THE IMPACT OF DIVIDEND POLICY ON INVESTMENT

CHAPTER ONE

Introduction

1.0          Background to the study

For firms to remain in business and pursue their set goals and objectives, they need to adhere to certain financial management principles and policies that can enhance their overall performance. These policies have impact on the bearing of the organization. There are so many financial policies open to firm’s management; and one of such policy is dividend policy. Dividend is the return that accrues to shareholders as a result of the money invested in acquiring the stock of a given company (Eriki and Okafor 2002). While dividend policy on the other hand is concerned with division of net profit after taxes between payments to shareholders (ordinary shareholders) and retention for reinvestment on behalf of the shareholders (Kempner 1980).

 Dividend policy serves as a mechanism for control of a managerial opportunism. Empirical studies show that firms in developing Countries (e.g. Nigeria) smooth on their income and therefore, their dividends. The pattern of corporate dividend policies not only varies over time but also across countries, especially between developed, developing and emerging Capital markets. If the value of a company is the function of its dividend payments, dividend policy will affect directly the firm’s cost of capital. But is there any significant relationship between dividend policy and corporate performance in form of profitability investment and Earning per Share? What are the factors affecting dividend policy in Nigerian firms? This topic continues as one of the most challenging and controversial issues in corporate finance and financial economies. Research into dividend policy has shown not only that a general theory of dividend policy remains elusive, but also that corporate dividend varies over time between firms. For a firm, which encounters financial difficulties, reliance is placed on retained earnings and accordingly results in lower payout ratios.

However, shareholders have keen enthusiastic interest in the outcome of their investments. These outcomes are expressed in terms of earnings and capital gains. These two ingredients are in turn affected by the quality of policies made by the management team of the enterprises. Among the most important decisions that management of an enterprise must take which has direct bearing on firms’ continuity, earning potentials, investors’ satisfaction and share price gain is the decision to withhold or distribute net earnings as retained profit or dividends.

Pandey (1999), stated firmly that "Dividend policy is a decision by the financial manager whether the firm should distribute all profit or retain them or to distribute a portion and retain the balance. Dividend policy is an important aspect of corporate finance and dividends are major cash outlays for many corporations.

Garrison (1999) defined dividend policy as payments made to stockholders from a firm's earnings, whether those earnings were generated in the current period or in the previous period. Dividend could also be referred to as that part of the enterprise earning that is given to shareholders as interest on their investment. Also, it represents the return to investors who put their money at risk in the company. Company pays dividend to reward existing shareholders and encourage others that are prospective shareholders to buy new issues of the common stock at high price.

However, many seem obvious that a firm would always want to give as much as possible to its shareholders by paying dividends. It might seem equally obvious that a firm can always invest the money for its shareholders instead of paying it out. The heart of dividend policy question is should the firm payout money to its shareholders or should the firm take the money and invest it for shareholders into the enterprise business.

Moreover, it has been discovered that the dividend policy of a firm always have short term or long term effect on the market price of its shares.

It is quite difficult to clearly identify the effects of payout on firm's valuation. The valuation of a firm is a reflection of so many factors that the long run effect of payout is quite difficult to separate.

Kehinde and Abiola (2001) viewed dividend policy as "the dividend policy of a firm accounts for how a firm divides its income between retained earnings and dividends. It states the policy measure of how much dividend to be declared, in what form should the dividend be declared- either as a cash dividend or as stock dividends. By dividend policy the corporate organization, strike a balance between current income to the shareholders and a future income. Income can be retained and reinvested into available profitable investment opportunities. The retained earnings provide the cheapest source of financing. This research is to examine empirically the factors that affect dividend policy of some listed quoted companies. In addition, it tends to identify the impact of dividend policy on examine the factors that impact on dividend policy in respect to investment; and determine if there is any significant relationship between dividend policy and earning per share of companies.

1.1                Overview of the Nigeria Economy and Stock Market

Nigerian is a West African Economy with a long coast line in the gulf of guinea which is the part of the Atlantic Ocean. The country shares international borders with Chad, Cameroon Benin and Niger. Nigeria ranks 32 in the world in terms of total area. The terrain of the country consists of southern lowlands and plateaus in the central region. The south east region has a mountainous surface, while the north consists of plains. Nigeria is the federal constitutional republic, with 36 states and 1 federal capital territory (FCT). Nigeria is recognized as the most populated nation in Africa. According to the 2009 estimates, the country has a total population in excess of 154 million, of which almost 70% live below the international poverty line.

Nigeria‟s economy is overly dependent on the petroleum sector; it is the largest oil producer in Africa. The petroleum industry is central to the Nigerian economic profile; it is the 12th largest producer of petroleum products in the world. The industry accounts for almost 80% of the GDP share and above 90% of the total exports. It is blessed with the high quantities of tin, iron ore, zinc, coal and some uranium. Nigeria is highly rich in terms of coal and natural gas which are untapped. Half of the population is earning their livelihood from the agriculture and allied activities and is producing rice, maize, groundnuts, rubber etc.

Nigeria is a middle-income nation with developed financial, communication and manufacturing sectors.  Nigeria’s manufacturing sector includes areas like vehicle production, textiles, pharmaceuticals, paper, cement etc. It is recognized as the eminent member of the OPEC. Nigeria is also one of the fastest growing economies in the international arena as the International Monetary Fund has projected its growth to be 9 per cent in 2008 and 8.3 per cent in 2009. It has the second largest stock exchange in the continent.

1.1.1   The Nigerian Economy

Nigeria's economy depended more on petroleum in the 1980s compared to the 1970s. The Nigeria's economy dependence on petroleum accounted for 77 percent of the federal government's current revenue and 87 percent of export receipts in 1988. In the 1980s declining oil production and prices contributed to another facet of the economy. The decline in per capita real gross national product (GNP) persisted until oil prices began to rise in 1990. GNP per capita per year decreased 4.8 percent from 1980 to 1987, which led to Nigeria's classification by the World Bank as a low-income country in 1989 (based on 1987 data) for the first time since the annual World Development Report was instituted in 1978. In 1989 the World Bank also affirmed that, Nigeria is poor enough to be eligible (along with countries such as Bangladesh, Ethiopia, Chad, and Mali) for concessional aid from the International Development Association (IDA).

The Nigerian economy had a chain of rapid changes in the government's share of expenditures. As a percentage of gross domestic products (GDP), national government expenditures rose from 9 percent in 1962 to 44 percent in 1979, but fell to 17 percent in 1988. Nigeria's government became more centralized as a result of the 1967-70 civil wars. This oil boom in the 1970s provided the tax revenue with the 35 ability to strengthen the central government further. With Expansion of the government's share of the economy, the government did small to enhance its political and administrative capacity, but did raise incomes and the number of jobs that the governing elites could distribute to their clients.

The economic crumpled in the late 1970s and early 1980s contributed to substantial disgruntlement and disagreement between ethnic communities and nationalities, which added to the political pressure to drive out more than 2 million illegal workers (mostly from Ghana, Niger, Cameroon, and Chad) in early 1983 and May 1985. The lower spending of the 1980s to a certain extent resulted in the structural adjustment program (SAP) which upshot from 1986 to 1990, first founded by the International Monetary Fund (IMF) and carried out under the patronage of the World Bank, which emphasized privatization, market prices, and reduced government expenditures. This program was based on the principle that, as GDP per capita falls; people would demand relatively fewer social goods (produced in the government sector) and relatively more private goods, which tend to be essential items such as food, clothing, and shelter. Widespread poverty and lack of industrial resources are the biggest challenges for Nigeria. The country ranks 151 out of 177 on the UN Development Index. During 2003-07, the government initiated strategic economic reforms to eradicate poverty and bring economic equality. However, corruption has been the main barrier to the success of any such effort.

1.1.2   History of Nigeria Stock Exchange

The Nigeria Stock Exchange is the second largest equities marketplace in Africa and the largest in West Africa. The Nigerian Stock Exchange was established in 1960 as the Lagos Stock Exchange and In December 1977 it became The Nigerian Stock Exchange, with branches established in some of the major commercial cities of the country. At present, there are eight branches of The Nigerian Stock Exchange. Each branch has a trading floor. The branch in Lagos was opened in 1961; Kaduna, 1978; Port Harcourt, 1980; Kano, 1989; Onitsha, February 1990; and Ibadan August 1990; Abuja, October 1999 and Yola, April 2002. Lagos is the Head Office of The Exchange. An office has just been opened in Abuja. The Exchange started operations in 1961 with 19 securities listed for trading. Today there are 262 securities listed on The Exchange, made up of 11 Government Stocks, 49 Industrial Loan (Debenture/Preference) Stocks and 195 Equity or Ordinary Shares of Companies or private holdings, all summing to a total market capitalization of well above N875.2billion. The year 2007 was quite outstanding for the Nigerian Stock Exchange as it experienced tremendous growth with a 74.7% return on index and market turnover of over 4 times the previous year. It is expected that with a hypothetical forecast of 100% ratio by 2012, that the Nigerian Stock Market would achieve a market capitalization of 29 Trillion Naira. The transactions in The Market are regulated by The Nigerian Stock Exchange which is an autonomous and self-regulatory organization (SRO), and the Securities and Exchange Commission (SEC) on the other hand is vested with the power to administer Investments and Securities according to the investment ruling of 1999. After the deregulation of the capital market in 1993 by the Federal Government, The Nigerian Stock Market was internationalized in 1995.The capital market was internationalized with the removal of laws that constrained foreign participation in the Nigerian capital market. Due to this removal of the Exchange Control Act of 1962 and the Nigerian Enterprise Promotion Decree of 1989, foreigners can now participate in the Nigerian capital market both as operators and investors. Currently there are no limits any more to the percentage of foreign holding in any company registered in Nigeria. Pricing and other direct controls have given way to indirect controls by the regulatory bodies, which are the Securities and Exchange Commission of Nigeria and The Nigerian Stock Exchange. Basically on the overall, the competitiveness of the Nigerian market has improved and in addition is more investor-friendly.

1.1.3   Structure of the Nigerian Stock Exchange (NSE)

The market broadly speaking is the arm of the financial market which trades in medium to long term financial instruments such as Loan Stocks, Government bonds and Equity or Ordinary Shares with maturity in excess of usually one year; without this markets investors would not be able to liquidate their investments or adjust their portfolio whenever they aspire to do so and there would be no motivation to invest in securities. Major Companies listed in Nigeria Stock Exchange are:

• A.A.A. Stockbrokers Limited
• AIL Securities Limited
• Alliance Capital Management Company Limited
• BFCL Assets & Securities Limited,
• BGL Securities Limited,
• Calyx Securities Limited
• Capital Assets Limited
• Dakal Services Limited
• Davandy Finance & Securities Limited
• EMI Capital Resources Limited

The stock market is segmented in two units, the primary market and secondary market. In the primary market where stock shares are first sold, Companies raise money for investment projects. Investment bankers specialize in arranging financing for companies in the primary market. Investment bankers often act as underwriters, buying newly issued stock from the company and then reselling the stock to the public. The primary market is best known as the market for initial public offerings (IPOs). The secondary market is where investors trade securities among themselves; the secondary market enhances the supply of funds to the primary market. If there were no secondary market where investors could cash their investment in listed securities they choose, many investors may not be able to buy new shares in the first place. Secondary market transactions are directed through three channels; directly with other investors and with a dealer or indirectly through a broker. Most common stock trading is aimed at an organized stock exchange. The most organized stock exchange is the New York Stock Exchange (NYSE), in the United State which is known as the Big Board, NYSE is owned by its members also partly by the government. From the perspective of the overall economy, the secondary market is particularly important, as it makes it possible for the economy to ensure long-term commitments in real capital. The Nigerian stock exchange has over two million individual investors and above three hundred institutional investors including NSITF, insurance companies and government parastatals, using the facilities of the stock exchange. In the last frothy years, the NSE has been free from any major fraud, shocks and scandals with the exception of the witnessed fraudulent sale of share certificates relating to Nestle Foods Nigeria Plc that took place recently. In this regard, the listing requirements and code of conduct of members and staff of the NSE have helped to ensure: Disciplined public accountability; persistent survival and improved performance of the quoted companies; Disciplined management of listed companies and market operators; an increasing pool of ingestible funds for economic development. The implementation of the Automated Trading System has significantly enhanced the trading process and made it easier for ordinary people who struggle with trading technicalities.

1.1.4   Efficiency of Nigerian Stock Exchange

Nigerian Stock Exchange can be mentioned as a recent establishment leading to very few studies investigating the efficiency of this emerging market.

According to Fama (1965) an efficient capital market is a market that is efficient in processing information. The prices of securities at any time are based on correct evaluation of all information available at that time. In an efficient capital market, prices fully reflect available information. In other words, the theory assumes that such information will be properly interpreted by the investors in their investment decisions. Given this fact, it is therefore expected that in an efficient market, information will be quickly and widely distributed and reasonably available to all investors. Price change as a matter of fact will only occur at the break of new information to the market which could affect future profitability of the company and consequently future dividends.

Samuel and Yacout (1981) used serial correlation test to observe weekly price series of 21 companies in Nigerian from July 1977 to July 1979. The results show that the stock price changes are not serially correlated but follow an unsystematic walk, thus accepting the notion of Weak-Form market efficiency.

In 1984, Ayadi tested the price behaviour of 30 securities quoted on the NSE between 1977 and 1980. The Monday closing prices of these shares where used, after adjusting for cash dividends and script issues. The result from these test showed that the share price movements on the NSE followed a random pace.

Anyanwu (1998) investigates the efficiency of the NSE from the perspective of the markets relationship to economic growth of the nation. He used indices of stock market development liquidity, capitalization, market size, among others to create an aggregate index of stock market development and associated it to the long-run economic growth index, emphasizing the GDP growth rate. At the end, results showed a positive relationship between the two indices and as a result concluded that NSE is efficient to the extent that it affects the economic development of the country. Olowe (1999) examined evidence of Weak-Form efficiency of the NSE using correlation analysis on monthly returns data of 59 individual stocks listed on the NSE over the period January 1981 to December 1992. The results provide support for the work of Samuels and Yacout (1981) and Ayadi (1984), that is, the NSE is efficiency in the Weak-Form.

Akpan (1995) studied the informational efficiency of the NSE including the risk implications of investing in the market, using time series data of stock market price indices covering the period 1989 to 1992. The results show evidence to reject the hypothesis of Weak-Form efficiency of the NSE.

1.2             Statement of problem

The dividend policy of a firm accounts for how a firm divides its income between retained earnings and dividends. It states the policy measure of how much dividend to be declared, in what form should the dividend be declared- either as a cash dividend or as stock dividends. Through dividend policy an organization, strike a balance between current income to the shareholders and a future income. Income can be retained and reinvested into available profitable investment opportunities. But, what factors affect dividend policies of organizations? Again, should the firm payout money to its shareholders or should the firm take the money and invest it for shareholders into the enterprise business. Consequently, the problem of this study resulted from the desire of the researcher to examine the factors that impact on dividend policy in respect to investment; and determine if there is any significant relationship between dividend policy and earning per share of companies?

1.3             Objective of the study

The objective of the study is to:

1. Examine the factors that affect dividend policy in an organization.
2. Determine the impact of dividend policy on Investment.
3. To determine if there is any significant relationship between dividend policy and Earning per Share of Companies.

1.4                Research questions

1. Is there any significant relationship between dividend policy and corporate profitability?
2. Is there any significant relationship between dividend policy and investment?
3. Is there any significant relationship between dividend policy and earning per share of companies?

1.5                Research hypotheses

The research hypotheses are stated below;

Hypotheses 1

Ho:     There is no significant relationship between dividend policy and corporate profitability.

Hi:      There is a significant relationship between dividend policy and corporate profitability

Hypotheses 2

Ho:     There is no significant relationship between dividend policy and investment.

Hi:      There is a significant relationship between dividend policy and investment

Hypotheses 3

Ho:     There is no significant relationship between Earning per Share and Dividend policy.

Hi:      There is a significant relationship between Earning per Share and Dividend policy.

1.6             Scope and Limitation of the study

The scope of this study is limited to the topic on discuss viz; Factors that determine dividend policies of some selected listed companies in Nigeria. Data for the study were extracted from annual report and accounts of twenty five (25) quoted companies in Nigeria. These data were subjected to regression analysis, using e-view software to find out if there is a significant positive relationship between dividend policies of organizations and profitability; and if there is a significant positive relationship between dividend policy and investments and if there is a significant positive relationship between dividend policy and Earnings Per. Share.  

1.7             Significance of the study

There have been many empirical investigations, analyses and studies in relation to what determines dividend policy of firms. This study will equally examine the factors that determine dividend policies. It will examine the variables and analyze its impact on the profitability, investment and the possible relationship between earnings per share and dividend policy.  

The unpredictability of trends in the Nigerian Stock Market are unprecedented, hence the researchers’ compelling interest to fully investigate, document and explain the factors that causes these trends, while underlining the opportunities apparent in the reordering of economic priorities and the opportunities for the investors in the market to learn how to make intelligent investment engagements and decisions.

At the end of the study Organizations would see the need to ensure that they have a good and robust dividend policy in place because it will enhance their profitability and attract investments to the organizations.

1.8             Definition of terms

Capital Market: Capital markets are markets for trading in long-term finance (long tem financial instruments like equities and debentures).

Nigeria Stock Exchange: Is the primary operator in the Nigerian capital market in which companies and other institutions can raise funds by issuing shares or loan stock but it is more important as a secondary market for buying and selling existing securities.

Mechanism: This includes the operative issue and transfer procedure. 

Institutions: These include regulatory agencies, issuing houses, the stock-broking firms etc.

Ordinary share: These are the real owners of company, because they bear the greatest risk in the company and also benefit from its success. They represent permanent capital of a company.

Preference shares: The holders are entitled to a fixed percentage of dividends before ordinary shareholders are paid any dividend.

Bonds: State and local governments go to raise funds on the floor of the NSE using bonds.

Debenture/loans stock: These are instrument used to raise corporate funds for financing long-term capital needs.

NSE: This is an acronym for Nigerian Stock Exchange

Dividend: Dividend is a distribution of profits earned by a joint stock company, among its shareholders.

Liquidity: if the dividends are to be paid by cash, of course, cash must be available to pay the dividend declared.

Stability of earnings: earnings are subject to varying degrees of risk and the greater the variability, the greater the likelihood of reduced dividend due to sudden drop in earnings.

Taxation: income distribution and capital gain have different tax implications for investors. This will affect the relative desirability of dividend and retained earnings. Hence the marginal rate of tax of the dormant shareholder can be an important consideration in determining dividend policy.

Investment: As used in the study refers to committing something into a means to generate revenue or interest in return. It could either be long term or short term investment.

Return on Investment: The yield accruing from committing something into another i.e. dividends to shareholders, accruals from lease etc.

Return on Capital Employed (ROCE): This is a summary measure of operating efficiency and management performance.

Fixed Asset (FIXA): These are assets purchased for a long-term use and are not likely to be converted quickly into cash.

Earnings per Share (EPS): This is the portion of a company’s profit allocated to each outstanding share of common stock.

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