ABSTRACT
This study examined the impact of dividend yield on stock prices of Nigerian banks; the
impact of earnings yield on stock prices of Nigeria banks and the impact of payout ratio on
stock prices of Nigeria banks. The study adopted the ex-post-facto research design and panel
data covering 5-year period 2006-2010 were collated from annual reports of banks and the
Nigeria Stock Exchange daily official list. The Ordinary Least Square Regression Model
was used to estimate the relationship between dividend yield, earnings yield, payout ratio
and stock prices. Average of daily stock prices was adopted as the dependent variable, while
the independent variables included dividend yield (DY), earnings yield (EY) and payout
ratio (POR). The result emanating from this study revealed that dividend yield had negative
and significant impact on commercial banks’ stock prices in Nigeria (coefficient of Dyield =
-3.365; p-value = 0.035). Earnings yield had negative and significant impact on commercial
banks’ stock prices in Nigeria (coefficient of Eyield = -0.331; p-value = 0.048) and dividend
payout ratio had negative and non-significant impact on commercial banks’ stock prices in
Nigeria (coefficient of Por = -1.411; p-value = 0.269). The study thus, revealed that the
dividend yield, earnings yield and payout ratio are not factors that influences stock prices
rather the bank size was found to have positive and significant impact on stock prices. The
study therefore recommends among others that managers should act in the best interest of
investor as to reduce the agency problem, thus complete information about the dividend
polices of the firm should be provided.
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
The subject matter of dividend policy remains one of the most controversial issues in
corporate finance. For a very long time now, financial economists have engaged in modeling
and examining corporate dividend policy and earnings as they affect banks stock prices in
Nigeria (Amidu, 2007). Black (1976) hinted that, “The harder we look at the dividend
picture, it seems like a puzzle with pieces that don’t fit together”. In over thirty years since
then a vast amount of literature has been produced examining dividend policy.
Recently, however, Frankfurterc and Wood (2002) concluded in the same vein as Black and
Scholes (1974) that the dividend “puzzle”, both as a share value-enhancing feature and as a
matter of policy, is one of the most challenging topics of modern financial economics. Forty
years of research have not been able to resolve it. Research no dividend policy and earnings
have shown not only that a general theory of dividend policy remains elusive, but also that
corporate dividend practice varies over time, among firms and across countries. The patterns
of corporate dividend policies not only vary over time but also across countries, especially
between developed and emerging financial institutions.
Glen, et al (1995) suggested that dividend policies in emerging markets differed from those
in developed markets. They reported that dividend payout ratios in developing countries
were only about two thirds of that of developed countries. Different scholars have defined
the term dividend policy differently. Hamid, et al (2012) defined dividend policy as the
exchange between retained earning and paying out cash or issuing new shares to shareholders.
Booth and Cleary (2010) defined dividend policy as an exclusive decision by the
management to decide what parentage of profit is distributed among the shareholders or
what percentage of it retains to fulfill its internal needs. Nwude (2003:112) defined the term
as the guiding principle for determining the portion of a company’s net profit after taxes to
be paid out to the residual shareholders as dividend during a particular financial year.
Emekekwue (2005:393) defined dividend policy as the portion of firm earnings that will be
paid out as dividend or held back as retained earnings. Huda and Farah (2011) pointed out
that dividend policy has been an issue of interest in financial literature; academics
and researchers has developed many theoretical models describing the factors that managers
should consider when making dividend policy decisions. Key factors behind the dividend
decision have been studied by numerous researchers. Lintner (1956) suggested that dividend
payment pattern of a firm is influenced by the current year earning and previous year
dividends. In this case, dividend may be seen as the free cash flows which comprises of cash
remaining after all business expenses have been met (Damodaran, 2002). The dividend
decision in corporate finance is a decision made by the directors of a company. It relates to
the amount and timing of any cash payments made to the company’s stockholders.
The decision as stated by Pandey (2005), is an important one for the firm as it may influence
the financial structure and stock price of the firm. In addition, the decision may determine
the amount of taxations that stockholders pay. The dividend payment ratio is a major aspect
of the dividend policy of the firm, which affects the value of the firm to the share holders
(Litzenberger and Ramaswany, 1982). The classical school of thought holds this view and
they believe that dividends are paid to influence their share prices. They also believe that
market price of an equity is a representation of the present value of estimated cash dividends
that can be generated by the equity (Gordon, 1959). Another classical school of thought, on
the other hand, believes that the price of equity is a function of the earnings of the company.
They believe that dividend payout is irrelevant to evaluating the worth of equity. What
matters, they say is earnings (Miller and Modigliani, 1961).
Mayo (2008: 364-365) observed that retained earnings provide funds to finance the firms on
long term growth. It is the most significant source of financing a firm’s investment.
Dividends are paid in cash, thus the distribution of earnings utilizes the available cash of the
company. When the firm increases the retained portion on net earnings, shareholders’
current income in the form of dividends decreases, but the use of retained earnings to
finance profitable investments is expected to increase future earnings. On the other hand,
when dividends increase, shareholders’ current income will increase but the firm may be
unable to retain earnings and, thus, relinquish possible investment opportunities and future
earnings.
The theoretical rationale for corporate dividend policy has been an important topic in
corporate finance for a very long time. After the dividend policy-irrelevance proposition by
Miller and Modigliani (1961), several theories have attempted to explain why and how
companies pay out the cash generated by their business operations as dividend. Three main
factors may influence a firm’s dividend decision. These are: - Free cash flows, Dividend
clientele and Information signaling (Pandey, 2005). Under the free-cash flow theory of
dividends, the payment of dividends is very simple: the firm simply pays out, as dividend,
any surplus cash after it invests in all available positive net present value projects. Criticism
of the theory is that it does not explain the observed dividend policies of real world
companies. Most companies pay relatively consistent dividend from one year to the next and
managers tend to prefer to pay a steadily increasing dividend rather than paying dividend
that fluctuates dramatically from one year to the next. These criticisms have led to the
development of other models that seek to explain the dividend decision (Brigham, 1995).
Under the dividend clientele, a particular pattern of dividend payments may suit one type of
stockholders more than another. A retiree may prefer to invest in a firm that provides a
consistently high dividend yield, whereas, a person with a huge income from employment
may prefer to avoid dividends due to their high marginal tax rate on income. If Clientele
exists for a particular pattern of dividend payment, a firm may be able to maximize its stock
price and minimize its cost of capital by catering to a particular clientele. This model may
help to explain the relatively consistent dividend policies followed by most listed companies
(Okafor, 1983). According to the clientele effect theory of dividend policy, investors who
would like to receive some cash from their investment always have the option of selling a
portion of their holding. This argument is even more cogent in recent times with the advent
of very low-cost discount stockholders. Thus, it remains possible that there are taxation
based clientele for certain types of dividend policies (Pandey, 2005).
Information content or signaling says that investors regard dividend changes as signals of
management earning potentials. The model was developed by Ezra (1983). It suggests that
dividend announcements convey information to investors regarding the firm’s value
prospects (Ezra, 1983). He said many earlier studies had shown that stock prices tend to
increase when an increase in dividend is announced but tend to decrease when a decrease or
omission is announced. Therefore, Ezra pointed out that, this is likely due to when investors
have complete information about the firm, they will look for other information that may
provide a clue as to the firm’s future prospects and also managers have more information
than investors about the firm and such information may inform their dividend decision. It
could be seen, therefore, that when mangers lack confidence in the firm’s ability to generate
cash flows in the future, they may keep dividends constant or possibly even reduce the
amount of dividends payout. Conversely, managers that have access to information that
indicates very good future prospects for the firm are more likely to increase dividends (Ezra,
1963).
Hence, the purpose of this study is to perform a cross-sectional study to find the situations in
Nigeria which these hypotheses apply and also determine how stock prices react to such
dividend and earnings report as indicated by investors’ ratio values with bias to bank stocks.
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