A Report

On

Impacts of dividend policy on share price

Course code: Mgt-303

Course title: Financial Management

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 Impacts of dividend policy on share price

Prepared for
Shah Ridwan Chowdhury
Assistant professor
Department of Management
Faculty of Business Studies
University of Dhaka

Prepared by
Group-21
Future Entrepreneurs

02 May, 2016

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 Group Profile
Future Entrepreneurs

ID Name Remarks

112 Md. Biplob Hossain

128 Tajul Islam

161 Md. Nasim Uddin

165 Md. Anamul Haque

207 Mahamudur Rahman

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Letter of Transmittal

02 May, 2016

Shah Ridwan Chowdhury

Assistant professor

Department of Management

University of Dhaka

Subject: An appeal for acceptance of this report.

Dear Sir,

According to your direction and the requirement of Financial Management (Mgt-303) course, a
report is made on “Impacts of Dividend policy on Stock price”. As this process is for learning,
we request you to accept this report with considering our all limitations.

Thanking

Future Entrepreneurs

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 Table of Contents

Serial no. Name of topic Page

1 Executive summary 1

2 Introduction 2

3 Literature review 3

4 Objective of the study 7

5 Limitations of the study 8

6 Analysis and Findings 9

7 Conclusion 11

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 Executive Summary

How dividend policy decisions affect a firm’s stock price, is a widely researched topic in the
field of investments and finance but still it remains a mystery that whether dividend policy
affects the stock prices or not. There are those who suggest that dividend policy is irrelevant
because they argue a firm’s value should be determine by the basic earning power and business
risk of the firm, in which case value depends only on the income (cash) produced, not on how the
income is split between dividends and retained earnings and opponents of this statement called
dividend is irrelevance, that investors care only about the total returns they receive, not whether
they receive those returns in the form of dividends, capital gains or both. The results of
researches conducted in various stock markets are different. There are many internal and external
factors, which simultaneously affect stock prices and it is almost impossible to segregate the
effect of each so the variations remain. Attempts are made to examine, what kind of relationship
exists between dividend policy and stock market returns of private commercial banks in
Bangladesh. Overall results of this study indicate that Dividend Policy has significant positive
effect on Stock Prices. It is very difficult to come to a decision that dividend actually influences
market price of stock in Bangladeshi stock market because of the greatest fall of the market in
the recent past. Stock price is also affected by some other reasons and that’s why to conclude the
decision is very tough as stock price is affected by dividend policy of the companies like banks
of Bangladesh. According to the analysis of this paper and with the calculation of company’s
data, stock price is highly correlated with dividend policy of company.

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 Introduction

Dividend policy is a major financing decision that involves with the payment to shareholders in
return of their investments. Every firm operating in a given industry follows some sort of
dividend payment pattern or dividend policy and obviously it is a financial indicator of the firm.
Thus, demand of the firms share should to some extent, dependent on the firm`s dividend policy.

Dividend policy is one of the most widely researched topics in the field of finance but the
question is whether dividend policy affects stock prices still remain debatable among managers,
policy makers and researchers for many years. Dividend policy is important for managers,
investors, lenders and for other stockholders. It is important for investors because investors
consider not only the sources of income but also a way to assess the firms from investment point
of view. It is the way of assessing whether the company could generate cash or not. Many
investors like to watch the dividend yield, which is calculated as the annual dividend income per
share divided by the current share price. The dividend yield measures the amount of income
received in proportion to the share price. If a company has a low dividend yield compared to
other companies in its sector, it can means two thing: (1) the share price is high because the
market reckons the company has impressive prospects and isn`t overly worried about the
company`s dividend payments, or (2) the company is in trouble and cannot afford to pay
reasonable dividends. At the same time however a high dividend yield can signal a sick company
with a depressed share price. Dividend yield is of little importance for growth companies
because, retained earnings will be reinvested in expansion opportunities, giving shareholders
profits in the form of capital gains.

Selecting a dividend policy is important for the bank because flexibility to invest in future
projects depends on the amount of dividends that they pay to their shareholders. If company pay
more dividends then fewer funds available for investment in future projects. Lenders are also
interested in the amount of dividend that a company declares, as more amounts is paid as
dividend means less amount would be available to the company to pay off their obligation. So,
the study will investigate the relationship between dividend policy and its impact on market
performance of the share. In this report, we will examine with some real life sample (commercial
banks) that whether the dividend policy has any effect on the firm`s share price. We just focus on
the specific factor; the dividend policy.

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 Literature Review

Irrelevance of dividend policy

(Miller & Modigliani, 1961) proposed irrelevance theory suggesting that the wealth of the
shareholders is not affected by dividend policy. It is argued in their theory that the value of the
firm is subjected to the firm’s earning, which comes from company’s investment policy. The
literature proposed that dividend does not affect the shareholders’ value in the world without
taxes and market imperfections. They argued that dividend and capital gain is two main ways
that can contribute profits of firm to shareholders. When a firm chooses to distribute its profits as
dividends to its shareholders, then the stock price will be reduced automatically by the amount of
a dividend per share on the ex-dividend date. So, they proposed that in a perfect market, dividend
policy does not affect the shareholder’s return.

Relevance of dividend policy based on Uncertainty of future dividends (Gordon, 1962)

suggested a valuation models relating the market value of the stock with dividend policy. Gordon
studied dividend policy and market price of the shares and proposed that the dividend policy of
firms affects the market value of stocks even in the perfect capital market. He stated that
investors may prefer present dividend instead of future capital gains because the future situation
is uncertain even if in perfect capital market. Indeed, he explained that many investors may
prefer dividend in hand in order to avoid risk related to future capital gain. He also proposed that
there is a direct relationship between dividend policy and market value of share even if the
internal rate of return and the required rate of return will be the same. In (Gordon, 1962)’s
constant growth model, the share price of firm is subordinate of discounted flow of future
dividends.

Relevance of dividend policy based on information content of dividend (Miller &

Modigliani, 1961) suggested that in imperfect market, dividend may affect the shareholders
price. So dividend announcements can be interpreted as a signal of future profitability of firm.
(Asquith & Mullins Jr, 1983) used a sample of 168 companies paying dividend for the first time
or paying dividend after at least 10-year interruption and studied the relationship between market
reaction and dividend announcement. They analyzed the daily abnormal stock returns for the ten-
day period prior and ten-day period following the dividend announcement.

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Impact of dividend policy on share price volatility

(Baskin, 1989) used a different method and examined the association between dividend policy
and stock price volatility rather than returns. He added some control variables for examining the
association between share price volatility and dividend yield. These control variables are earning
volatility, firm’s size, debt and growth. These control variables do not only have clear effect on
stock price volatility but they also affect dividend yield. For instance, the earning volatility has
effect on share price volatility and it affects the optimal dividend policy for corporations.
Moreover, with assumption that the operating risk is constant, the level of debt might have
positive effect on dividend yield. Size of firm would be expected that affect share price volatility
as well. That is, the share price of large firms is more stable than those of small firms as the large
firm tend to be more diversified. Furthermore, small firms have limited public information and
this issue can lead to irrationally react of their investors. (Baskin, 1989)’s work was based on
following fundamental models that connect dividends to risk of stock. The models are the
duration effect, the rate of return effect, the arbitrage pricing effect and the information effect.
(Baskin, 1989) proposed that fluctuation in the discount rate has less impact on high dividend
yield stocks because high dividend yield can be a signal of more near-term cash flow so the firm
with high dividend yield would be expected to have less volatility in share price. This is then
being named as duration effect. (Baskin, 1989) used the Gordon growth model for demonstrating
this effect. Moreover, he explained that based on the rate of return effect, it is possible that firms
with low dividend yield and low pay out to be assessed more valuable than their assets in place
due to their growth opportunities. Since forecasts of earning from growth opportunity have more
error than prediction of earning from assets in place, companies with low pay out and low
dividend yield are expected to have more volatility in their share price. He also proposed that
higher dividend yield will lead to higher arbitrage profit because the excess return is subordinate
of dividend yield and price discount rate. Baskin also argued that managers can control the stock
price volatility and stock risk by dividend policy and Distribution of dividend at the time of
earning announcement may be interpreted as signal about stability of firm.

The Effects of Dividend Policies on Stock Prices

The accumulated profits of a firm are recorded in the retained earnings account of stockholders’ equity, which
is the surplus of assets over liabilities. Retained earnings are the only source for dividend payments, whereas
internal growth, in the form of new projects, asset purchases, etc., can be financed using retained earnings, new
issues of stock, and/or with debt. Cash dividends, if paid, are usually declared and distributed quarterly, Stock
dividends are occasional distributions of additional stock to shareholders. The dividend yield is the annual
dividend amount divided by the current share price.

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Dividend Discount Model

The dividend discount model posits that the current stock price is equal to the present value of all future
dividend payments. As the present value increases, stock prices rise. Thus, higher dividends translate directly
into higher stock prices. There are problems with the model, however. It doesn’t explain the prices of non-
dividend stocks, and it expects that the rate of capital gains growth will always be steady and not exceed
investors' required rate of return, which is known as the cost of capital.

Modigliani-Miller Theorem

The Modigliani-Miller Theorem states that shareholders are indifferent to the division of retained earnings into
dividends and new investments. If correct, it predicts that the amount of retained earnings spent on dividends,
which raise stock prices, is offset by the effect of issuing new stock to replace the money spent on dividends,
which lowers stock prices. The model doesn’t consider the use of debt instead of new stock issuance. The M-
M Theorem concludes that dividend policy does not affect stock price.

Clientele Effect

The clientele effect is an acknowledgment that income-oriented investors are drawn to dividend-paying stock,
while those who are less risk-adverse prefer capital gains. Thus, if a company makes substantial changes to its
dividend policy, some shareholders will approve and may buy additional shares, while other shareholders will
sell their shares and find others that are more to their liking.

Signaling Effect

This theory states that an increase in the dividend rate should be viewed as a vote of confidence by the
corporation board about the company’s prospects to increase growth and earnings. If the board thought that the
firm would be short of funds, it would cut dividends rather than raise them. Since board directors know the
most about the company, the positive signals it sends should be viewed by investors as a reason to buy shares
and thus raise share prices.

When Dividends Go Down

If a company reduces the dividend it pays on its stock, the stock becomes less attractive to
investors. That means that the price of the stock will drop. If you own this stock, you will not
only receive a lower dividend, but you will also watch your share prices fall. The market reacts
very quickly to dividend changes, so even a hint of a dividend reduction can cause your stock to
go down in price.

When Dividends Go Up

When dividends go up, the stock becomes more attractive to buyers. That increased demand will
cause sellers to raise the price to gain more profits. If you hold this dividend stock, the share
price will go up as the dividend rises. Investors generally consider rising dividends a sign of a
company's good health. Always make sure the company that issues the dividend stock reports

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growing profits along with the increased dividend. Avoid companies that raise their dividends
without increased profits to make their stock look more attractive, because those companies may
not be able to pay the increased dividend over time.

Company Signals

You can anticipate changes in dividends by going on the company's website, reading the annual
report, participating in quarterly calls and paying close attention to any press releases issued by
the company regarding dividend changes. The stock price will react before the actual dividend
change based on company news. Your stock price will also rise or fall based on profit and sales
projections, because these tend to be leading indicators of a coming change in dividends.

Anticipating Dividend Changes

You should also pay attention to many non-company indicators so you can anticipate changes in
dividends. Keep up with analyst ratings and expectations, news headlines and industry
announcements that could affect the particular company that issues your stock. Use such market
signals to determine whether the dividend is likely to rise or fall so you can make buying and
selling decisions long before any announcement of a reduced or increased dividend.

How Dividends Affect Stock Price

When a company goes through the process of issuing a dividend, the company’s stock price can
potentially be impacted in two different ways:

1. If the company declares a dividend payment that’s higher or lower than expected, market
sentiment may shift causing the stock price to rise or drop accordingly.
2. An expected change in price occurs on the ex-dividend date when the company decreases
its market cap by the declared shareholder payout.

Price Changes on Declaration Day

When a company declares a dividend amount that’s higher or lower than expected, the
company’s stock price can fluctuate in response to the declaration. Let’s consider two examples.

Example 1: A Lower-than-Expected Dividend is announced

Let’s say company XYZ typically pays a dividend of $0.50 per share and has stuck to that
amount for the last 5 years. Then, XYZ declares a dividend amount of only $0.04 per share.

In this case, the market sentiment around company XYZ may cause its stock price to drop as
investors speculate as to the reasons why the dividend amount was lower than normal.

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Example 2: A Higher-than-Expected Dividend is announced

Sticking with the same hypothetical company, let’s say XYZ just announced a dividend of $0.60
per share – up 10 cents from previous dividend payments. In this case, market sentiment around
the company may cause a rise in stock price as investors wonder if the company is exhibiting
more growth.

Price Changes on the Ex-Dividend Date

When a company issues a dividend, the cash that makes up the dividend payment no longer
belongs to the company. Because this is transferred to shareholders, the company’s share price is
reduced by the amount of the dividend payment on the ex-dividend date.

For stocks with small dividend payments, you may not even notice the decrease; one or two
cents per share may look like normal trading activity. Bigger dividend payouts, however, can be
more noticeable. In 2004, the share price of one stock dropped by more than $2.00 per share
when a company paid out dividends.

Objective of the study

The principal objective of the study is to evaluate the effect of dividend policy on share price of
some selected listed companies in Bangladesh. To accomplish this objective following specific
objectives have covered:
 To examine the relationship between dividend per share and share Price.
 To evaluate the dependency of dividend per share and retained earnings on share price.
 To draw inferences on the basis of analysis.

Hypotheses of the Study

Hypothesis is the statement that shows the inferred relationship among different variables. The
conjectured relationships between the variables are established on the basis of available
literature. These relationships can be verified using certain statistical tests or techniques. These
hypotheses may be substantiated or not, depending upon the results derived from statistical
analysis. As per the objectives of the study, the following hypothesis was developed for testing:
H1: Dividend policy has significant effect on share price. So the hypothesis is-

Ho: There is no significant effect of dividend policy on share price

HA: There is a significant effect of dividend policy on share price

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Data collection and analysis methodology

The report is prepared by collecting data from the sources like;

a) Secondary sources: Annual report of IBBL-2013, Annual report of IFIC bank-2014, Annual
report of Marchentile bank Ltd.-2014, Annual report of Prime bank Ltd.-2014.
b) Data is analyzed by following the formula of statistics.

Limitations of the study

For the lack of proper knowledge and insufficiency of available data are the basic limitations of
this report. Moreover, in a fallen stock market of Bangladesh stock price of commercial bank is
not worthy according to the demand. As there is a negative scenario in the banking sector to lend
money stock price is not in its real price. These market constraints along with insufficiency of
time are the limitations of this report. Instead of all these limitations, it was tried to make this
report unique and perfect for this respective study.

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 Analysis and findings

Data analysis result is shown below in tables:

Islami Bank Bangladesh Limited (IBBL)

Particulars Arithmetic mean S.D C. V.
Market value/share 62.64 19.17 .31
Dividend percentage 25 9.07 .42
P/E ratio 11.55 .57 .05
D/P ratio 53.78 4.45 .08
EPS 4.22 1.05 .25
Co-relation between dividend percentage and share price is 0.9627 that indicates that a positive
co-relation exists between them and share price is obviously influenced by dividend.

Marchentile Bank Ltd.

Particulars Arithmetic Mean S.D. C.V
Market value/Share 16.5 2.71 0.16
Dividend percentage 15 7.91 0.53
P/E ratio 7.73 1.30 0.17
D/P ratio 67.70 6.37 0.09
EPS 2.18 0.54 0.25

Correlation between dividend percentage and stock price of Marchentile bank ltd. is moderately
positive that is 0.4586 which indicates that stock price is significantly influenced by declared
dividend.

Prime Bank
Particulars Arithmetic Mean S.D. C.V.
Market value/share 27.47 8.81 0.32
Dividend percentage 15.83 3.82 0.24
P/E ratio 11.95 3.17 0.27
EPS 2.33 0.55 0.24
Correlation between dividend percentage declared by the company and market price of share is
0.9988 that indicates a highly positive correlation between share price and dividend declared by
the company.

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 IFIC Bank
Particulars Arithmetic Mean S.D. C.V.
Market value/share 32.20 5.37 0.17
Dividend percentage 13.33 2.89 0.22
P/E ratio 10.34 2.64 0.26
EPS 3.17 0.32 0.10
The stock price and dividend of IFIC bank is highly correlated with r = 0.98406. It means that
stock price of IFIC bank is significantly dominated by dividend payout ratio.

Testing hypothesis
As the dividend percentage declared by the commercial banks impacts the stock price
significantly according to the analysis of gathered data, there is no reason to accept our null
hypothesis and that’s why alternative hypothesis is accepted at 95% level of significance.

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 Conclusion

After the study based on the collected data it is clear that dividend has a significant impact on
stock price of commercial banks and that’s why there is no reason to accept null hypothesis
rather alternative hypothesis. Stock price can be influenced by so many factors. That’s why to
conclude with this decision that only dividend policy impacts the stock price is not worthy.
Dividend policy can be an accelerator of stock price. On the other hand unexpected dividend can
do fall in stock price. But one thing is clear enough that dividend policy impacts the stock price
of commercial banks and it is highly correlated.

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