dividend policy from agency perspective

American Journal of Scientific Research ISSN 1450-223X Issue 45 (2012), pp. 22-32 © EuroJournals Publishing, Inc. 2012 http://www.eurojournals.com/ajsr.htm

Determinant Factors of Dividend Policy in Firm Listed in

Tehran Stock Exchange (TSE)

Javad Moradi Corresponding Author, Assistant Professor, Accounting Department

Marvdasht Branch, Islamic Azad University, Marvdasht, Iran E-mail: [email protected]

Fax: +987116214835

Hashem Valipour Assistant Professor, Accounting Department, Firoozabad Branch

Islamic Azad University, Firouzabad, Iran E-mail: [email protected]

Tel: 00989173086986

Seyedeh Sara Mousavi Master of Accounting, Marvdasht Branch Islamic Azad University, Marvdasht, Iran

E-mail: [email protected]

Abstract

Dividend payout is one of the information which affects investors’ decision making. There are many factors which affect this parameter. Firm ownership structure is one of such factors. Various investors groups can have various effects on firm performance and dividend payout. The most significant questions are: Is dividend payout in accordance with opportunistic goals proposed in agency contexts? Does outside directorship have any effect on profit distribution? And, can these variables be considered as indirect substitutes or supplements for mitigating agency costs?

The research provides answers to the above questions. For this purpose, the information for 67 firms listed in Tehran Stock Exchange (TSE) in a period during 2001 to 2008 was analyzed by statistical techniques. Results show that there is a negative and meaningful relationship between outside directorship ratio, asset structure, business risk, debt level and dividend payout ratio. Also, there was a positive and significant relation between profitability, liquidity and insider ownership ratio and dividend payout ratio. Firm size and growth opportunities have no effects on dividend payout. Keywords: Dividend Policy, Free Cash Flow, Independent Board Members, Business

Risk, Agency Theory. 1. Introduction The capital market which is considered as the economic heart of developed countries is one of the most important resources of financing and the instrument of efficient allocation of resources which is located

Determinant Factors of Dividend Policy in Firm Listed in Tehran Stock Exchange (TSE) 23

in the center of financial and accounting researchers’ attention in positive approaches for determining the market and investors behavioral model. Despite the fact that there are some deficits in the structure of Tehran Stock Exchange and the unfamiliarity of Iranian families with financial investments, stock exchange has its own attractions for investors and studying it can improve investors behavioral model and influence the efficient allocation of economical country resources. Investors in the stock exchange choose earning of benefits from firms' dividends and increasing of share price as their goals and starting to speculate with the hope of increasing outcomes and fortune. From this point of view, choosing a suitable dividend policy is one of the issues that can affect the investors' interest and motivation and lead the market resources, as well.

Up to now, several researches have been done considering this special issue and also there is different analysis about the factors which influenced the firm’s dividend policy. One of the issues which are investigated in this case is the agency issue related to the motivations of profits distribution from the profit owners' view point. Although, determining the firms basic policy and administrating of performance is under the authority of the board of directors, changing this policy into an executive plan of enterprise activity is under the control of the firm’s president or executive manager, which is finally expected to align with the owner’s interest. Then, in addition to the disagreement among shareholders' interests, which can affect the firm’s major policies, the contrast between executive interest and owners interest can cause heterogeneity in optimal polices of owners and managers.

In this regard, as the result of organization complexities and development of economic enterprises activities, considering and focusing on the way of managers' decision making in resource management increase and the decisions which are related to significant dividend policy. The decisions which are made by high level management suggestions' and owners' acceptance influence the long-term firm goals. One of the most important factors which investors consider in evaluating the companies stocks are the cash flows caused by investments like dividends which comes from investing stocks and the amount of that influenced by firms' dividend policy. Now the question is whether earning pay and determining non active members of board of directors are done with opportunistic purposes which noted in agency texts, and if we can consider these variables (indirectly) as substitution or completion of agency costs reduction or not. In this study, we are going to answer this question. 2. Literature Review Successful companies may invest their earned profits in operative assets, use them in acquisition of securities and in repaying the debts or divide them between share holders. Dividend policy is one of the most favorite subjects of financial literature in recent years and up until now different studies has been done about justifying reasons and the way of distributing the profits between share holders and this subject remains as the dividend policy maze in the financial literature.

Cash share earnings is very interesting for the companies' owners because this earning is obvious and tangible and the firms' investors have special interest in this subject with the purpose of knowing the capability of making cash and distributing it among the share holders. Because of this, apart of managers' ability and attention is attracted to a subject which called “dividend policy”. But finding the reasons for selecting a special dividend policy by the firms is more important than dividend policy itself.

This matter can be the resolution of the important economical decision makings for the different beneficial groups especially investors. Because the reasons and determining factors which this research yielded, not only help to explain the firms' behavior in the past, but also hand in an instrument for predicting their movement and future policy in this context. The decision concerning the distribution of dividends is a kind of financing decision which influenced the share holders' returns and on the other hand affects the level of retained earnings and reinvesting the firm's dividends. Dividend policy shows firm's pay policy and the level of cash which are distributed among share holders.

24 Javad Moradi, Hashem Valipour and Seyedeh Sara Mousavi

Resolving the contrast involving dividend and paying out of cash resources from the firm or reinvesting the benefits in the firm and making a balance between these two issues and finding necessary resources for firms' future development are really complex and important decisions. As the benefit distribution decisions, investment and financing are related to each other the manager can't separate the dividend policy from other decisions.

The firm's managers and owners, select the dividend policy extremely carefully, because they strongly believe in the influence of this decision on the firms' value and share holders fortune. The investors have such a belief as well, because they consider the cash dividend as an influential factor on the expected future cash and their own expected return.

Dividend policy can be discussed from agency theory view point. From this point of view, the agency costs are caused by potential contrast which exists between managers and owners' interests. For this, when the owner manager sells apart of his stock to the investors who don’t have any roles in the management, the agency costs increase.

Dividend could be seen as one of the most effective instruments which the manager can use for decreasing the agency contrasts within the firms.

Paying the share benefits may reduce the agency contrast in the firm for two reasons; first, dividends decrease the firms' free cash flow which may use by the person who has access to the confidential information in existing projects for their own benefits and for share holders' costs. Second, the outcome of dividends may encounter the firm with repeated investigations from stock markets, because paying the benefits increases the probability of new regular stock publishing.

The non active members of board of directors are considered as one of the most useful and effective means of solving the agency contrast in the context of firms' dividend policy. Having this group helps executive managers administrate, control and reduce the agency costs.

In the case of firms' dividend policy, there are many different studies which have been done inside and outside the country that will be noted in the following parts. For the first time, Linter (1956) tried to investigate the analysis of dividend policy by using experimental and survey approach. His investigations in financial literature lead to introduction of 15 effective variables on the dividend policy such as firms' size investment costs, tendency to use outside financing, earning per share, benefit stability and ownership. Miller and Modigliani indicated that as the firms follow stable dividend policy, any changes in this policy assess carefully by investors as the symptom of future firms earning benefits. One of the suggested resolutions for reducing this contrast in their interest is minimizing the cash which is under the management control by distributing a large amount of that as dividends.

Bathala and Rao (1995) study the determining factors in the structure of board of directors in the agency theory and also investigate the extreme to which the structure of board of directors can substitute the agency problems such as debt level, dividend policy, ownership of the person with confidential information's. They used a sample of 261 American firms in 1986 and a negative relationship between non active members of board of directors and dividend policy is revealed.

Borokhovich et al. (2005) investigated the relationship between the independency of board of directors and dividend policy within the time period of 1992 to 1999. Their findings are the same as reported results from Bathala and Rao study (1995).

In Iran, Etemadi and Chalalki (2005) investigate the relationship between management performance and the cash dividend of the accepted firms in Tehran stock exchange, as well. The results show that there is a significant relationship between management performances and cash dividends.

Jahankhahi and Ghorbani (2005), study the determining factors of dividend policy. In this investigation, in addition to theories which are examined in studies which have been done outside the country, they try to take the special situation of stock market in Iran into consideration. The result of this research indicates that firm’s dividend policy follows the random talk model.

Amidu and Abor (2006), study and determine the dividend pay ratio on the base of financial statements of accepted companies in African exchange within a 6-year time period. The results of this research show a positive relationship between dividend pay ratio and earning, cash flow and tax and


also a negative relationship between dividend pay ratio and risk, institutional ownership, development and market value to the book value. They also indicate that there is no significant relationship between risk and institutional owner ship.

Twaijry (2007) investigates the data of 300 firms. Within 2001 – 2005 which randomly selected from accepted firms in Kuala Lumpur stock exchange for realizing the variables which are expected to influence dividend policy and dividend pay ratio in an efficient market. The results show that the dividend ratio doesn’t have an important impact on the future firms' benefits, but it has a negative relationship with the firms' financial leverage. He also finds that earring per share and book value of shares has a positive and significant relation with the dividend pay ratio.

Abdelsalam and others (2008), study the dividend policy in 50 firms in Egypt from 2003 to 2005 .They find a positive and significant relationship between institutional ownership and firms' efficiency.

Also by affirming the sign theory, we expected that if a firm has a high growth in profits (low), its cash return is high (low), as well. The firm’s size, investment opportunities, financial structure, risk and financial leverage are among the other things which play roles in explanation of dividend policy of accepted firms in stock exchange. Porhaydarie et al. (2009), investigate the dividend policy of the accepted firms in Tehran stock exchange from 2001 to 2005. Their observed evidences indicate that the accepted firms in Tehran stock exchange don’t have a stable dividend policy and the most important factor in determining distribution of dividends among share holders is the net earnings of that year . 2. Methodology, Data collection, Analysis The present study has applicable purposes and it’s correlated. In this study, the information were gathered from suitable resources in the first step, then the research variables were assessed then they were analyzed by multiple regression and SPSS software. 3. Research Hypothesis Higher dividend pay is under investigation as the resolution of reducing the amount of cash available for the managers and also as a risk reduction of excessive investment. Borokhovich et al. (2005) show that the cash dividends can decrease the agency problems and they say that firm’s with higher external investments, experience less unusual profits when the increase of earning per share announced. Increasing the stock earnings indicates the fact that the firms will invest less in future which shows that the managers have some information about the firm’s future which share holders don’t have access to them. The research hypotheses are as follows:

Hypothesis 1: There is a significant relationship between the non active members of board of director’s ratio and dividend pay ratio.

We can account members of board of directors’ ratio by dividing the number of the non active members of board of to the number of members of board of directors. The agency cost comes from this fact that share holders have little information about the firm and managers behavior (to the other managers). This matter causes disagreement between managers and shareholders .In this case, managers may take opportunistic decisions, which make a huge cost for the shareholders. The non active members of board of directors considered as a useful and effective means of resolving the agency contrast related to firm’s earning per share. The non active members of board of directors help administrating and controlling the executive performance and reduce the agency costs.

Hypothesis 2: There is a significant relationship between operation earning and dividend pay ratio.

Earning scale is the firm’s business performance which defines as the firm’s ability to make net income and in this study is assessed by dividing net operating cash flow to the total assets. Firm’s earning considered as an important and effective factor on the firm’s dividend policy, because


profitable firms have more tendency toward paying more dividends. So, we expect a positive relationship between firm’s earning and dividend pay.

Hypothesis 3: There is a significant relationship between liquidity and dividend pay ratio. Liquidity scale is the level of firm’s ability in satisfying the commitments and determined by

dividing the free cash flows to the total assets. Increase (decrease) in working capital – capital expenditure – deprecation - (tax rate) earnings

before interest and tax (EBIT) = free cash flow Paying dividends need the existence of cash in the firm and we expect that the firms with high

liquidity pay higher dividends. Hypothesis 4: There is a significant relationship between asset’s structure and dividend pay

ratio. Asset's structure defines as a function of firm’s tangible assets and calculates by dividing fix

assets to total assets. What we expect is a positive relationship between firm's assets’ structure variable and dividends pay.

Hypothesis 5: There is a significant relationship between business risk and dividend pay ratio. Business risk caused by the firm’s unique situation (special risk of firm’s operation) which is

expected to influence share price and in this study is accumulated by using the β coefficient of the stock market. Business risk is the probability of loss or any non optimal news about firm’s operation or performance which block the ability of that firm to provide the investment return.

Hypothesis 6: There is a significant relationship between firm’s size and dividend pay ratio. In this research we use the total assets logarithm as the substitution of the firm’s size. Doukas et

al. (2005) show that bigger firms probably have higher agency costs considering their complexity and the problems which their owners encounter in gaining the firm’s information

Hypothesis 7: There is a significant relationship between growth opportunity and dividend pay ratio.

Growth opportunity means the extreme base on which firm’s keep its own growth level in comparison with other firms. In this investigation, we use the division of stock market value to book value of stock holders’ equity. The firms with high growth opportunity have several chances for investment, so we expected less dividend pay.

Hypothesis 8: There is a significant relationship between financial leverage and dividend pay ratio.

Financial leverage indicates the mixture of using debts and stock holders’ equity for financing of firm’s assets and we use the ratio of long-term debt to the total stockholders’ equity for calculating this. Leverage firms as they have high risks, have no tendency toward dividends distribution. So we expect a negative relationship between debt level and dividend pay.

Hypothesis 9: There is a significant relationship between the board of directors'members' percent of ownership and dividend pay ratio.

The higher the percent of managers’ ownership is, the higher the opportunity of paying dividend, because these dividends are going to managers accounts. Also, if they pay considerable amount of this dividend to non active people or a person outside the firm, the probability of paying dividends reduces and managers compensate that reduction with execution bonus. Al-malkawi (2007), also believes that if the ownership percent of board of directors members increases, the agency costs decrease. So in firms which board of directors' members has high ownership, there is no need to employ dividend as a way of reducing the agency costs.

For examining the research hypotheses the following regression model is used:

0 1 2 3 4 5 6

7 8 9

OUTSIDE CFAit

i

D FCF TANG BETA SIZE

MB FL BOARDOWN

Tii i i

i

P ln β

1 PL X

.


Dependent variable in this model is the cash dividend ratio which assessed in two ways. First this variable was calculated by dividing cash earnings per share to the earning per share which is used in this model. Then, in the form of a logistic regression, this variable was ambiguously investigated by probability function as follows (1 for the firms which pay the dividends and 0 for the firms which don’t pay the dividends.

In this research, financial leverage, systematic risks and firm’s size variables considered as controlling variables and non active members of board of directors ratio, free cash flow, and earning opportunities variables considered as a substitution for agency costs. 4. Population and Statistical Sample The statistical population of the study includes all accepted firms in stock exchange in the time period between 1380 and1387. Among the firms in statistical population we selected the ones which had the following characteristics:

1. Accepted in stock exchange before 2001. 2. The end of their financial year is March 29th of each year and within the investigated time

period, their financial year doesn’t change. 3. Their data is from the available software.

5. Examining Hypotheses and Analyzing Research Findings Descriptive statistics of the research variables are presented in table 1 and results of the test of normality of dependent variable distribution (Kolmogorov- Smirnov Test) presented in table 2. Table 1: Descriptive statics

Variables N Mean Std.Deviation MedianOUTSIDE. DRCT 536 0.7317 0.19460 0.8000CFA 536 0.318060 0.122577 0.7269574FCF 536 0.177631 2.2031422 -0.0200000TANG 536 0.2512 0.24935 0.1710BETA 536 0. 2097 1.63722 0.1800SIZE 536 5.6741 0.83578 5.5600PTBV 536 3.654 4.9722 2.065FL 536 0. 5000 1.36607 0.1361CHS 104 45.158173 20.6127430 49.70000Dit 536 0.717030 0.4057320 0.787722

Table 2: Kolomogrov- Smironov Test

Dependent Variable N Sig Kolomogrov-Smironov_ZDit 536 0.125 1.178

Based on above table the significance level is 0.125 which is more than %5.Therefore, null

hypothesis isn’t rejected and data has a normal distribution. Table 3: Model Summary

Model R R Square Durbin- Watson Sig

1 0.759 0.576 0.0002 0.851 0.724 0.0003 0.877 0.770 0.000


Table 3: Model Summary - continued

4 0.889 0.890 0.0005 0.907 0.822 0.0006 0.912 0.832 0.0007 *0.917 0.840 0.938 0.000

As we can see in table 3, the used model is significant in 0.05 error level and in final model

business risk, debt level, free cash flow, non active members of board of directors' ratio, the ownership percent of board of directors’ members, fix assets ratio, and earning variables will enter respectively. The %84 predicting ability of the model (R2 coefficient) shows that the independent variables which are used in optimal final model have the ability to describe %84 of changes in dependent variables. The statistical output related to the significance of variables coefficients are presented in table 4. As you can see in the table, the first, second, third, fourth, fifth, eighth and ninth research hypotheses are confirmed with %5 error level. Table 4: Coefficients

Model Std.Error Unstandardized

CoefficientsStandardized Coefficients t VIF Sig

β BETAConstant 0.140 0.961 6.860 0.000BETA 0.021 -0.041 -0.131 -1.917 1.140 0.0058FL 0. 015 -0.126 -0.404 -8.183 1.154 0.000FCF 0.019 0.108 0.263 5.652 1.174 0.000OUTSIDE.DRCT 0.030 -0.087 -0.156 -2.891 1.148 0.005CHS 0.001 0.003 0.121 2.487 1.487 0.015TANG 0.137 -0.316 -0.128 2.314 1.193 0.023CFA 0.027 0.062 0.128 2.284 1.120 0.024

VIF coefficient related to the entering variables to the final model indicates that there is no

significant change in the coefficient compared to one and there is no liner relation among the entering dependent variables in final model. Considering the fact that firm's size and growth opportunity don’t enter the final model, the sixth and seventh hypotheses are rejected with %5 error level which means that there’s no significant relationship among firm size, growth opportunity, and cash earnings ratio. Therefore, the final model is like this:

CFATANG

CHSDRCTOUTSIDEFCFFLBETAD it

062/0316/0

003/0.078/0108/0126/0041/061/9

(BETA): Beta for the firm (FL): Borrowing ratio (OUTSIDE.DRCTR): The number of outside directors on bords (FCF): Free cash flow per share (TANG): Fixed assets ratio (CFA): Cash flow/Total assets (CHS): Closely held shares In the next part, the logistic model were administrated with ambiguous dependent variable (if

they pay the dividends during the time period, it is 1, if not, it is 0). Table five includes x2test which shows the similarity between observed cases and expected ones. Table 5: Hosmer Test

Step Negelkerke R square 2

K Sig1 0.747 1.910 0.895


Table 6: Variables in the Equation OUTSIDE.DRCT β Wald df SigFCF -0.2600 23.510 1 0.000CFA -0.001 0.000 1 0.111TANG -1.050 3.200 1 0.036BETA -5.500 25.300 1 0.000SIZE -0.990 12.800 1 0.000FL -0.120 0.070 1 0.600PTBV 0.680 7.350 1 0.005CHS -0.178 6.390 1 0.12Constant 0.617 0.087 1 0.542 267.787 0.020 1 0.890

Table six indicates the entering variables into the model and the result of Wald test.

Considering the significance level of each variable, firm size and ownership percent of board of directors’ members don’t enter the model because of their significance level which is 0.600 and 0.542 respectively. So the final model was predicted as below and as it can be seen in Table 5, the predicting ability of the final model is estimated about %47 (Nagelkerke determining coefficient).

( ) 2 / 600 0 / 001 1 / 050 5 / 500 0 / 990 0 / 680 0 / 1781

pLn OUTSIDE FCF CFA TANG BETA FL MB

p

6. Discussions and Conclusion Generally, the results show that we can predict the firms' cash dividends to an acceptable level by using this study variables’. In following parts research findings are discussed.

a. There is a negative and significant relationship between non active members of board of directors’ ratio and dividends pay ratio. The results show that there is a negative and significant relationship between non active

members of board of directors’ ratio and dividends pay ratio. Therefore, when the firms employ more non active managers, they pay fewer dividends. This findings compromise with the substitution theory and indicate that firms with weak corporate governance need to make credit for themselves by paying dividends which means that paying dividends are considered as a substitution of managerial duties performance of non active members of board of directors. So, for attracting more external resources one firm should seek credit by paying dividends or making suitable situation for corporate governance. Findings of the present study are similar to Najar and Hosseini’s (2009) research in this regard.

b. There’s a positive and significant relationship between earnings and dividends pay ratio. The signing theory of dividend policy includes the result which says that the profitable firms

have the tendency to pay more dividends. On the other hand, in profitable firms as the returns from owners’ investments are pretty high, so the owners want to invest the cash flows in the firm again and the future cash earnings increase which the observed results from logistic model confirm. In this regard, the hieratical theory suggests that the firms' financing their own investment opportunities with special priority. In the first step, they can do this by saving earning in the firm, and in the second step, financing with borrowing and finally with owners. If the cost of debt and publishing the shares take into consideration, the firms with few earnings also don’t have the tendency to pay dividends. These findings are consistent with finding’s Najar and Hossinie (2009).

c. There is appositive and significant relationship between free cash flows (liquidity) and Dividend pay ratio. Generally, free cash flow is a scale which can present a better view of firms' financial flexibility

to the creditors and stock holders. From their viewpoint, a firm with high free cash flows has an optimal condition because this firm can use this cash for administrating an operation, repaying the


debts, distributing the dividend and developing the enterprise. Results indicate that free cash flow has a direct, significant relation with dividend pay ratio.

Najar and Hossinie (2009) conclude that there is no relationship between liquidity and dividend pay ratio.

d. There is a negative and significant relationship between assets' structure and dividend pay ratio. When tangible assets in a firm increase, debts and short-term borrowings increase, as well. On

the other hand, the firms which burden higher investing costs by investing on fix assets need more financing and on the bases of hierarchal order financing theory, they prefer to distribute less cash dividends and financing more with inside resources. The outcomes in this field confirm Najar and Hossinie (2009) findings.

e. There is a negative and significant relationship between business risk and dividend pay ratio. Risk earnings, may block the business unit ability to provide return which stock holders

expected. Furthermore, the higher the business risk, the higher the probability of bankruptcy is and therefore, the possibility and probability of firm's dividend pay reduces. Najar and Hossinie (2009)show that there is a negative relationship between dividend pay and business risks which consistent with this research finding.

f. There is a negative and significant relationship between debt level and dividend pay ratio. Firms with lower debt level in assets' structure and having more collateral assets have higher

financial comfort, therefore, they can distribute more incomes among stock holders. Najar and Hossinie (2009) have achieved similar results. On the other hand, results fromlogistic model show that the more leverage the firm has, the higher the possibility of cash dividend pay is and managers persist strongly on paying cash dividend which is in line with the conception of agency text.

g. There is a significant relationship between ownership percent of the board of directors' members and dividend pay ratio. The higher the concentration of ownership in the board of directors members, the more the

dividends because in this way, the earnings are going into managers' account and the dividend pay opportunities are low if considerable amount pay as the profits to the people outside the firms. In the second condition, managers compensate their own loss with other profits and fees which show that there is a positive relationship between ownership percent of board of directors' members and dividend pay ratio. Najar and Hossinie (2009) show a negative relationship between these two variables.

Firm size and earning opportunity variables have no significant relationship with cash dividend ratio and don’t enter the final model. 7. Implications and Suggestions for Further Study Considering the research results, stock holders who are looking for the cash dividends gain should pay attention to the firm cash dividend return in previous years and the level of profit growth in making their own investments decisions.

Firm's managers also must watch their own decisions about dividend policy, because if a firm's manager want to act against the firms special characteristics' in the previous cash return, risk position, investment opportunities and the things like that and try to change the firms dividend policy, then it may encounter with the negative market reaction. So presenting complete information by firms' managers is necessary for delighting the public and stock holders' mind which can prevent the market negative reaction.

Financial institutions can also use the results of this research, because in granting their financial facilities document, they limited the firms' dividend policy to some special conditions. Therefore, knowing the firms dividend policy can be useful in optimizing the work method and the way of conducting these limitations. On the other hand, financial analysts' can consider the way of dividing share earning which investigated in the study for estimating firms' stock market values to recognize a basket of suitable stocks.


For future studies the following suggestions can be taking into consideration: 1. Investigation of the influence of other factors of corporate governance such as the stock

ownership percent of institutional investors, and stock ownership percent of private investors on the dividend policy.

2. Investigation of the impact of other factors of corporate governance such as manager's independence, the number of them an agers' employment years, managers' income and board of directors structure on the dividends policy.

3. In this study an eight year time period is investigated, we suggest that if you have access to the necessary information its better to examine, longer time periods to have more reliable results.

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dividend policy from agency perspective

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