggested another approach which states that dividend
payment is relevant to earning performance of firms. According to him, firms will increase dividend
payment when manager is confident over firms’ future performance and they will reduce dividend if
the firm will not be having a prosperous future. These evidences yield a prominent suggestion on
dividend payment characteristic which is called ‘sticky of dividend’. Further,Lintner’s model
suggested that firms cannot disguise the signal by increasing the payout when they do not have ‘true’
increasing on firms’ performance. Ross (1977) also accepts the signaling information of dividend. He
identifies that investors normally form their expectation about future value of firm based on changes in
capital structure and dividend policy. When firms change the policy on capital structure or dividend
policy, then investors will adjust their perception on the future value of the firm and that will
automatically reflect on the stock prices.
The followings are some of the reviews of the literatures which were published recently in the context
of Indian firms.

Thirumalvan & Sunita (2005) studied the impact of Share repurchases & Dividend announcements
on Stock prices in the context of Indian Corporate sector during the period (2002-2004). They
examined the signaling effect of Stock repurchases and Dividend announcements. The study revealed
abnormal returns during various repurchase levels. Firms listed in the BSE Index were taken for the
purpose of empirical investigation. The impact on stock prices five days prior and after the dividend
announcement was covered in the study. The result shows an upward trend of share price movement
after the dividend announcement. The major finding from their study is that positive signaling existed
only for a day after the announcements. The extent of positivism of share price movements starts
declining after the first day. It shows that market reactions in the Indian context to events or
announcements such as share repurchases and dividends are generally reflected ina day or two.
Rao (1999) in a study conducted on BSE listed companies during 1988-89 identified that stock prices
and dividend declaration is positively related so that the stock prices start to move even 2 days before
the declaration date. The adjustments of stock prices occurred exactly on announcement day itself for
bonus announcements; where as in case of right issue announcements, the adjustment started one day
late and it continued till the next day. He attributed this reaction of stock prices to signaling.
Bajaj and Vijh (1995) conducted a study in NYSE listed firms over the period of July 1962 to June
1987 and found a 0.21% average excess return over the three day announcement period. Further they
found evidence of increased information production around dividend announcement days which
resulted in greater trading volume and increased price volatility. There was positive correlation
between excess returns, price volatility and trading volume. It was found that high positive abnormal
returns were available for small firms stocks and low priced stocks. They attributed the abnormal
return to absorption of dividend information.

Akhigbe, Stephen and Madura (1993) measured the share prices response to dividend increase for
both insurance firms and financial institutions. Using event study methodology, they found that
insurance firms’ stock prices react positively to increase in dividendstaking over a four day interval
surrounding the announcements. But it was found that these reactions differ depending upon the
insurer’s primary line of business. Their results showed that the market reaction for each segment of
the insurer is greater than the market reaction for financial institutions.  >  RJCBS:  Volume:  04,  Number:  08,  June-­‐2015                                                                                                                  Page  2  

Below and Jhonson (1996) examined the differential share price reaction to dividend increase and
decrease announcements with respect to cycles in the market phase. They found that market phase has
a significant impact on abnormal returns around the announcement. It appears that more information is
conveyed by dividend increase or decrease announcements which run against the market phase.
In a study conducted by Shaveta Gupta, BalramDogra, A K Vashisht, Shevata Ghai(2012)on Stock
Price Reaction to dividend announcements, it was found that dividend announcements has a positive
impact on stock prices.The study was aimed at analysing the stock price reaction by 28 companies’
stocks listed on BSE Sensex to 65 dividend announcements (increase). The analysis used Event study
methodology and exposed the fact that stock prices do react to increase in dividend announcements
and dividend announcements do have signaling role. The study also concludes that Indian stock market
is inefficient.
Bhattacharya (1979)found that firms announcing dividend initiations and increases will have a
positive abnormal return while a reduction or cutting of dividend will havenegative abnormal returns.
He also states that higher the extent of changes in dividend, higher will be the abnormal returns.
Francis, Schipper and Vincent (2005) states that there will be only mild changes in the stock prices
when there is change in the dividend at a higher rate. This table highlights thethree evaluation criteria
used by the investors:

Table1: Evaluation criteria

Dividend Change Signaling Attribute Expected stock reaction
role clarity
Change in Dividend > 0 No/Low/Medium Confirmatory Clear (High)
(with more margin) (Positive/Negative)
Change in Dividend > 0 (with Clarificatory Clear (Low) Medium/High
less margin) (Positive/Negative)
Change in Dividend <= 0 Unclear Unclear (Low) Low/Medium
Given the above background, the study makes an attempt to examine the effect of dividends on stock
price movements with special reference to Indian Banking sector Companies.

3. Research Methodology
3.1 Research objectives
• To analyze the stock price movements around one particular dividend policy i.e. dividend
• To examine the role and impact of dividend announcements on stock prices.
• To analyze whether changes in dividend policy affect the efficiency of the stock market on

3.2Data characteristics
The population includes banks listed in NSE (National Stock Exchange) Bank Nifty Index and on BSE
Bankex. For this study, secondary data was collected of 12 banks listed on NSE Bank Nifty and BSE
Bankex, which have increased final dividend during 2009- 2013. The following criteria have been
followed for selecting the sample:
a) The company must be listed with NSE Bank Nifty and BSE Bankex.
b) The company must have gone for increase in final cash dividends during 2009- 2013.
c) The company must have only dividend increase announcements without any other corporate event
(e.g. stock splits, share repurchases, stock dividends and right issues).
The banks selected are Axis Bank Limited, Bank of Baroda, Bank Of India, Canara Bank, Federal
Bank, HDFC Bank Limited, ICICI Bank Limited,Indusind Bank, Kotak Mahindra Bank Limited,
Punjab National Bank, State Bank of India, and Yes Bank.  >  RJCBS:  Volume:  04,  Number:  08,  June-­‐2015                                                                                                                  Page  3  

The research work was conducted for a period of 8 weeks. The analytical studies were done with 5
years data. The following are sources of secondary data used in this study: Website of NSE and BSE,
books and journals for theoretical reference and other websites for general information.

3.3 Statistical tools and techniques

The data in the present study has been analyzed by using Event Study. The procedure for event studies
is to investigate whether there are abnormal returns around the announcement date. The announcement
effect exists only if abnormal returns are significant.
Similar to Gurgul et al. (2003), the announcement (event) date has been considered as the occasion of
the very first official statement on dividends of the executive board of the analyzed firm that can be
identified in press releases such as daily newspapers that are nationally circulated and websites. In the
current study, dividend announcement (event) period has been considered as the day of the
announcement, namely, day 0. Finally, the examined period is restricted to five years.
Standard Event Study Methodology:
Fama, Fisher, Jensen and Roll, developed this method to analyse the effect of stock split increases the
wealth of the shareholders. An event test analyzes the security both before and after an event, such as
stock split, dividend, earnings, etc.
For conducting this study, standard event study methodology is used.

The market model assumes a linear relationship between the return of the security to the return of the
market portfolio. The NSE Bank Nifty Index and BSE Bankex have been taken as the benchmark
The abnormal return for each of the day in the event window was the difference between the actual
stock return during that day and the expected normal return according to the NSE Bank Nifty Index
and BSE Bankex. For being able to draw overall inference on the abnormal returns, the abnormal
returns were summed up trading day wise resulting in the average abnormal return (AAR) for each
trading day ‘t’ in the event window. Then, the cumulative average return (CAAR) was computed for
each trading day‘t’ in the event window by adding AAR of each period.
In brief, this approach involved the following sequence:
As the event study methodology specifies, the following tools were used, to test the impact of
announcement on Banking Companies Stock Price:
1. The Daily Returns
The daily returns on each security in the sample were calculated by using:
Ri =P (o) -P(c)
P (o)
Ri = Returns on security i.
P(o) = Opening Price of the security at time t
P(c) = Closing Price of the security at time t  >  RJCBS:  Volume:  04,  Number:  08,  June-­‐2015                                                                                                                  Page  4  

2. Abnormal Returns (AR)
There are three methods commonly used for estimating the abnormal returns namely, mean adjusted
returns, risk – adjusted returns and market adjusted returns. In this study the abnormal returns are
calculated as per the market adjusted abnormal returns. Abnormal returns is excess of actual returns
over the returns from the market index, which is calculated by the following equation:
AR(t )= Ri(t) – Rm(t)
AR(t )= Abnormal returns on security j at time t
Ri(t) = Actual returns on security j at time t
Rm(t)= Actual returns on market index .
3. Average Abnormal Returns (AAR)
The significance of reaction of security price to corporate event announcement are tested through
average abnormal returns (AAR).
AARi = 1 ∑ AR(i,t)
Where, AARi is the average abnormal returns on day ‘t’ and ‘AR is the abnormal return on security ‘i’
at time ‘t’. ‘N’ is the number of samples.
Testing Significance: The significance of the AAR t is tested using the t statistics.
t-stat = AAR x Sq.Rt(n) / S
Where, ‘S’ is standard deviation of abnormal returns and ‘n’ is the number of samples in the event .
4. Cumulative Average Abnormal Returns (CAAR)
The behaviour of security prices to corporate event announcement information are tested using
cumulative average abnormal returns (CAAR). The cumulative average return (CAAR) was
computed for each trading day‘t’ in the event window by adding AAR of each period.
5. Mean Cumulative Abnormal Returns:
It is computed by adding Abnormal returns for each period, and then taking the average of it.
6. Security Returns Variability (SRV)
The relevance of event information (dividend announcement) for valuing the securities are tested by
using the security returns variability (SRV) model.
SRV = Security returns variability of security i in time t
AR is the abnormal return on security i on day t
7. Testing the significance of ASRV
The significance of reaction in prices is tested using the t-test. The t-statistics is calculated as:
t-stat = (ASRVt – 1) x Sq.Rt(n) / S
Where, ‘S’ is standard deviation of abnormal returns and ‘n’ is the number of samples.

3.4 Hypotheses of the study

Null Hypothesis, H01: There is insignificant (zero) share price response to dividend increase
Alternate Hypothesis, H11: There is significant share price response to dividend increase
Null Hypothesis, H02: The Indian stock market is inefficient.
Alternate Hypothesis, H12: The Indian stock market is efficient

4. Data analysis and interpretation

a) Analysis of Abnormal Returns for Sample Event Announcements  >  RJCBS:  Volume:  04,  Number:  08,  June-­‐2015                                                                                                                  Page  5  

Table 2: Average Abnormal Returns of Sample Companies in NSE and BSE
tstat = AAR x tstat = AAR x
10 -0.07% 0.632000258 -0.37% 2.6305
9 0.20% 1.872391645 0.31% 2.2212
8 -0.10% 0.94704454 0.25% 1.7923
7 -0.63% 6.028908582 -0.80% 5.7026
6 -0.07% 0.627845471 -0.11% 0.8136
5 0.23% 2.190959728 0.61% 4.4044
4 0.02% 0.206251359 0.25% 1.7831
3 0.06% 0.55670186 0.13% 0.9223
2 -0.41% 3.885644678 -0.55% 3.9093
1 -0.35% 3.297902145 -0.33% 2.3868
0 0.87% 8.26513521 1.29% 9.2341
-1 0.24% 2.310208205 0.23% 1.6156
-2 0.21% 2.024232202 0.10% 0.7472
-3 -0.09% 0.885245996 -0.29% 2.0830
-4 -0.65% 6.226663951 -0.53% 3.8182
-5 0.12% 1.133235094 0.06% 0.4241
-6 0.44% 4.146038853 0.38% 2.7374
-7 -0.15% 1.44866037 -0.40% 2.8485
-8 0.45% 4.269589637 0.52% 3.7281
-9 0.38% 3.655767304 0.52% 3.6956
-10 0.06% 0.606949639 0.19% 1.3710

All sample banking companies enjoyed positive Average Abnormal Returns on the day of
announcement. The sample banks in NSE registered highest value of AAR 0.87% (and statistically
significant at 95%), on the announcement day. The sample banks in BSE registered highest value of
AAR 1.29% (and statistically significant at 95%), on the announcement day. In other words, investors
would have obtained better returns on the announcement day for their investment in those sample
companies. The abnormal returns reached a significant level due to announcement. From the overall
analysis of the Table, it is clear that after the announcement, the average abnormal returns of the
sample companies started to decrease continuously.
Thus, Null Hypothesis, H01: There is insignificant (zero) share price response to dividend
increase announcements, is rejected and Alternate Hypothesis, H11: There is significant share
price response to dividend increase announcements, is accepted.
Table 3: Average Cumulative Abnormal Returns of Sample Companies in NSEand BSE
Mean tstat = Avg CAR x SQRTn
T Mean CAR tstat = Avg CAR x SQRTn / S CAR /S
-1 to 1 1.03 24.70 1.67% 56.81
-2 to 2 0.81 19.43 1.52% 42.02
-3 to 3 0.70 16.90 1.44% 39.56
-4 to 4 0.65 15.65 1.34% 39.65
-5 to 5 0.66 15.83 1.28% 43.55
-6 to 6 0.66 15.79 1.27% 43.46
-7 to 7 0.62 14.89 1.23% 45.22  >  RJCBS:  Volume:  04,  Number:  08,  June-­‐2015                                                                                                                  Page  6  

-8 to 8 0.59 14.23 1.16% 45.98
-9 to 9 0.57 13.55 1.17% 46.25
-10 to
10 0.53 12.74 1.11% 44.68
A close examination of the above Table reveals that dividend initiations have the most significant
abnormal returns in the 1-day window, highest return being 1.03% in NSE and 1.67% in BSE and as
the analysed time period widened the mean CAR decreased and reached 0.53% in NSE and 1.11% in
BSE. A possible explanation for the result here could be that the market reaction in the Indian market
is complete within a day and there is no lagging response to dividend announcements. This also
suggests that the Indian stock market responds quickly and efficiently to the information content in
dividend announcements. Hence, we can conclude that the Indian stock market is efficient and thus
results in rejecting the null hypothesis, and accepting the alternate hypothesis.
Table 4: Average Security Return Variability Of Sample Companies In NSE and BSE
T ASRV tstat = (ASRVt – 1) x sqrt(n )/ S ASRV tstat = (ASRVt – 1) x sqrt(n )/ S
10 1.03 0.40796 1.21 2.901975567
9 0.79 2.69349 0.97 1.42567223
8 0.76 3.12462 0.94 0.803027536
7 0.98 0.20486 1.14 1.908354135
6 0.87 1.68920 1.00 1.46977552
5 0.97 0.41595 1.04 0.60920899
4 1.40 5.20972 1.45 6.127074162
3 0.78 2.89996 0.73 3.692985189
2 1.05 0.59903 1.04 1.82513865
1 1.25 3.27250 1.20 2.723620186
0 1.91 12.01939 1.85 11.69031727
-1 0.83 2.23312 0.77 3.086427309
-2 0.83 2.29874 0.88 1.591014601
-3 0.92 1.10951 0.85 2.0414397
-4 0.89 1.42153 0.86 1.970755531
-5 1.04 0.51677 1.02 0.337243248
-6 0.87 1.66023 0.89 1.444846546
-7 0.76 3.18855 0.80 2.744958526
-8 0.96 0.56285 1.10 1.318847641
-9 0.95 0.71359 0.99 0.121599581
-10 0.90 1.30590 0.87 1.732673707

The above table shows the results of ASRV and t-statistic for the 21 day event window. The ASRV for
sample banking companies volatilized with the highest value of 1.91for NSE and1.85 for BSE on the
announcement day (Day 0). From the analysis, the ASRV on the dividend announcement day is
statistically significant at 95%. Hence, it strongly supports, for rejecting the null hypothesis (H01)
of insignificant (zero) share price response to dividend announcements and accepting the
alternate hypothesis of significant share price response to dividend announcement.

5. Conclusion
There hasn’t been a consensus among the academic researchers and practitioners regarding the level of
impact of dividend policy on the market price of the shares. But dividend policy certainly affects the
shareholders to a great extent. The outcomes of this study also indicates the strong correlation between
dividend payment and share prices. The Indian stock market is considered as an efficient one in
relation to the impact of dividend information on the share prices. Globally, the extent of this effect  >  RJCBS:  Volume:  04,  Number:  08,  June-­‐2015                                                                                                                  Page  7  

may vary from economies to economies on the basis of tax policies, market structure and economic
policies of the Government. The upward movement of share prices around the dividend announcement
date certainly proves the applicability of dividend signaling theory in the banking sector of India. The
impact may vary in other sectors of the same economy which can be analyzed in further studies.
Banks supports the economic framework and fuels the economic growth of an economy. Hence a
strong understanding of the investors and their expectations will boost the sector that will ultimately
lead to economic prosperity.

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