I

SNA VII DENPASAR BALI, 2-3 DESEMBER 2004

Tax Position, Investment Opportunity Set (IOS), and Signaling Effect as A Determinant of Leverage and Dividend Policy Simultanity

(An Empirical Study on Jakarta Stock Exchange)

By

Elok Pakaryaningsih

Abstract

Studies on corporate leverage and dividend policy usually take under the assumption that both, leverage and dividend policy are independent. Recently, many researchers find that, in order to lessen the agency conflict, leverage and dividend policy are simultaneous. On that case, agency theory is capable to explain their simultaneity. Eventhough there is an agreement on this argument, Barclay, Smith and Watts (1995) argue that, not only agency theory can explain the leverage and dividend policy simultaneity. Through their empirical study Barclay et.al (1995) find three factors that can affect the simultaneity, there are: tax position, investment opportunity set (IOS), and signaling effect.

According to Barclay et.al (1995), this study is aimed to, test the three factors of leverage and dividend policy simultaneity in Indonesian manufacturing industry. This study uses 100 firm samples, which consists of firms listed in Jakarta Stock Exchange (JSX) from 1994 until 1998. The samples and data are collected, using pooling data and purposive sampling method.

In order to test the simultaneity, this study uses two-stage least square (2SLS) method of analysis. As dependent variables this study use market leverage ratio and dividend payout ratio, and the independent variables are; non-debt tax shield, market-to-book value of equity, future abnormal earnings, assets tangibility, and liquidity position. The result of the analysis shows that variables used, as a proxies for tax position, investment opportunity set (IOS) and signaling effect have significant influence on leverage and dividend policy simultaneity. The other variables, assets tangibility and liquidity position also have significant effect on leverage and dividend policy. This study also find the simultaneous positive relationship between leverage and dividend policy.

Keywords: Leverage, Dividend, Tax Position, Investment Opportunity Set (IOS), and Signaling Effect

I. Introduction

In making a decision about financing, company usually faces a problem on determining the level of optimal capital structure. Generally capital structure is defined as the relative mix of leverage and equity securities, in the long-term financial structure of a company (Megginson, 1997). The choice between leverage and equity becomes an important issue because it will affect the distribution of companys earning, in the form of dividend. In this case an optimal capital structure will raise a problem about determining the proportion of debt over total equity.

Many researchers have been developing a study about determining the proportion of debt and the proportion of earning paid as a dividend. These studies generally take under the assumption that, leverage decision and dividend decision are independent (not simultaneous).

Recently, the relevancy about the assumption of independent relationship between leverage and dividend decision has been argued in many empirical studies, which have found simultaneous relationship on the two decisions. In these studies, agency theory is used to explain the simultaneity between leverage and dividend decision. This theory states that, an agency relationship arises whenever an individual or group, called a principal, hires someone called an agent to perform some services, where the principal delegates decision-making power to the agent (Brigham and Daves, 2004). Further, the conflict will emerge, due to agents personal goals that compete with principals wealth maximization. In this case, leverage and dividend decision perform as a control mechanism to the conflict. Jensen, Solberg and Zorn (1992) find that the level of insider ownership is strongly affecting the simultaneity between leverage and dividend decision. Further, they find that company with high level of insider ownership has a small dividend and also small leverage. Using the same argument, Crutchley and Hansen (1989) find that, company uses three decisions simultaneously in order to lessen the agency cost, they are: managerial ownership, leverage decision and dividend decision. Noronha, Shome and Morgan (1996) study, also find the simultaneity, on the company, which has been characterized with low growth and no block holder.

On the contrary, Barclay, Smith and Watts (1995) argue that, not only agency theory but also signaling theory is capable to explain the simultaneity between leverage and dividend decisions. They have found that, three factor which are: companys tax position, investment opportunity set (IOS), and signaling effect are capable to predict the simultaneity. Using three method of regression analysis that is pooled regression, cross section regression and fixed effect regression, they find that the three factors have significant effect on the simultaneity.

The consideration about tax in the companys capital structure has proposed by Modigliani and Miller (1958), which have called irrelevance theory. On that proposition they assume that, tax is not relevant to be considered in the companys capital structure, for there is no such tax, either individual or corporate tax. Therefore there is no tax-shield on using certain amount of debt. According to this view, the large amount of leverage in the companys capital structure will not affect companys value. However, the absence of tax is unrealistic, because it does exist, both individual and corporate (Modigliani and Miller, 1963; Miller, 1977). In this case the amount of interest inherent in the use of debt can reduce the amount of corporate tax. As a consequence, company will use higher leverage in their capital structure, to capture this interest-tax shield. Therefore, higher leverage will cause higher companys value.

Besides the advantage of interest-tax shield, there is also a non-debt tax shield that can affect the simultaneous relationship between leverage and dividend (DeAngelo and Masulis, 1980). In this case, company with high non-debt tax shield will prefer to use low leverage (McKie-Mason, 1990).

As an opposite of the company, there is no tax-shield on individual income. Investors have to pay high amount of tax on their earning paid by the company (cash dividend). However, reinvested earning which results in the form of capital gain will caused lower tax. Thus, investors prefer to collect lower dividend or reinvest their earning to the company in order to capture the capital gain. Chang and Rhee (1990), find that higher individual tax compared to capital gain tax, persist the company pays low dividend and uses high retained earning in their capital structure.

The simultaneous relationship between leverage and dividend decision is also determined by companys investment opportunity set (IOS). The argument about IOS is proposed by Myers (1977). On this proposition, they argue that, mainly company is a mix between its assets in place that is tangible, and future investment option or growth option that is intangible. Future investment option reflects companys investment opportunity (through the choice of many projects with positive NPV). Thus, companys opportunity to grow, will depend on the choice between: executes those projects with positive NPV or abandons them. The choice usually called managerial discretion.

Generally high growth companies have higher investment opportunity compared to those slow growth companies. However they dont have sufficient collateral assets that are tangible when external financing, such as debt, is required. With this condition, high growth companies will choose low leverage or high internal financing such as retained earning to finance those potential projects. As a result the dividend paid to investors will be low.

The opposite site happens on slow growth companies, these companies usually use high leverage and pay high dividend (Long and Malitz, 1985; Williamson 1988). Further, Jensen (1986) argue that the tendency on using leverage and dividend in both, high and slow growth companies, can be explained through the existence of free cash flow problem. On the slow growth companies, which are particularly mature, debt or leverage is used as a bonding to investors that free cash flow will extend the amount of dividend paid. This argument directly indicates the simultaneous relationship between leverage and dividend decision.

The third factor to explain the simultaneity between leverage and dividend decision is signaling effect. This effect appears because of the existence of asymmetric information between managers and investors. In this case, different investors have different views on both, the level of future dividend payments and the uncertainty inherent in those payments, and managers have better information about future prospects than public stockholders. This difference of view, will affect the stock market, indicated by stock price changing around dividend announcement. Smith (1986), Venkatesh (1989), Koch and Shenoy (1999), and Kale and Noe (1990) examine the effect of signaling on leverage and dividend decision.

Using the argument about tax, investment opportunity set and, signaling effect, this study develops a model to examine the simultaneity between leverage and dividend. The two stage least square (2SLS) method is used to find the existence of the simultaneity. Two models of equations will be developed: first, the leverage equation, with leverage as an endogenous variable, and second, the dividend decision, with dividend also as an endogenous variable. The three factors proposed by Barclay et.al. (1995), which are: tax position, investment opportunity set (IOS) and signaling effect then, will be use as control variable in both equations. Another two variables will also be use in the model, to meet the identification of equation, require in the 2SLS method. They are: assets tangibility that will be added on the leverage equation and liquidity position that will be added on the dividend equation.

II.

Theoretical Background and Hypothesis Development

2.1. Tax Position

According to the irrelevance theory, companys value will only be determined by investment decision. This decision will only affects the left hand side of the balance sheet that is companys assets. In this case, the tangibility of assets being used will determine that value. 2.1.1. Leverage and Tax Position

By considering the existence of tax, Modigliani and Miller (1963) revise their argument in the irrelevance theory. On their revised proposition, they find that using a certain amount of leverage can reduce corporate tax. Further, the interests payment inherent in that leverage can be used as a tax shield. They conclude, this interest tax shield is the explanation for higher leverage decision.

Besides the advantage of interest tax shield, some companies also have the benefit from another form of debt tax shield, that is non-debt tax shield. This form of tax shield usually provided by the government, concerning the risk inherent in the companys business. The non-debt tax shield can be classified into two forms: tax loss carryforward and investment tax credit. However, on the studies generated by Bradley, Jarrel and Kim (1984) and also by Noronha et.al (1996), another non-debt tax shield can also be found in the form of depreciation. These studies argue that, the level of depreciation reflects the amount of companys tangible assets, which can be use as collateral assets; hence companies characterized by high depreciation cost tend to use high leverage.

Many studies have been conducted to examine the effect of non-debt tax shield on leverage decision; however the results are still ambiguous. Scott (1976), find positive relationship between non-debt tax shield, which is proxies by the level of depreciation, and leverage decision. He concludes that, the level of depreciation reflects the amount of tangible assets, which can be use as collateral assets. Thus, company with high level of depreciation should have more debt in its capital structure. This result is consistent with Bradley, Jarrel and Kim (1984) and also by Noronha et.al (1996). However, Mc-Kie Mason (1990) find negative relationship between leverage decision and non-debt tax shield. He argues that, for high-risk companies (such as mining and exploration companies), which always have to face the possibility of negative earning, tax shield is very important. Therefore in some countries, the government gives a number of tax facilities, through some tax regulations such as: zero-tax status and tax loss carryforward. These facilities subsequently, affect companys leverage decision, which always tend to be low. This conclusion is consistent with the proposition stated by DeAngelo et.al (1980) in which, the higher the benefit from non-debt tax shield, the lower the leverage will be used.

2.1.2. Tax Position and Dividend Decision

On the level of individual income there is no tax shield. Miller (1977) argues that, for an individual income such as dividend, investors have to pay income tax, which is remarkably higher than those on capital gain. Therefore, investors will prefer to obtain low than high dividend, or reinvest their earning to capture the capital gain. Chang and Rhee (1990) find that tax on individual income affect leverage and dividend decision simultaneously. In this case, investors preference on capital gain, insists the company to pay low dividend and use high retained earning. Consequently, company will use low leverage.

2.2. Investment Opportunity Set (IOS)

According to the concept of investment opportunity set (IOS), the mix between companys assets in place and investment opportunity or growth option, will determine companys growth level. Moreover the choice to execute the investment opportunity that consists of positive NPV projects will increase companys growth if the projects being chosen give some benefit in the future.

2.2.1. Investment Opportunity and Leverage Decision

Facing several investment opportunity, financing decision usually perform as a tradeoff between underinvestment and overinvestment problem. These problems are related with companys level of assets in place and investment opportunity. High growth companies, which are characterized with high investment opportunity usually, face an underinvestment problem. This problem appears when companies have to operate the positive NPV projects that require more debt financing. However, these companies generally dont have sufficiency on both, assets in place and cash flow to cover up their debt. If equity financing - by issuing new common stock - is chosen, then some risks will emerge such as, the existence of asymmetric information and the raise of conflict between shareholders (particularly new shareholder) and creditors. Therefore issuing new equity will costly. For some companies, this situation will lead to run off those investment opportunities, however some are prefer to continue those projects using retained earning than to leave them.

On the contrary, slow growth or mature companies, which are characterized with high free cash flow, high assets in place, but small number of investment opportunity, have to deal with overinvestment problem. Jensen (1986) argues that, overinvestment problem is a conflict between managers and shareholder, which is generally, arises due to the difference view of free cash flow. Managers, who always seek for optimal size of the company, tend to see this free cash flow as a non-profit fund, when it has to be reinvested to the companys main business. Thus for some managers, they have a tendency to plow this fund into another project, which is different with companys core business. However, investors see this free cash flow as an additional amount for dividend paid. In order to lessen the conflict, managers then use leverage to fund any investment opportunity. This leverage is also used as a bonding mechanism to the investors that free cash flow will be paid as an increasing dividend.

Another study to provide evidence about the effect of investment opportunity and assets in place is generated by Long et.al (1995). This study found that company with high investment opportunity reflected in high R&D and high advertising cost, have lower leverage compare to those with low R&D and low advertising cost.

2.2.2. Investment Opportunity and Dividend Decision

Investment opportunity is also affecting dividend decision. Fast growing companies, with high investment opportunity, usually need large account to support their growth. Holder, Langrehr and Hexter (1998), find that high growth companies usually use internal financing that is retained earning to support their growth and also to avoid transaction cost when external fund is used. This view is consistent with pecking order theory proposed by Myers and Majluf (1984) which is argue that, companies prefer to use internal fund than external fund to support their investment. The similar view is also used in the study generated by Adedeji (1998).

Moreover, Gaver and Gaver (1993) have examined the simultaneous relationship between leverage and dividend decision affected by investment opportunity. They find that investment opportunity affects three decisions simultaneously; they are leverage decision, dividend decision and managerial compensation decision. Reflect on the investment opportunity examination, Barclay et.al. (1995), propose the concept of IOS called investment opportunity spectrum. However, this concept is merely the summary of IOSs cost and benefit on leverage and dividend decision, as shown on table 2.1. bellow:

Table 2.1.

The Cost and Benefit of IOS on Leverage and Dividend Decision

Investment Opportunity Spectrum

Assets in Place Growth Option

Cost of Debt (Underinvestment)LowHigh

Benefit of Debt (Free Cash Flow)HighLow

Predicted LeverageHighLow

Cost of Dividends (Flotation Cost)LowHigh

Benefit of Dividends (Free Cash Flow)HighLow

Predicted Dividend YieldHighLow

Source: Barclay, M.J., Smith, C.W., and Watts, R.L.1995. The determinant of corporate leverage and dividend policies. The New Corporate Finance: Where Theory Meets Practice, 214-229.

2.3. Signaling Effect

Principally signaling effect occurs due to the existence of asymmetric information between managers and investors. In this case, managers have better information about the companys future earning rather than investors. As a consequence, investors have a tendency to make different perception about companys earning announcement. In that case stock price will change around this announcement, as a reflection of the difference.

2.3.1. Signaling Effect and Leverage Decision

Announcement on using higher leverage is a reflection of companys optimism about their increasing future earning. It also reflects managerial optimism about companys ability to pay those debts. Barclay et.al. (1995), use the term high quality firm or undervalued firm, for company whose earnings have the tendency to increase in the future. For those companies, the stock market subsequently reacts positively showed by stock price increasing.

Further Barclay et.al. (1995), argue that likewise the optimism view on increasing income, the insensitive characteristic of leverage on mispricing and thus prevent stock price volatility, become the main rationalism on using higher leverage. This view is also similar with Smith (1986).

2.3.2. Signaling and Dividend Decision

Dividend decision can also be explain by means of signaling effect. In this case, dividend performs as an instrument to convey positive information from managers to investors that is increasing future earning. This increasing earning will reflect on rising dividend. As a consequence if companies fail to sustain this increasing earning, the stock price will fall. In summary, high quality companies pay high dividend.

The effect of signaling on dividend decision is proven by Kale et.al. (1990). Their study finds that companies which characterized with stable cash flow and high earning, have a tendency to pay high dividend. Another study on signaling effect is also generated by Koch et.al. (1999). Their study finds significant effect of signaling on leverage and dividend decision simultaneity. Further, they also find that, the strong effect of signaling is occurs both on underinvestment and overinvestment companies.

III. Research Methodology

3.1. Population and Sample

All JSX firms within the manufacturing sector are chosen to be the population for this study. Then 100 samples is selected using purposive sampling method through three criteria, first they must be listed in the Jakarta Stock Exchange from 1994 to 1998. The time period on choosing those companies is preferred with the concern of the activating period of several tax facilities in Indonesia. Second, these firms must be continuing listed in the JSX from the time period being chosen. Finally, they are maintaining paying dividend. Bellow is the detail of the sample:

Table 3.1.

The Number of Manufacturing Companies

YearThe Number of The Companies

199429 companies

199529 companies

199616 companies

199711 companies

199815 companies

Total Number 100 companies

Three main sources are used to obtain the samples: a) Indonesian Capital Market Directory published from 1994 to 1998, b) records about tax regulation especially tax facilities published by Indonesian Tax Department and c) other publication which is relevant with this study.

3.2. Variables Measurement

3.2.1. Leverage

From the first equation, that is leverage equation, leverage decision performs as dependent variable. This study will use market ratio of leverage, that is, the comparison between total book value of leverage and market value of the firm, as a proxy for leverage. This market ratio is used with the consideration on its capability to identify the future value of tangible asset, which can be used as collateral for leverage (Barclay, et.al., 1995). Another reason on using this ratio is because market value of leverage is capable on predicting the cash flow stability and future debt service ability (Brigham, Gapenski and Daves, 1999). The formula for market ratio of leverage is shown bellow:

Leverage =

(3)

The companys market value will be calculated using the formula, as shown bellow:

Market value of the firm =

(4)

The term LEVERAGE then will be used to determine this variable.

3.2.2. Dividend

Similar with leverage decision, dividend decision also performs as a dependent variable in the dividend equation. The dividend payout ratio (DPR) that is dividend per share (DPR) divided by earning per share (EPS) will be used as a proxy for dividend decision. The formula for dividend payout ratio is:

Dividend =

(5)

We will use the term DIVIDEND to represent this variable in the model.

3.2.3. Non-Debt Tax Shield

The dummy variable will be used to assess non-debt tax shield. A criterion 1 is given for companies which have the benefit from tax facility given by the government. This tax facility including: tax deducting, tax-delaying and tax-releasing. Another criterion that is 0 is given for companies, which have no tax benefit. Five tax facility regulations will be used as a guide to conduct the dummy variables, they are:

a. PP No. 45 Year 1996 and KEPPES No. 7 Year 1999

b. The tax regulation letter No. 272 Year 1998

c. KMK No. 19/KMK. 04/1994, followed by SE-31/PJ. 52/July 1995, SE-58/PJ. 52/ December 1995, and SE-72/PJ. 52/April 1996

d. KMK No.855/KMK.01/1993 and KMK No.293/KMK.01/1994

e. PP No.3 Year 1996 and KMK No.291/KMK.05/1997

Then, the term NDTS will be use to represent the variable.

3.2.4. Investment Opportunity

The level of investment opportunity or growth option is projected by market to-book value of equity ratio, which has proposed by Kallapur and Trombley (1999). They have conducted a research to find the best ratio to proxy the investment opportunity. From the 12 ratios being observed, they have found that only market to-book value ratio is capable to disclose companys future growth. Therefore this ratio is the finest proxy for investment opportunity. The formula for market to-book value of equity is:

Market-to-book value of equity = (6)

The term MTBEQ will be used to determine this variable in the model.3.2.5. Signaling Effect

The theory of signaling pronounces that signaling effect portrays companys future quality, either low or high. Since the quality can be explained by the tendency of companys future earning to change, Barclay et.al (1995), argue that future abnormal earning can be employ to asses the signaling effect. The formula for future abnormal earning is:

Future abnormal earning = (7)

The term FAE will be use to point out this variable in the model.

3.2.6. Asset Tangibility

The amount of tangible assets reflects on its book value employed by companies, will affect the amount of leverage. The collateral feature innate in those tangible assets, produce more leverage (Titman et.al, 1984). With this view, this research will use the assets tangibility ratio that is book value of tangible or fixed assets divided by total assets. The formula is:

Assets tangibility =

(8)

The term TANG will be used to determine this variable.

3.2.7. Liquidity Position

Liquidity position is another independent variable that will be added to the dividend equation. This variable shows the amount of cash on hand that will be used to pay cash dividend. The higher the liquidity position, the higher the dividend will be paid. This research will use the current ratio to represent companys liquidity position. Other liquidity ratios are eliminated because they cannot show the actual companys liquidity position. The formula for the current ratio is:

Current ratio = (9)

We will use the term CRATIO to point out this variable.

3.3.Research Design

This study develop a research design based on the explanation about tax position, investment opportunity, and signaling effect and their effect on leverage and dividend decision, as shown bellow:

Figure 3.1

The Simultaneous Relationship Between Leverage and Dividend Decision

Exogenous Variables

Endogenous Variables

3.4.Equation Model

The effect of tax position that is non-debt tax shield, investment opportunity and signaling effect on the leverage and dividend decision will be modeled in the equation as shown bellow:

Leverage= (10 + (11(Tax Position) + (12(IOS) + (13(Signaling Effect) + (14Dividend (1)

Dividend = (20 + (21(Tax Position) + (22(IOS) + (23(Signaling Effect) + (24Leverage (2)

Derived from the equation model, we can see that if (11 and (21 have positive associations with leverage and dividend decision, and if (12 and (22 also have positive associations with leverage and dividend decision, and if (12 and (22 have the same positive effect with leverage and dividend decision, therefore the associations between (14 and (24 will be positive.

3.5.Hypotheses Development

In keeping with the explanation about tax position, investment opportunity and signaling effect, and also with the concept of IOS spectrum on leverage and dividend decision, this research predicted the effect of those three factors as shown bellow:

Table 3.2.

The Hypotheses

HypothesesPredicted Effects

H1: Leverage DividendPositive

H2a: Tax Position LeverageNegative

H2b: IOSLeverageNegative

H2c: Signaling EffectLeveragePositive

H2d: Assets TangibilityLeveragePositive

H3a: Tax PositionDividendNegative

H3b: IOSDividendNegative

H3c: Signaling EffectDividendPositive

H3d: Liquidity PositionDividendPositive

IV. Result and Discussion

4.1. Summary Statistics

The descriptive statistics summarizes the characteristics of the samples being used. Table 4.1. shows the total number of the samples used, the maximum and minimum value, the mean value, the standard deviation and the summation of each variables.

Table 4.1

Descriptive Statistic

NMinimumMaximumSumMeanStd. Deviation

DIVIDEND1000.0034.25855.8310.558310.63097

LEVERAGE1000.0270.95143.9680.439680.24624

NDTS10001350.350.48

MTBEQ1000.12716.498223.0572.230572.57728

FAE100-1.2692.7802.7202.72E-020.44369

TANG1000.1110.76539.6830.396830.16107

CRATIO1000.4137.786165.8251.658251.06050

Valid N (listwise)100

As observed, total valid number of samples is 100 firm-years. The endogenous variable or dependent variable, that is, dividend decision has 0.003 of minimum value and 4.258 of maximum value. The total value, that is the summation of total number of the dividend sample, is 55.831, with 0.63097 of standard deviation. Another endogenous variable that is leverage decision has minimum and maximum value that is 0.027 and 0.0951, with 43.968 of total value, and 0.43968 of mean value.

From the summary statistics we can also see the characteristics of the exogenous variables. For the non-debt tax-shield, the maximum and minimum value is 1 and 0. The total value of this variable is 35, results in the mean value of 0.35. It also has 0.35 of mean value and 0.48 of standard deviation. The second exogenous variable, that is, market-to-book value of equity, the maximum and minimum value is 16.498 and 0.127. The total number of this variable is 223.057, with the mean and standard deviation is 2.23057 and 2.57728. Future abnormal return has 1.269 minimum value and 2.780 maximum value. This variable also has 0.4439 of standard deviation and 2.72E-2 mean value.

4.2. Discussion

4.2.1. Leverage Equation

The data collected is analyzed, with the help of SPSS program. The result for leverage equation is shown on table 4.2 bellow:

Table 4.2

2SLS Result for Leverage Equation2SLS Results

Equation 1

Dependent Variable = Leverage

Independent VariablesCoefficientsTSig T

(Constant)-1.495175-9.0520.0000

DIVIDEND4.61119712.5520.0000

NDTS-1.454518-11.1700.0000

MTBEQ-0.098155-14.8850.0000

FAE0.65163911.7200.0000

TANG0.1781002.2010.0302

F = 58.62866Signif F = 0.0000

R Square = 0.75720

Derived from table 4.2, the join effect of the exogenous variables, which are, dividend, non-debt tax shield, market-to-book value of equity, future abnormal earning and tangibility, on leverage decision is 75.72%, significant at the level of 0.05. The positive coefficient of endogenous variable, that is, dividend, is consistent with the hypothesis 1 which predicts the positive simultaneous relationship between leverage and dividend decision. Similar with the result on the endogenous variable, the negative coefficients on non-debt tax shield and market-to-book value of equity and positives coefficients on future abnormal earning and assets tangibility are also consistent with the hypotheses 2a, 2b, 2c, and 2d.

4.2.2. Dividend Equation

Using the same statistical tools, the result for structural equation 2, that is, dividend equation is presented in the table 4.3 bellow:

Table 4.3

2SLS Result for Dividend Equation

2SLS Results

Equation 2

Dependent Variable = Dividend

Independent VariablesCoefficientsTSig T

(Constant)-7.831348-5.4150.0000

LEVERAGE17.3188325.7090.0000

NDTS-2.216659-4.7670.0000

MTBEQ0.7602535.7280.0000

FAE-1.016480-5.1320.0000

CRATIO-0.070800-1.3050.1950

F = 8.67238Signif F = 0.0000

R Square = 0.31568

The table shows that, jointly, the exogenous variables, which are, leverage, non-debt tax shield, market-to-book value of equity, future abnormal earning and current ratio, affects the dividend decision for about 31.568%. The positive sign and statistical significance of leverage indicate that leverage and dividend decision are positively interdependent. This result is consistent with the hypothesis 1. Unlike with the endogenous variable, the exogenous variables show conflicting result with the hypotheses. Non-debt tax shield is related negatively to dividend that is meaning consistent with the hypothesis 3a. However, the other exogenous variables, that is, market-to-book value of equity, future abnormal earning and current ratio show different sign with the hypotheses 3b, 3c, and 3d, even though they are still statistically significant.

V. Summary and Conclusion

5.1.

Summary

The results of the analysis support the main hypothesis that leverage decisions and dividend decisions are interdependent. Specifically, leverage decision has a positive influence on dividend decision and also dividend on leverage. This result can be shown on the significant r-squared on both leverage equation and dividend equation. These observations suggest that companies set their leverage and dividend decision due to their tax position, investment opportunity and signaling effect.

The significant result on non-debt tax shield and its consistency with the hypothesis, on both equation indicates that the tax facilities given by the government has a large impact on the amount of leverage used. However the market-to-book value of equity shows inconsistent result with the hypothesis on dividend equation. The positive sign of this variable indicates that, even though high growth companies generate high cash flow, they usually do not have enough internal funds to deal with their investment opportunities. Therefore they will use high leverage. This result is also consistent with Baskin (1989) and Gaver et.al (1993).

The other inconsistent result on dividend equation is occurred on future abnormal earning. However the negative sign of this variable support the study generated by Woolridge and Gosh (1995). On that study, they argue that, the increasing of investors rationality makes dividend announcement is perceive as positive signal on companys future earnings indicated by high investment opportunity. In that case, high investment opportunity will require companies to use internal fund, which means pay low dividend. However, this argument cannot be directly generated for Indonesian stock market. Soetjipto (1997) and Giyartiningrum (2000) argue that, Indonesian investor have the tendency to discard the information content inherent on dividend announcement. Consequently, there will be no abnormal return and stock price changing around dividend announcement. However, they predict that the negative influence is caused by the existence of insider and institutional ownership. On that case, managers who always also act as an owner, will be very conservative on using leverage, thus they prefer use internal funds.

On the leverage equation additional exogenous variable, that is, asset tangibility has positive influence on leverage. This result is consistent with the hypothesis, which pronounces that high collateral assets, that is, tangible assets will lead to high leverage. The other additional variable, that is, current ratio, shows inconsistent result. The negative sign for that variable indicates that cash flow is preferred to fund another projects than paid as cash dividend.

5.2. Suggestion for Future Research

This study, however has many obstacles, therefore need some improvements. First, for the better result, it is feasible to consider another variable in the model, which may enhance the simultaneity effect. Second, the inconsistency of some variable such as market-to-book value of equity and future abnormal earning may need another proxy to represent these variables precisely. Third, the prediction that insider and institutional ownership are also affecting the simultaneous relationship between leverage and dividend decision, can also be considered for future research. Forth, even though the dummy variable shows better proxy for non-debt tax shield, it is possible to apply another proxy, such as depreciation. The time differences are also possible to analyze, by considering the economic crisis begin in 1998. For this reason, the analysis can be divided into two periods, before and after the crisis. Last, the better result may emerge, if the maturity of leverage also considered.

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Leverage

Non-debt tax shieldNDTS

Market-to-book valueMTBEQ

Future abnormal earning FAE

Assets tangibilityTANG

Dividend

Current ratioCRATIO

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