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THE EFFECT OF SCRIP DIVIDEND ON THE RETURNS OF SECURITIES

LISTED AT THE NAIROBI SECURITIES EXCHANGE

ADOW ABDI IBRAHIM

D61/60842/2011

A RESEARCH PROJECT SUBMITTED IN PARTIAL FULFULMENT OF THE

REQUIREMENTS FOR THE AWARD OF MASTER IN BUSINESS

ADMINISTRATION, UNIVERSITY OF NAIROBI

OCTOBER, 2013

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DECLARATION

This research project is my original work and has not been presented for a degree or any

other examination to any other university.

Signature ……………………… Date………………………………………..

Adow Abdi Ibrahim. D61/60842/2011

This research project has been submitted for examination with my approval as the University

Supervisor,

Signature………………………………………. Date…………………………………

Mr. Herick Ondigo,

Lecturer, Department of Finance and Accounting

School of Business, University of Nairobi

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DEDICATION

I would like to dedicate my research project to my family for their love and support during

this study.

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ACKNOWLDGEMENT

I want to thank almighty Allah (SWT) most gracious, most merciful for enabling me to

complete my studies successfully. My sincere appreciation goes to my parent who stood

beside me all through my studies.

Many thanks go to my supervisor Mr. Herick Ondigo for giving me the required guidelines

all the way till I was through. My fellow classmates especially Gideon Kipchumba and

Keziah Njuguna who assisted me in various ways cannot be forgotten since their contribution

had a positive impact.

I can‘t also forget the entire management of University of Nairobi for their cooperation

towards providing library facilities where I accessed much information concerning this

research study.

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ABSTRACT

Dividends are payments made by a company to its shareholders. Dividend policies are

influenced by many factors. Scrip dividends are relevant because they have informational

value. Financial signaling theory implies that dividends may be used to convey information.

Information, rather than dividends itself, affects returns of securities. Stock dividends

supplement, rather than take place of cash dividends. Some scholars argue that Scrip

dividend is irrelevant whereas others view it otherwise. There are also those that argued that

the effect of a change in dividends has on the price of a firm‘s stock is related primarily to

information about expected future earnings conveyed by a change in dividends. Thus, the

study sets to determine whether there exists a causal relationship between scrip dividend and

the returns of securities of a firm. An event study research design was used in the study. The

research depended on secondary data from companies‘ published financial statements. This

research was based on all the 60 companies that are listed at the NSE, as at 31st December

2012. The firms were selected consisting of all the firms quoted consistently at N.S.E for a

period of 10 years from 2003 – 2012. Dividend data on was extracted from published reports

of quoted companies. This information was obtained at the N.S.E library and from the

company libraries. Data on the market returns of securities was obtained from the returns of

securities as reported by N.S.E. Event study was used in data analysis. From the findings

the study concludes that the Kenyan market reacts positively to scrip dividend issue

announcements. There was an increase in volumes of shares traded after scrip dividend issue

as compared to those before the scrip dividend issue. The study also concludes that managers

of the companies sought issues scrip dividend to encourage investors to purchase their stock

which appeared cheaper. This study showed that there were positive mean returns with

respect to scrip dividend, this was in agreement with the signaling hypothesis which stated

that managers of companies‘ issues scrip dividend to act as a means of passing information to

stock holders and potential investors.

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TABLE OF CONTENT

DECLARATION..................................................................................................................... ii

DEDICATION........................................................................................................................ iii

ACKNOWLDGEMENT ....................................................................................................... iv

ABSTRACT ............................................................................................................................. v

TABLE OF CONTENT ......................................................................................................... vi

LIST OF TABLES ................................................................................................................. ix

LIST OF FIGURES ................................................................................................................ x

LIST OF ABBREVIATIONS ............................................................................................... xi

CHAPTER ONE: .................................................................................................................... 1

INTRODUCTION................................................................................................................... 1

1.1 Background of the Study ................................................................................................ 1

1.1.1 Scrip Dividend ......................................................................................................... 2

1.1.2 Returns of Securities ................................................................................................ 5

1.1.3 Effects of Scrip Dividends on Returns of Securities ............................................... 6

1.1.4 The Nairobi Securities Exchange ............................................................................. 8

1.2 Research Problem ........................................................................................................... 9

1.3 Objective of the Study .................................................................................................. 11

1.4 Value of the Study ........................................................................................................ 11

CHAPTER TWO .................................................................................................................. 13

LITERATURE REVIEW .................................................................................................... 13

2.1 Introduction ................................................................................................................... 13

2.2 Theoretical Review ....................................................................................................... 13

2.2.1 Dividend Irrelevance Proposition: Modigliani & Miller Approach (1961) ........... 13

2.2.2 Dividend Policy and Asymmetric Information ...................................................... 14

2. 3 Types of Dividends ...................................................................................................... 15

2. 3.1 Cash Dividend ....................................................................................................... 16

2.3.2 Stock Dividend....................................................................................................... 16

2.3.3 Property Dividend .................................................................................................. 16

2.3.4 Scrip Dividend ....................................................................................................... 17

2.3.5 Liquidating Dividend ............................................................................................. 17

2.4 Managerial Considerations in Determining a Scrip Dividend ...................................... 17

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2.4.1 Fund Needs of the Firm ......................................................................................... 17

2.4.2 Liquidity ................................................................................................................. 18

2.4.3 Ability to Borrow ................................................................................................... 18

2.4.4 Assessment of Any Valuation Information............................................................ 19

2.4.5 Control ................................................................................................................... 19

2.4.6 Nature of Stockholders .......................................................................................... 20

2.4.7 Restrictions in Bond Indenture or Loan agreement ............................................... 20

2.4.8 Inflation .................................................................................................................. 20

2.5 Empirical Studies .......................................................................................................... 21

2.6 Summary of Literature Review ..................................................................................... 30

CHAPTER THREE: ............................................................................................................. 31

RESEARCH METHODOLOGY ........................................................................................ 31

3.1 Introduction ................................................................................................................... 31

3.2 Research Design............................................................................................................ 31

3.3 Population ..................................................................................................................... 31

3.4 Sample........................................................................................................................... 31

3.5 Data Collection ............................................................................................................. 32

3.6 Data Analysis ................................................................................................................ 32

CHAPTER FOUR: ............................................................................................................... 34

DATA ANALYSIS AND INTERPRETATION ................................................................. 34

4.1 Introduction ................................................................................................................... 34

4.2 Findings......................................................................................................................... 34

4.2.1 Abnormality of Returns Following Scrip Dividend Announcement ..................... 34

4.2.2 Security Returns Variability (SRV) ....................................................................... 35

4.3 Interpretation of Findings ............................................................................................. 39

CHAPTER FIVE: ................................................................................................................. 41

SUMMARY, CONCLUSION AND RECOMMENDATIONS ........................................ 41

5.1 Introduction ................................................................................................................... 41

5.2 Summary ....................................................................................................................... 41

5.3 Conclusion .................................................................................................................... 43

5.4 Recommendation for policy .......................................................................................... 43

5.5 Limitation of the study .................................................................................................. 44

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5.6 Suggestion for Further Research ................................................................................... 44

REFERENCES ...................................................................................................................... 45

APPENDICES ....................................................................................................................... 50

Appendix I: Companies Listed at Nairobi Securities Exchange as at 31st Dec, 2012. ....... 50

Appendix II: Average Abnormal Returns (AAR) ............................................................... 53

Appendix IV: Summary of Data ......................................................................................... 57

Appendix V: Data Collection Sheet .................................................................................... 58

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LIST OF TABLES

Table 4.1: Average Value of ASRV for dividend issue scrip dividend issue Announcement 36

Table 4.2: CAR Across the Event Windows .......................................................................... 36

Table 4.3: One-Sample Statistics ............................................................................................ 38

Table 4.4: Average Value of ASRV for scrip dividend issues ............................................... 39

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LIST OF FIGURES

Figure 4.1: Average CAAR for all the companies .................................................................. 37

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LIST OF ABBREVIATIONS

AR - Abnormal Returns

CAPM – Capital Asset Pricing Model

CAR - Cumulative Abnormal Returns

C.F.O - Chief Finance Officer

CRSP – Center for Research in Security Prices

E.A.B.L- East African Breweries Limited

M&M - Miller & Modigliani

NSE - Nairobi Securities Exchange

NYSE - New York Stock Exchange

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CHAPTER ONE:

INTRODUCTION

1.1 Background of the Study

Dividends are payments made by a company to its shareholders. When a company earns a

profit, that money can be put to two uses. Either the funds could be held by the firm for

reinvestment or distributed to members as dividends. Bitok et al (2010) defined; dividends

refer to the distribution of earnings. The common ways of distributing part of firms‘ value to

its owners include payment of cash dividends, repurchasing of stock and payment of stock

dividends. Quoted companies usually pay dividends on a fixed schedule, commonly

annually, bi-annually or quarterly, however they may declare a dividend any time. Cash

dividend is used more often while repurchasing of stocks is not possible in all countries.

Stock dividends do not have real values and when paid after cash dividends they are

perceived to convey positive information about future cash flows. Dividend policies are

influenced by many factors. The legal rules provide that dividends be paid from earnings.

Contractual constraints could restrict payment of dividends.

Other factors considered include cash needed to repay debt, stability of earnings and growth

prospects. Market considerations with respect to access to capital markets are also important.

John Lintner (1956) observes that corporate managers are averse to changing the dollar

amount of dividends in response to changes in earnings, particularly when earnings decline.

Three of the more commonly used dividends policies are constant payout ratio, regular

dividend policy, and low-regular and extra dividend policy. The dividend policy of the firm

is irrelevant in a perfect capital market because the shareholders can effectively undo the

firm‘s dividend strategy. If a shareholder received a greater dividend than desired, he or she

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can reinvest the excess funds. Conversely, if the shareholder received a smaller dividend than

desired, he or she can sell off extra shares of stock, Miller and Modigliani‘s (1958,

1961).While increased dividends generally increase common stock value, sometimes this is

not always the case. If a company‘s overall performance is questionable, then raising

dividends may not encourage investors (Gitman, 2008).

Therefore, dividends are per-share payments designed by company‘s board of directors to be

distributed among shareholders. For preferred shares, it is generally a fixed amount. For

ordinary shares, the dividend varies with the earnings of the company and the amount of cash

on hand. It may be omitted if the business is poor or the directors withhold earnings to invest

in plant and equipment.

The factors that determine dividend paying capacity are; capital needs, expansion plans, debt

repayment, operation cushion, contractual requirements, past dividend paying history of a

business and dividends of a comparable company should be investigated. After analyzing

these factors, percentage of the net income of average cash flow that can be used for the

payment of dividend can be estimated. What also must be determined is the dividend yield,

which can best be determined by analyzing comparable companies. Brealeys and Myers

(2002) list dividends as one of the ten important unresolved problems in finance reinforcing

the conclusion that much more empirical and theoretical research on the subject of dividend

is required before a conclusion is reached.

1.1.1 Scrip Dividend

Scrip Dividend refers to new shares, which a shareholder elects to receive in lieu of cash

dividend where the shareholder is given the right to make such an election. (Nairobi

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Securities exchange; Listing Manual, 2009). Stock dividends/ Bonus issue involves

capitalization of retained earnings and does not increase the wealth of shareholders. This is

because retained earnings are converted to shares (Pandey, 1991). Scrip Dividend is treated

as a normal dividend followed by the purchase of shares equal to the dividend amount.

Companies can decide whether or not they want to pay dividends, how much to pay, and

when to pay them. Shareholders have absolutely no say in the payment of dividends.

However, companies are not prone to changing their dividend policies very often, since

cutting out dividends or decreasing the amount of a dividend, particularly cash dividends, is

generally a sign that the company is in trouble. Boards of directors will only increase

dividends if they are absolutely certain that the company is doing well enough that it can

handle the increase. Typically, companies pay dividends in two ways (though there are

others, such as property). The most popular and common way to pay dividends to

shareholders is with cash. This money comes from either current earnings, from accumulated

profits, or from the earnings made by reinvesting money into the company. Cash dividends

are taxable and count as investment interest/income. The issuance of scrip dividends will

make the price of the stocks fall. They probably won't fall very much, but the price will fall

on the ex-dividend date, or the day four days before the record date. So if you know that a

company is going to pay its dividends in stock, and you want to buy stock at a lower price,

then you will probably want to buy just before or on the ex-dividend date. However, the drop

will be low enough that it will probably be equaled out by transaction costs and taxes.

Scrip dividends are relevant because they have informational value. Financial signaling

theory implies that dividends may be used to convey information. Information, rather than

dividends itself, affects returns of securities (Brigham and Gapenski, 2004).

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Stock dividends supplement, rather than take place of cash dividends. As long as the cash

dividend per share remains unchanged, the effect of stock dividends is to raise the cash

dividend (when adjusted back to the old shares) in the ratio of stock dividends to shares

outstanding. The device of the stock dividends thus adds appreciably to the continuity of

changes to annual cash dividends. The stock dividend will capitalize a portion of these

undistributed earnings, which the board of directors considers should be retained in the

business. At the same time, the stock dividend will provide common stockholders with

tangible evidence of this investment by issuing additional shares to them and by placing this

investment on a dividend-paying basis. It should be stressed that, apart from the effect upon

cash dividends, a policy of stock dividends has inherent value of in its own right. Since

neither the anticipated earnings- risk profile nor the allocation thereof to existing

shareholders is affected; the value of each stockholder‘s holdings is presumably unaffected.

Associated with increase in shares, therefore is a proportional decrease in value per share

(Ross, Westerfield, Jaffe, 1993).

The payment of dividends conveys to shareholders that the company is profitable and

financially strong. This in turn causes an upsurge in demand for the firm‘s shares causing a

rise in their market prices. When a firm changes its dividends policy, investors assume that it

is in response to an expected change in the firm‘s profitability which will last long. An

increase in payout ratio signals to shareholders a permanent or long term increase in firm‘s

expected earnings. Accordingly, the prices of shares are affected by changes in dividends

policy. This, therefore call for studies to be conducted in the area of scrip dividend and how

this policy affects market prices of shares.

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1.1.2 Returns of Securities

Returns are gains or losses of securities in a particular period. The return consists of the

income and the capital gains relative on an investment. It is usually quoted as a percentage.

In standard asset pricing theory, expected returns on securities are related cross-sectionally to

returns' sensitivities to state variables with pervasive effects on investors' overall welfare.

Security whose lowest returns tend to accompany unfavorable shifts in that welfare must

offer additional compensation to investors for holding the security. Liquidity appears to be a

good candidate for a priced state variable. It is often viewed as an important feature of the

investment environment and macro-economy, and recent studies and that fluctuation in

various measures of liquidity are correlated across assets. This empirical study investigates

whether market-wide liquidity is indeed priced. That is, we ask whether cross-sectional

differences in expected returns on securities are related to the sensitivities of returns to

fluctuations in aggregate liquidity (Gibbons).

It seems reasonable that many investors might require higher expected returns on assets

whose returns have higher sensitivities to aggregate liquidity. Consider, for example, any

investor who employs some form of leverage and faces a margin or solvency constraint, in

that if his overall wealth drops sufficiently he must liquidate some assets to raise cash. If he

holds assets with higher sensitivities to liquidity, then such liquidations are more likely to

occur when liquidity is low, since drops in his overall wealth are then more likely to

accompany drops in liquidity. Liquidation is costlier when liquidity is lower, and those

greater costs are especially unwelcome to an investor whose wealth has already dropped and

who thus has higher marginal utility of wealth. Unless the investor expects higher returns

from holding these assets, he would prefer assets less likely to require liquidation when

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liquidity is low, even if the latter assets are just as likely to require liquidation on average

(Grinblatt,)

1.1.3 Effects of Scrip Dividends on Returns of Securities

It is clear enough that in a perfect capital market in which external financing is freely

available, rational investors would be indifferent between components of their returns: Scrip

dividends and Capital gains. However, it is equally clear that in an imperfect market the firm

should consider the possible impact of the differential tax brackets of its shareholders,

dilution of control, floatation and transaction costs the stability of earning etc, when reaching

its scrip dividend decision. Under these circumstances, it is not clear if scrip dividends

would be preferred to capital gains or vice versa (Levy and Sarnat, 2000).

A regularly paid scrip dividend well covered over the long run by the earnings of a company,

will tend to boost the value of the common stock in the market compared with the common

stock of a similar company with similar earnings that pays only occasional scrip dividends or

no scrip dividends are declared even though company earnings have not risen in proportion

or not at all. Even though earnings are the prime economic force behind the value of a share

of equity, the actual distribution equity, the actual distribution of such earnings has been

looked upon by many analysts as an almost separate contribution to value. Other analysts

and scholars have argued that increased scrip dividends are interpreted by the market as an

announcement of a permanent or expected increase in earnings. The apparent collective

market judgment about the desirability of scrip dividends does not take into account the

opportunities for profitable reinvestment of such funds within the company, in the so-called

―growth companies‖ (Helfert, 1966).

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Ross (2007) argued that in an inefficient market, management can use scrip dividend policy

to signal important information to the market, which is only known to them. For example, if

management pays high scrip dividends, it signals high expected profits in future to maintain

the high scrip dividend level. This would increase the share price/value of the firm and vice-

versa. MM (1961) attached this proposition and suggests that the change in share/value

following the change in scrip dividend amount is due to informational content of scrip

dividend policy rather than scrip dividend policy itself. Therefore, scrip dividends are

irrelevant if information can be given to the market to all players. Scrip dividend decisions

are therefore relevant in an inefficient market and the higher the scrip dividends, the higher

the value of the firm as indicated by its returns of securities. The theory is based on the

assumptions that: the sending of signals by management should be cost effective, the signal

should be correlated observable events no company can imitate its competitors in sending the

signals. Managers can only send true signals even if they are bad signals. Sending untrue

signals is financially disastrous to the survival of the firm (Pandey, 2001).

Offer and Siegel (1997) examined the relationship between scrip dividend changes and

subsequent earnings by considering the properties of analysts‘ forecasts errors before and

after the announcements of a scrip dividend change. They found that the security analysts

revise their price forecasts following unexpected scrip dividend changes and that the greater

the unexpected scrip dividend change, the greater is the forecast revision. Also Carroll (2005)

examines the same relation but for quarterly announcements and provide evidence that

analysts revise their quarterly share price forecasts subsequent to scrip dividend changes.

Carroll also provides evidence that earnings increases are more likely to follow scrip

dividend increases than flat or scrip dividend decreases.

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Benartzi, Michaely, and Thaler (2007) implemented two types of analyses (discrete

categorization analysis and linear regression analysis) to test whether or not scrip dividend

changes convey any information about subsequent earnings changes. They found that, at

best, scrip dividend changes are not related, and, at worst, are negatively related to future

changes in earnings. Furthermore, they found no relation between future earnings and the

size of scrip dividend increases in prior years, although they did find some evidence that

scrip dividend increases signal that recent earnings jumps are permanent. However, because

many scrip dividend – signaling models predict a relation between profits and lagged scrip

dividends, Benartzi, Michaely, and Thaler‘s results seriously challenge signaling as an

important component of scrip dividend policy.

1.1.4 The Nairobi Securities Exchange

A stock market is a place where securities are traded. These securities are issued by listed

companies and by the government, with the aim of raising funds for different purposes such

as to fund expansion for the former, and development and finance budget deficits for the

latter. Common securities traded on a stock exchange include company shares, corporate

bonds, and government debt in the form of treasury bonds. (The NSE Hand book 2011)

The Nairobi Securities Exchange which was formed in 1954 as a voluntary organization of

stock brokers is now one of the most active capital markets in Africa. Nairobi. As a capital

market institution, the Securities Exchange plays an important role in the process of

economic development. It helps mobilize domestic savings thereby bringing about the

reallocation of financial resources from dormant to active agents. Long-term investments are

made liquid, as the transfer of securities between shareholders is facilitated. The Exchange

has also enabled companies to engage local participation in their equity, thereby giving

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Kenyans a chance to own shares. (www.nse.co.ke). Companies can also raise extra finance

essential for expansion and development. To raise funds, a new issuer publishes a prospectus

which gives all pertinent particulars about the operations and future prospects and states the

price of the issue. A stock market also enhances the inflow of international capital. They can

also be useful tools for privatization programmes. Here are some of the companies that have

issued scrip dividends at the NSE: Access Kenya, Bamburi, Barclays, C.F.C, Car and

General, Carbacid, Centum, City Trust, CMC Holdings, Cooperative Bank, Crown Burger,

Diamond Bank, Dunlop, East African Cables, E.A.B.L among others.

1.2 Research Problem

Dividend Irrelevance Proposition according to Modigliani and Miller (1961) show that under

certain simplifying assumptions, a firms‘ dividend policy does not affect its value. The

researcher will want to find out whether those conditions apply in the Nairobi Securities

Exchange by conducting a study on the same area. Scrip Dividends are new shares which a

shareholder elects to receive in lieu of cash dividend where the shareholder is given the right

to make such an election. It is normally assumed that these dividends should have an effect

on the returns of securities.

Companies use these dividends to convey information about the company but in return affect

the returns of the securities. In the last 20 years, companies listed on the Nairobi Securities

Exchange have been using Scrip dividend as a mode of paying dividends. This growing trend

may be attributed to the liquidity problems, political stability, economic growth in the

country, higher investors‘ awareness because of the advent of information technology and the

appealing phenomenon amongst the investors.

http://www.nse.co.ke/

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Edwin and Martin (1982) utilized the monthly data on dividends, prices and returns for New

York Stock Exchange securities available on the University of Chicago's CRSP tape. Elton

and Gruber (1970) conducted a study about the relationship between dividends and returns.

They found out that dividends have been postulated as affecting stock returns because of tax

effects.

Aharony and Swary (1980) also conducted a study on how dividends and returns relate and

found out that agency costs affect dividend and returns. Black (1976) argues that firms

should distribute little or no cash to stockholders once payout taxes are introduced to an

otherwise frictionless model, a prediction strongly contradicted by the substantial taxable

distributions actually made by firms. Black‘s ‗‗dividend puzzle‘‘ relies on his interpretation

of MM (1961) as showing that low payouts are optimal, albeit not uniquely so, absent taxes.

Thus, he reasons, zero or near-zero payouts should be strictly preferable once payouts are

taxed.

Gichema (2007) conducted a study on the effects of bonus shares on the market share prices

on all the companies quoted at Nairobi Stock Exchange. The study found out that there are

abnormal returns surrounding the bonus issues announcement had a positive direction and

magnitude of the stock price adjustment on announcement of bonus issue. Muasya (2010)

also conducted a study on all the companies quoted at Nairobi Stock Exchange and looked at

the impact of bonus issues on stock liquidity. He looked at the relationship between bonus

issue and the stock liquidity of firms quoted at the Nairobi Stock Exchange for the period

between 2003 and 2009. Kennedy (2010) did a study about investigation of the information

content of bonus share announcements for companies quoted at the Nairobi Securities

Exchange.

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It has however remained a puzzle whether a company‘s scrip dividend really affect the firm‘s

returns in terms of market price and volumes traded. Some scholars argue that Scrip dividend

is irrelevant (Miller and Modigliani, 1961) whereas others view it otherwise. Weston and

Brigham, (1981) argue that the effect that a change in dividends has on the price of a firm‘s

stock is related primarily to information about expected future earnings conveyed by a

change in dividends. Thus, the study sets to determine whether there exists a causal

relationship between scrip dividend and the returns of securities of a firm.

1.3 Objective of the Study

To determine the effects of scrip dividend on returns of Companies listed at the Nairobi

Securities Exchange

1.4 Value of the Study

The findings of this study will be of interest to the following:

The management of publicly quoted companies will be able to determine the effects of scrip

dividends on the value of their firms so that they can make an informed and timely dividend

decisions when they are issuing scrip dividends.

The study will help the government of Kenya in establishing proper policies relating to

dividends and taxes. The study of the impact of Scrip dividends on the value of the firms will

assist in ascertaining the appropriate tax amount to be charged on dividend payments without

decreasing the investors ‗confidence at the stock exchange.

The findings will enable the financial Analysts and consultants to offer proper services to

their clients when deciding on issuance of Scrip dividends or the time of issuance. This

relates to optimal scrip dividend where the values of their firms can be maximized.

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Scholars and academicians who may wish to use the findings of this study as a basis for

further research on this subject, hence acts as a springboard to further their research.

Investors who may need to know the relationship between dividends policy and value of the

firm for them to choose which firm to invest their funds in. Therefore, they can monitor the

announcements made by different firms, thus making informed decisions.

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CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

This chapter presents literatures, theories and empirical studies that have been done on the

effect of Scrip Dividend on the Returns of securities

2.2 Theoretical Review

During the last fifty years there are several theoretical and empirical studies that were done

leading to the mainly three outcomes: the increase (decrease) in dividend payout affects the

market value of the firm or the dividend policy of the firm does not affect the firm value at

all. However, we can say that empirical evidence on the determinants of dividend policy is

unfortunately very mixed. The shareholders are indifferent between the different types of

dividends. All they want are high returns either in the form of dividends or in the form of re-

investment of retained earnings by the firm. This study is based on two theories discussed in

relation to this approach

2.2.1 Dividend Irrelevance Proposition: Modigliani & Miller Approach (1961)

In 1961, Merton Miller and Franco Modigliani (M&M) showed that under certain

simplifying assumptions, a firms‘ dividend policy does not affect its value. The basic premise

of their argument is that firm value is determined by choosing optimal investments. The net

payout is the difference between earnings and investments, and simply a residual. Because

the net payout comprises dividends and share repurchases, a firm can adjust its dividends to

any level with an offsetting change in share outstanding. From the perspective of investors,

dividends policy is irrelevant, because any desired stream of payments can be replicated by

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appropriate purchases and sales of equity. Thus, investors will not pay a premium for any

particular dividend policy.

M&M concluded that given firms optimal investment policy, the firm‘s choice of dividend

policy has no impact on shareholders wealth. In other words, all dividend policies are

equivalent. The most important insight of Miller and Modigliani‘s analysis is that it identifies

the situations in which dividend policy can affect the firm value. It could matter, not because

dividends are ―safer‖ than capital gains, as was traditionally argued, but because one of the

assumptions underlying the result is violated. The propositions rest on the following

assumptions namely: Information is costless and available to everyone equally, no distorting

taxes exist, floatation and transportation costs are non- existent and non-contracting or

agency cost exists

2.2.2 Dividend Policy and Asymmetric Information

In a symmetrically informed market, all interested participants have the same information

about a firm, including mangers, bankers, shareholders, and others. However, if one group

has superior information about the firm‘s current situation and future prospects, an

informational asymmetry exists. Most academics and financial practitioners believe that

managers possess superior information about their firms relative to other interested parties.

Dividend changes (increases and decreases), dividend initiations (first time dividends or

resumption of dividends), and elimination of dividend payments are announced regularly in

the financial media. In response to such announcements, returns of securities usually increase

following dividend increases and dividend initiations, and returns of securities usually

decline following dividend cuts and dividend eliminations. The idea that dividend payouts

can signal a firm‘s prospects seems to be well accepted among the CFOs of large US

15

corporations. In a survey of these executives conducted by Abrutyn and Turner (1990), 63%

of the respondents ranked signaling explanation as the first reason for dividend payouts.

Information about the prospects of a firm may include the firm's current projects and its

future investment opportunities. The firm's dividend policy, either exclusively or in

combination with other signals, such as capital expenditure announcements or trading by

insiders, may communicate this information to a less informed market. Empirical studies in

this area include Akerlof‘s (1970) Bhattacharya model (1979), John and Williams model

(1985) Miller and Rock model (1985) Constantinides and Grundy (1989) John and Nachman

(1986) Kale and Noe (1990), Allen. Bernado and Welch (2000) Pettit (1972) documented

that announcement of dividend increases are followed by significant price increases and that

announcements of dividend decreases are followed by significant price drops. Three studies

of large changes in dividend policy—Asquith and Mullins (1983) (dividend initiations),

Healy and Palepu (1988), and Michaely, Thaler, and Womack (1995) (dividend omissions)—

showed that the market reacts dramatically to such announcements. Other research studies

which tested the dividend announcement effects include Aharony and Swary (1980) Ofer and

Siegel (1987),Dyl and Weigand (1998)

2. 3 Types of Dividends

A dividend is generally considered to be a cash payment to the holders of company stock.

However, there are several types of dividends, several of which do not involve the payment

of cash to shareholders. These dividend types are: According to (Van Horne, 1993)

16

2. 3.1 Cash Dividend

The cash dividend is by far the most common of the dividend types used. On the date of

declaration, the board of directors resolves to pay a certain dividend amount in cash to those

investors holding the company's stock on a specific date. The date of record is the date on

which dividends are assigned to the holders of the company's stock. On the date of payment,

the company issues dividend payments.

2.3.2 Stock Dividend

A stock dividend is the issuance by a company of its common stock to its common

shareholders without any consideration. If the company issues less than 25 percent of the

total number of previously outstanding shares, you treat the transaction as a stock dividend. If

the transaction is for a greater proportion of the previously outstanding shares, then treat the

transaction as a stock split. To record a stock dividend, transfer from retained earnings to the

capital stock and additional paid-in capital accounts an amount equal to the fair value of the

additional shares issued. The fair value of the additional shares issued is based on their fair

market value when the dividend is declared.

2.3.3 Property Dividend

A company may issue a non-monetary dividend to investors, rather than making a cash or

stock payment. You record this distribution at the fair market value of the assets distributed.

Since the fair market value is likely to vary somewhat from the book value of the assets, the

company will likely record the variance as a gain or loss.

17

2.3.4 Scrip Dividend

A company may not have sufficient funds to issue dividends in the near future, so instead it

issues a scrip dividend, which is essentially a promissory note (which may or may not

include interest) to pay shareholders at a later date. This dividend creates a note payable.

2.3.5 Liquidating Dividend

When the board of directors wishes to return the capital originally contributed by

shareholders as a dividend, it is called a liquidating dividend, and may be a precursor to

shutting down the business. The accounting for a liquidating dividend is similar to the

entries for a cash dividend, except that the funds are considered to come from the additional

paid-in capital account.

2.4 Managerial Considerations in Determining a Scrip Dividend

These are the various factors that firms in practice can and should analyze when approaching

a scrip dividend decision.

2.4.1 Fund Needs of the Firm

The expected operating cash flows of the firm, expected future capital expenditures, any

likely build-ups in receivables and inventories, scheduled reduction in debt, and anything that

affects the cash position of the firm should be taken into account. The key is to determine

the likely cash flows and cash position of a change in dividend. In addition to looking at

expected outcomes, we should factor in business risk so that we may obtain a range of

possible cash-flow outcomes.

The firm wishes to determine if anything is left over after servicing its fund needs, including

profitable investment projects. In this regard, the firm should look at its situation over a

18

reasonable number of future years, to iron out fluctuations. The likely ability of the firm to

sustain dividends should be analyzed relative to the probability of distributions of possible

future cash flow and cash position. On the basis of this analysis, the firm can determine its

likely future residual funds (Van Horne, 1993).

2.4.2 Liquidity

The liquidity of company is a prime consideration in many dividend decisions. As dividends

represent cash outflow, the greater the cash position and overall liquidity of a company, the

greater its ability to pay a dividend. A company that is growing and profitable may not be

liquid, for its funds may go into fixed assets and permanent current assets. Because

management of such a company usually desires to maintain some liquidity cushion to give it

flexibility and protection against uncertainty, it may be reluctant to jeopardize this position in

order to pay a large dividend. The investment decision determines the rate of asset expansion

and the firm‘s need for funds, and the financing decision determines the way in which, this

need will be financed (Weston & Brigham, 1991).

2.4.3 Ability to Borrow

A liquid position is not the only way to provide for flexibility and protect against uncertainty.

If a firm thereby has the ability to borrow on a comparatively short notice, it may be

relatively flexible. The ability to borrow can be in the form of a line of credit or a revolving

credit from a bank or simply the informal willing of a financial institution to extend credit. In

addition, flexibility can come from the ability of a firm to go to the capital markets with a

bond issue. The larger and more established a company, the better its access to capital

markets. The greater the ability to borrow, the greater is its ability to pay a cash dividend.

19

With ready access to debt funds, management should be less concerned with the effect that

the cash dividend has upon its liquidity (Van Horne, 1993).

2.4.4 Assessment of Any Valuation Information

Regression analysis involving similar companies may give some indication, even though

studies on this line have statistical problems in addition to the troublesome job of trying to

hold all else constant. As a result, it usually is difficult to make company-specific

generalizations concerning the impact of script dividends on stock market prices. Most

companies look at the dividend payout ratios of other companies in the industry, particularly

those having about the same growth. It may not matter that a company is out of line with

similar companies but it will be conspicuous; and unusually a company should judge the

informational effect of a dividend. What do investors expect? Here security analysts and

security reports are useful. The company should ask itself what information it is conveying

with its present dividend and what it should convey with a possible change in dividend

(Helfert, 1966).

2.4.5 Control

If a company pays substantial dividends it may need to raise capital at a later time through

sale of stock in order to finance profitable investment opportunities. Under such

circumstances, the controlling interest of the company may be diluted if controlling

stockholders do not or cannot subscribe for additional shares. These stockholders may prefer

low dividends payout and the financing of the investment needs with retained earnings.

Control can work two ways, however. When a company is being sought by another company

or individuals, a low dividend payout may work to the advantage of the ―outsiders‖ seeking

control. The outsiders may be able to convince stockholders that the company is not

20

maximizing shareholder wealth and that they (the outsiders) can do a better job.

Consequently, companies in danger of being acquired may establish a high dividend payout

in order to please stockholders (Weston & Brigham, 1991).

2.4.6 Nature of Stockholders

When a firm closely held, management usually knows the dividend desires of its

stockholders and may act accordingly. If most stockholders are in high tax brackets and

prefer capital gains to dividends, current income the firm can establish a low dividend

payout. The low payout, of course, would be predicated upon having profitable investment

opportunities for the retained earnings. The corporation with a large number of stockholders

can judge their desires for dividends only in a market.

2.4.7 Restrictions in Bond Indenture or Loan agreement

The protective covenants in a bond indenture or loan agreement often include a restriction on

payment dividends. The restriction is employed by the lenders to preserve the company‘s

ability to service debt. Usually, it is expressed as a maximum percentage of cumulative

earnings. When such a restriction is in force, it naturally influences the dividend policy of

the firm. Sometimes the management of a company welcomes a dividend restriction

imposed by lenders because it does not then have to justify stockholders the retention of

earnings. It need only point to the restriction (Kolb & Demong, 1998).

2.4.8 Inflation

Inflation also may have an influence upon dividend policy. With rising prices, funds

generated from depreciation are not sufficient to replace or restore existing assets as they

wear out or become obsolete. Consequently, a case can be made for retaining earnings

21

simply to preserve the earning power of the firm. The decision must base upon investment

policy and valuation (Seitz, 2000).

2.5 Empirical Studies

Early studies lend support to the signaling rationale that the information content of dividends

is reflected in the movement of stock price, as the announcements of dividend increases

precede significant price increases and that announcements of dividend decreases precede

significant price decreases. For example, Pettit (1972) shows that the price shifts are

observed prior to the announcements of dividends, which was a result of market imperfection

regarding insiders‘ action. Charest (1978) finds that the announcement of a dividend increase

generates excess returns of about 1%. But his study does not necessarily suggest what the

information content of dividends is, since it does not preclude the effect of contemporaneous

earnings announcements. Aharony and Swary (1980) overcome this shortcoming; they find

that in cases where earnings announcements follow dividend announcements, the average

abnormal return is 0.36% for announcements of dividend increases and -1.13% for dividend

decreases. Stock prices are positively related to dividend announcements after controlling for

contemporaneous earnings announcements, indicating that dividend payment conveys

information that is not entirely contained in published earning information. In addition, their

study supports the efficient market hypothesis; that dividends provide information to stock

market and affect stock price. Grullon, Michaely, and Swaminathan (2002) investigate a

sample that consists of large dividend changes of more than 10% and provide supportive

results for the dividend signaling model that the average abnormal return to dividend

increases is 1.34% and the average abnormal market reaction to dividend decreases is 3.71%.

Using the Fama-French three-factor model Grullon,Michaely and Swaminathan (2002) report

22

three-year significant abnormal returns of 8.3% for dividend increases. They did not detect

any abnormal performance for dividend decreasing firms.

Not surprisingly, the post-dividend abnormal performance is even more pronounced for

initiations and omissions. Michaely, Thaler and Womack (1995) reported a market-adjusted

return of almost 25% in the three years after initiations and a negative abnormal return of

15% in the three years after omissions. Assuming that both dividend initiations and dividend

omissions represent extreme changes in dividend policy, stock markets should have more

dramatic responses to announcements of dividend initiations and dividend omissions than to

announcements of dividend increases and dividend decreases.

Asquith and Mullins (1983) argue that dividends ‗effects should be most visible at initiation

since initial dividends are more likely to be unexpected than normal dividend changes. If this

is the case, the market reaction on announcement day of dividend initiation should fully

reflect the effect. Their sample consists of firms that did not pay dividends for at least 10

years. The majority of firms exhibit a positive market reaction to the announcement of initial

dividend. The 2-day excess return is +3.7% and t-statistic is 6.59. This result is comparable

to the returns reported by other studies that focus on dividend initiations. For example, Healy

and Palepu (1988) report two-day excess returns of 3.9 percent, and Michaely, Thaler, and

Womack (1995) find three-day excess returns of 3.4 percent. The market apparently views

the announcement of an initial dividend as good news regarding firms‘ future prospects.

Their study was done to investigate whether dividend policy of the U.S. equity market

portfolio, forecasts future earnings growth. The study comprised companies in the S&P 500

23

which tend to be large and well established firms in advanced economies (Zhou and Ruland,

2006).

The positive relationship is also driven by sticky dividends combined with mean reversion in

more volatile earnings (Arnott and Asness, 2003). The temporary increases and decreases in

earnings subsequently reversed cause the payout ratio to be positively correlated with future

earnings growth. Their robustness check for the mean reversion of earnings suggested that

earnings seem to revert to the mean but may revert most strongly in terms of their ratio to

dividends. However, Farsio et al. (2004) argue that no significant relationship between

dividends and earnings hold in the long run and studies that support this relationship are

based on short periods and therefore misleading to investors. They proposed three scenarios

that would render the long-term relationship of dividends and future earnings insignificant.

First, they point out that an increase in dividends may lead to a decline in funds that are to be

reinvested by the firm. Firms that pay high dividends without considering investment needs

may therefore experience lower future earnings (Farsio et al., 2004). There is thus a negative

relationship between dividend payout and future earnings.

Secondly, an increase in dividends in a quarter may be the result of the management‘s policy

to keep investors satisfied and prevent them from selling the stock at times when future

earnings are expected to decline or current losses are expected to continue (Farsio et al.,

2004). This is a case of rising dividends followed by declining earnings. An increase in

dividends may be the result of good performance in previous periods which may continue

into the future (Farsio et al., 2004). This supports the view of a positive causal relationship

between current dividends and future earnings. From these scenarios, they argue that the

overall long-term relationship is insignificant since there is a positive relationship between

24

dividends and future earnings in some periods and a negative relationship in other periods.

Nissim and Ziv(2001) showed that dividend increases were directly related to future

increases in earnings in each of the two years after the dividend change. What therefore

happens when there is a steady increase in dividends for a given number of years? Nissim

and Ziv (2001) found that dividend increases and decreases are not symmetric. Dividend

increases are associated with future profitability for at least two years after the dividend

change, whereas dividend decreases are not related to future profitability after controlling for

current and expected profitability. They propose that this lack of association can be explained

by accounting conservatism. They therefore conclude that there is a positive relationship

between dividend payout and future earnings but the relationship is stronger for future

abnormal earnings.

In a study that examines whether dividend policy influences firm performance in the Ghana

Stock Exchange, Amidu (2007) found that dividend policy affects firm performance

especially the profitability measured by the return on assets. The results showed a positive

and significant relationship between return on assets, return on equity, growth in sales and

dividend policy. This showed that when a firm has a policy to pay dividends, its profitability

is influenced. The results also showed a statistically significant relationship between

profitability and dividend payout ratio. Astudy by Howatt et al. (2009) also concluded that

positive changes in dividends are associated with positive future changes in mean real

earnings per share.

Adelegan (2003) evaluated the incremental information content of cash flows in explaining

dividend changes, given earnings in Nigeria. She carried out an 882 firm–year study by

analyzing the dividend changes–cash flow relationship on a sample of 63 quoted firms in

25

Nigeria over a wider testing period from 1984 to 1997. She found a significant relationship

between dividend changes and cash flow, unlike previous studies. The empirical results

reveal that the relationship between cash flows and dividend changes depend substantially on

the level of growth, the capital structure choice, the size of each firm and economic policy

changes.

The information content of scrip dividends hypothesis formulated by Miller and Modigliani

(1961) has been the subject of numerous studies in the last few decades. The validity of this

hypothesis hinges on the belief that a firm‘s managers shape the scrip dividend policy in a

manner that is consistent with their appraisal of the firm‘s future prospects in an environment

characterized by asymmetric information. Two of the early extensive empirical studies that

attempted testing this hypothesis and measuring the impact of scrip dividends on stock prices

were Pettit (1997), and Watts (1997).

Pettit (1972) found that market participants make considerable use of the information implicit

in announcements of changes in scrip dividend payments. However, Watts (2007) regressed

year t+1‘s earnings on year it‘s scrip dividends and concluded that examining the relationship

between unexpected scrip dividend changes and stock prices indicates that these changes

communicate no information beyond that reflected in other contemporaneous variables (for

example, earnings). The dramatically opposed conclusions of these two studies, and because

of the importance of understanding the impact of script scrip dividends on prices and future

earnings, several researchers tried to follow up on these issues. A summary of the major

studies is as follows:-

26

Gonedes (2000) provides evidence that is inconsistently with the view that the annual scrip

dividend signals reflect information beyond that reflected in contemporaneous annual income

signals. Thus, he rejects the scrip dividend information content hypothesis. Although

Charaset (1978) found that announcing a scrip dividend increase generates an excess return

of about 1%, he concluded that his evidence does not necessarily reveal the presence of

information in scrip dividend announcements since he made no efforts to isolate the effect of

contemporaneous earnings announcements.

On the other hand, Aharony and Swary (1990), Kwan (1991) Eades (1992) and Woolridge

(1992), using scrip dividends announcements made apart from other firm news reports, found

a significantly positive association between scrip dividend changes and announcement day

stock returns. In each case, these results were attributed to the information content of scrip

dividends.

The two most frequently cited studies in this area are Aharony and Swary (1990), Asquith

and Mullings (1993). Both of these studies used a naïve scrip dividend forecasting model

(that is, next quarter‘s scrip dividend is expected to be the same with last quarter‘s scrip

dividends). Aharony and Swary (1990) examined the impact of script scrip dividends

announcements which were made at different dates than earnings announcements, and found

them to have the same effects on stock prices as the entire sample of announcements. Thus,

the impact of earnings announcement cannot explain the observed stock price behaviour

around scrip dividends announcements.

Following similar lines of investigation, Asquith and Mullings (1993) tried to refine the

credibility of Watts‘s results by re-examining the stock price reaction to scrip dividend

27

announcement, using daily stock data to control for other contemporaneous information

announcements. Their results show significant positive abnormal returns at scrip dividends

initiation announcements. Healy and Palepu (1998) focus on scrip dividend initiations and

omissions, the two scrip dividend policy changes that have been documented in the literature

as having the largest average announcement returns. Consistent with the scrip dividend

information hypothesis, their findings indicate that the information conveyed by scrip

dividend initiation and omissions are related to earnings changes following the

announcements of these scrip dividend policy changes. Investors therefore interpret scrip

dividend initiations and omissions as changes in management‘s earnings forecasts.

A study conducted by Gichema (2007) found that in the recent past companies quoted on the

Nairobi Stock Exchange have been using stock dividend as a mode of paying dividends. This

emerging trend may be attributed to the pecking order theory, economic growth in the

country and the appealing phenomenon amongst the investors. This study focused on the

effect of bonus share issues on stock prices of companies quoted at the Nairobi Stock

Exchange. The objectives of this study were to determine whether there are abnormal returns

surrounding the bonus issues announcement and to establish the direction and magnitude of

the stock price adjustment on announcement of bonus issue. The sample consisted of all the

companies quoted at NSE which declared bonus issues between the periods of interest, I

January 2004 to 31 July 2007, and were drawn from all the segments of the Nairobi stock

exchange. In order to achieve this objectives secondary data obtained from the NSE

Secretariat informational database and the companies‘ financial statements were used.

Further, the study entailed the determination of the precise day of the bonus share issue

announcement and this day was made to be day zero; definition of the period to be studied; in

28

this study the study period was 101 days surrounding the announcement date. The magnitude

of bonus issue announcement was expected to vary across the firms because the

announcements were made by companies in different industries and at different times. It was

hence useful to examine the behavior of each company independently. Data was presented

using tables and graphs. Descriptive statistics i.e. mean and standard deviation and t-tests

were used to analyze data. The findings of this study were such that bonus issues typically

generate positive stock prices reactions in the short run but produce no lasting gains in the

market price for widely held stocks in the Nairobi Stock Exchange. The limitations

encountered included heavy reliance on secondary data, reliance on research studies

conducted in the developed countries for literature review and due to unavailability of data

this study was restricted to companies quoted in the Nairobi Stock Exchange.

Muasya (2010) conducted a study on the impact of bonus issues on stock liquidity has been a

subject of study in various markets with varying results. This study examined the relationship

between bonus issue and the stock liquidity of firms quoted at the Nairobi Stock Exchange

for the period between 2003 and 2009. The study used the multi-dimensional measures of

liquidity to avoid the shortcomings of the one-dimensional measures. The study adopted a

causal research design in establishing the relationship between stock liquidity and bonus

issues on a sample size of 20 companies that had issued bonuses between 2003 and 2009.

Secondary data from Nairobi Stock Exchange was used. The study collected the daily share

prices, trading volumes and number of transactions from which weekly averages were used

to compute the three liquidity measures-Liquidity ratio liquidity ratio 3 and Flow ratio. The

study then used descriptive statistics (mean, standard deviations, minimum and maximum

values), measures of association (correlations and ANOVA) and regression analysis in

29

establishing the relationship between stock liquidity and bonus issues. The study established

the regression model to be significant at (p<0.039). A further Analysis of Variance by sector

segments showed a significant relationship between bonus issue and stock liquidity (flow

ratio) for Financial Sector (p=0.003) and Industrial and Allied Sectors (p = 0.004) while for

Commercial Sectors liquidity ratio 3 was the most significant measure of liquidity (p =

0.023). The study concludes that the stock liquidity reaction to the information content of the

bonus issues in Kenya is positive, in line with evidence from semi strong efficient markets.

Odumbe (2010) also conducted a study in NSE and found that there is a theory that bonus

shares can signal management's view of the condition of a firm and that firm managers use

bonus shares announcement to signal a firm's quality. The information content of events and

its dissemination determine the security prices in the capital market. This study was to test

the semi-strong form of market efficiency on the Kenyan Capital Market. The study

investigated to information content of bonus issue announcements by companies quoted at

the Nairobi Stock Exchange. This study was an event study, evaluative research design was

used. Analysis of Average Stock Returns Variability (ASRV) and Abnormal Returns (AAR)

were used. ASRV analysis is used if announcement contained information relevant for

valuation companies' stocks and the announcement effect exists only if abnormal returns are

significant. The study empirically examined the information content of corporate event of

stocks with regard to 38 bonus issue announcements released by the 26 companies over the

period January 2000 and September 2010. The results of the study showed that the stock

prices reacted to the announcement of bonus issue. Therefore, the he concluded that bonus

announcement contained information useful for valuing the stocks. Thus information of

bonus announcement can be used by the investors for making abnormal returns at any point

30

of the announcement period, through the strategy of short selling. Further, the results show

that market positively received the bonus announcement information before the

announcement came up. However, the analysis depicts the fact that the market gained

significant reactions in the stock prices during the pre and post announcement periods. Thus

one can conclude from the foregoing discussions that the capital markets in general are not

perfectly efficient, to the announcement of bonus issue. This informational inefficiency can

be used by the investors for making abnormal returns at any point of the announcement

period. The study recommended that stock market may use that information to revise the

prices of securities and the investors are advised that when the company comes up with the

bonus issue, the investor should take immediate investment decision (buy or sell) in order to

benefit from the bonus issue announcement.

2.6 Summary of Literature Review

From the literature review, the effect of script dividend on return of securities has been

discussed. From the discussion, the empirical theory has been seen basing its ground on the

platform of inefficiency of the market and asymmetry of information. Some studies and

empirical evidences also contradicted the information signalling hypothesis. The consistency

of information signal of dividend is still unresolved more so when dividends are reduced. An

increase in subsequent earnings after dividend cut which is not in line with the contention

that a dividend omission indicates less-than-anticipated earnings in the future. The aim was

to point out crucial issues and pave way for further research in identifying the impact of

script dividend on return of securities in Nairobi Stock Exchange.

31

CHAPTER THREE:

RESEARCH METHODOLOGY

3.1 Introduction

This chapter presents the research methodology employed in this study. It included the

research design, population and sampling criteria, data collection and data analysis tools.

3.2 Research Design

An event study research design was used in the study. An empirical study performed on a

security that has experienced a significant catalyst occurrence, and has subsequently changed

dramatically in value as a result of that catalyst. The event can have either a positive or

negative effect on the value of the security. Event studies can reveal important information

about how a security is likely to react to a given event, and can help predict how other

securities are likely to react to different events. This is the most appropriate since there were

sufficient secondary data available in the market for analysis to establish the facts. The

research depended on secondary data from companies‘ published financial statements.

3.3 Population

This research was based on all the 60 companies that are listed at the NSE, as at 31st

December 2012. (Appendix 1)

3.4 Sample

The population of interest in this study consisted of all the firms quoted at the Nairobi Stock

Exchange (N.S.E). This study used census because the population is not large. The firms

was selected consisting of all the firms quoted consistently at N.S.E for a period of 10 years

from 2003 – 2012. A period of 10 years is chosen because the researcher considers the

32

period to be adequate for establishing any relationship between dividend payout ratio and the

value of the firm as reflected in the returns of securities.

3.5 Data Collection

This study was facilitated by the use of secondary data. Dividend data on was extracted from

published reports of quoted companies. This information was obtained at the N.S.E library

and from the company libraries. Data on the market returns of securities was obtained from

the returns of securities as reported by N.S.E.

3.6 Data Analysis

Event study was used in data analysis. Event study is an empirical analysis that is normally

used to measure the effect of an event on stock prices (returns). The basic idea is to find the

abnormal return attributable to the event being studied by adjusting for the return that stems

from the price fluctuation of the market as a whole (Ronald and Bernard, 1995).The

researcher will use event study methodology under the following steps.

i) Normal

The expected return, E(R), is used as the benchmark return in the normal situation to

compare with the actual return during the event window(s). Normal return is the return that

would be expected if the event did not take place. The benchmark return represents the return

that is not related to the event of interest.

RRRR tftmitfjiE

,,,,

33

ii) Abnormal Return

Abnormal return was used to appraise the event‘s impact. It is the difference between the

actual return on time (t) in the event window and the expected return of the firm.

RRAR tititiE

,,,

iii) Cumulative Abnormal Return (CAR)

In this stage, the abnormal return of each stock is aggregated over the event window. The

researcher used the CAR to determine the aggregate over the event window.

ARCAR tii

T

TtTT ,,

3

2

32

iv) Testing the Significance of CAR

To test the significance, the researcher used parametric test of t-statistics. Non-parametric

tests will be applied to test the results. For an individual firm, t-test was calculated using the

formula below.

SARt teitiAR ,,/

Across firms, the following formulae will give parametric test statistics, which was used to

investigate if the average cumulative or buy-and-hold abnormal returns are equal to zero.

nCARCAR titiCARt // ,,

n is the number of events in the study. in this study, n was the number of companies in NSE.

34

CHAPTER FOUR:

DATA ANALYSIS AND INTERPRETATION

4.1 Introduction

This chapter presents the data findings on effects of scrip dividend on returns of Companies

listed at the Nairobi Securities Exchange. These data were collected from the NSE offices.

Analysis involved evaluation of abnormal return and security variability around dividend

issue. The study covered a period of 2003 to 2012; the study sampled 10 year period, 10

years is chosen because the researcher considers the period to be adequate for establishing

any relationship between dividend payout ratio and the value of the firm as reflected in the

returns of securities.

4.2 Findings

4.2.1 Abnormality of Returns Following Scrip Dividend Announcement

The study analysed the returns of the shares and compared the same with the market returns

so as to establish the abnormality of returns following scrip dividend announcement. The

analysed data was presented in Appendix II , which shows the abnormal returns for the

entire market following the scrip dividend announcement shows that t-2 to t1 had a positive

abnormal returns of values greater than 1; 1.0894, 2.3329, 4.5166 and 3.2317 respectively.

The period between t2 to t10 had average abnormal return of less than 1 which means that no

investor benefitted from above normal returns pointing at market adjusting to the scrip

dividend issues. This implies that the market do not react fast to scrip dividend issue which

could point to efficiency, but not perfectly efficient. However, period between between t-15

to t1 had above normal returns meaning that the investors enjoyed above normal returns. This

35

could point at insider trading just before the scrip dividend issues anouncement or

management using scrip dividend issues to adjust stock price to a more marketable range.

4.2.2 Security Returns Variability (SRV)

The study sought to establish the variability of the stock return following scrip dividend

issues thus determine the market reaction to scrip dividend issues announcement. The

information presented in Appendix IV shows that that the variability in stock prices does

decrease erratically with time though there is more variability in the days preceding and after

scrip dividend issues announcmnet. Between t-3 to t9, the securities return variability was

found to be negative an indication that the market was negatively reacting to scrip dividend

issues announcment. However, the t-significance shows 11 of the statistics were significant

as their significance value was less that 0.05; 6 of which were in the post-announcement

period. 6 out of the 10 were between t0 and t15. The announcement day had an average

ASRV of -6.2265 at 95% confidence level. Apart from day t-30, t-29, t-28, t-5, t10, t15, t12,

t13, t16, t19 and t29, other periods had ASVR of less than 1. Results support the semi-strong

form efficient market hypothesis since stock prices adjust so fast to public information that

no investor can earn an above normal return by trading on the announcement day and period

thereafter.

36

Table 4.1: Average Value of ASRV for dividend issue scrip dividend issue

Announcement

Estimation Period Security Return Variability

From day -15 to day +15 4.3362

From day -15 to day -1 1.0607

From day 0 to day +15 3.4875


From day -1 to day 1 3.3604

Form day -3 to day +3 1.8787


Source: Research Findings

To analyze the speed at which the stock market absorbs the scrip dividend issues

announcement in its prices, the study presented the average security return variability across

the announcement periods. As indicated by the table, stock variability was more in post

announcement period than pre-announcement period; while t-15 to t-1 had ASRV of 1.0607,

t0 to t15 had ASRV of 3.4875. Between t0 and t1 the ASRV was 3.8742, t-1 to t1 had a

variability of 3.3604. Day t-3 to t3 had ASRV of 1.8787 and t-7 to t7 had ASRV of 1.0753.

Therefore, the stock market positively absorbed scrip dividend issues contained information

positively.

Table 4.2: CAR Across the Event Windows

Days Mean of CAR Variance

t-30 to t-21 3.200135 2.698851

t-20 to t-1 11.606 54.117

t0 to t1 30.50557 16.91172

t-1 to t1 29.065 26.12547

t+2 to t+20 22.383 1.745567

t+20 to t+30 29.035 57.56523

t-30 to t+30 16.28562 98.38799


37

To track abnormal returns over a number of trading days, cumulative abnormal return (CAR)

is computed through out the event period for the scrip dividend issues announcement as

presented in table above . From the table, it can be noted that CAAR for the sampled stocks

are positive during entire event window.

Figure 4.1: Average CAAR for all the companies


Figure above shows a plotted graph trading volume activity ratio against days around scrip

dividend issues announcement for the sampled companies listed in NSE that had issued scrip

dividend. It shows how the market reacted on days before and after scrip dividend issues.

The graph shows that there was generally an increase in shares traded when scrip dividend

issues was announced. This can be shown by the increase in trading activity before and after

scrip dividend issues. Trading activity after the scrip dividend issues date was however found

to be more than that before scrip dividend issues. The trading activity was found to be

especially high from day 2 to day 15 after scrip dividend issues announcement.

38

Table 4.3: One-Sample Statistics

Days T Mean CAAR Sig. (2-tailed)

15 -.008 -.0375 .994

14 .128 .5876 .901

13 .126 .5119 .902

12 .158 .5993 .878

11 -.092 -.2818 .929

10 -.157 -.4655 .879

9 -.195 -.5942 .850

8 -.212 -.6714 .837

7 -.277 -.8767 .787

6 -.674 -1.8009 .516

5 -.653 -1.6090 .528

4 2.023 -2.2557 .330

3 2.495 -.9429 .631

2 2.461 -.7805 .655

1 1.277 .3476 .787

0 1.985 .9602 .348

1 2.150 .9728 .277

2 .845 .9259 .418

3 2.953 2.8412 .079

4 2.660 2.4830 .128

5 .995 1.7084 .343

6 .931 1.7262 .374

7 .684 1.3705 .510

8 1.122 2.4945 .288

9 1.119 2.6855 .289

10 1.127 3.0673 .286

11 .938 3.0849 .370

12 .841 3.1002 .420

13 1.093 4.4908 .300

14 1.068 4.6181 .311

15 .776 3.8150 .456


From the results shown in table above the mean CAAR was found to be positive in the period

after scrip dividend issues an indication that the trading volume reacted positively towards

the scrip dividend issues announcement, in the period before scrip dividend issues the mean

CAAR was found to have both negative value and indication the market was not sensitive to

scrip dividend issues, in the results on t- value the study found that period surrounding the

39

event date the value of t was close to 2 an indication that trade volume were very sensitive to

scrip dividend issues by the companies.

Table 4.4: Average Value of ASRV for scrip dividend issues

Estimation Period Security Return Variability


From day -15 to day -1 1.1278



From day -1 to day 1 3.1439

Form day -3 to day +3 1.9787



To analyze the speed at which the stock market absorbs scrip dividend issues announcement

in its prices, the study presented the average trade volumes return variability across the

announcement periods. From the results in the table above, trade variability was more in post

announcement period than pre-announcement period; while t-15 to t-1 had ASRV of 1.1278,

t0 to t15 had ASRV of 3.1148. Between t0 and t1 the ASRV was 3.1769, t-1 to t1 had a

variability of 3.1439. Day t-3 to t3 had ASRV of 1.9787 and t-7 to t7 had ASRV of 1.2353.

Therefore, the trade volumes in the stock market positively absorbed scrip dividend issues

contained information positively.

4.3 Interpretation of Findings

The study found that no investor benefitted from above normal returns pointing at market

adjusting to scrip dividend issues as the abonormal return around t2 to t10 had average

abnormal return of less than 1, the study also found that the market do not react fast to scrip

40

dividend issues which could point to efficiency, but not perfectly efficient, in some day

surrounding the scrip dividend issues the abonromal return were above normal return,

meaning that the investors enjoyed above normal returns which could be attributed to insider

trading just before scrip dividend issues anouncement or management using scrip dividend

issue to adjust stock price to a more marketable range.

41

CHAPTER FIVE:

SUMMARY, CONCLUSION AND RECOMMENDATIONS

5.1 Introduction

The chapter provides the summary of the findings from chapter four. The objective of this

study was to establish the effects of scrip dividend on returns of Companies listed at the

Nairobi Securities Exchange.

5.2 Summary

This chapter presents discussions of the summary of key findings presented in chapter four,

conclusions drawn based on such findings and recommendations there-to. This chapter will

thus be structured into summary, conclusion, recommendations and areas for further

research. From the findings on the abnormal returns for the entire market following the scrip

dividend issue announcements shows that t-2 to t1 had a positive abnormal returns of values

greater than 1; 1.0894, 2.3329, 4.5166 and 3.2317 respectively. The period between t2 to t10

had average abnormal return of less than 1 which means that no investor benefitted from

above normal returns pointing at market adjusting to scrip dividend issue. This implies that

the market do not react fast to scrip dividend issue which could point to efficiency, but not

perfectly efficient. In the period between between t-15 to t1 had above normal returns

meaning that the investors enjoyed above normal returns. This could point at insider trading

just before scrip dividend issue anouncement or management using scrip dividend issue to

adjust stock price to a more marketable range.

42

The study establishes the variability of the stock return following scrip dividend issue

announcements thus determine the market reaction to scrip dividend issue. In 2006, the

security return variability rose to 11.1829, in 2004 the SVR rose to 6.0276 while in 2010 the

SRV was 0. The t-significance shows 15 of the statistics were significant; 10 of which were

in the post-announcement period. 6 out of the 10 were between t0 and t15. The

announcement day had an average ASRV of 3.9164 at 95% confidence level. Apart from day

t1, t11, t15, t12, t15, t16, t22, t24, t26, t28 and t29, other periods had ASVR of less than 1.

Results support the semi-strong form efficient market hypothesis since stock prices adjust so

fast to public information that no investor can earn an above normal return by trading on the

announcement day and period thereafter.

From the findings, the results indicated that generally, there was an increase in the volumes

of shares traded when scrip dividend issue were announced. This was especially so in the

days around the scrip dividend issue. Trading activity was also seen to generally increase

after scrip dividend issue as compared to that before scrip dividend issue. The disparity in

trading activity before and after scrip dividend issue was found not to be very big except. All

the companies showed increases in trading activities but not with disparities. The results

showed there was a positive announcement effect on shares traded as a result of scrip

dividend issue. On the issue date, there was a positive average abnormal return which was

very significant at 0.05% level. To track abnormal returns over a number of trading days, the

cumulative abnormal return was computed throughout the event period.

43

5.3 Conclusion

From the findings the study concludes that the Kenyan market reacts positively to scrip

dividend issue announcements. There was an increase in volumes of shares traded after scrip

dividend issue as compared to those before the scrip dividend issue. The study also concludes

that managers of the companies sought issues scrip dividend to encourage investors to

purchase their stock which appeared cheaper. This study showed that there were positive

mean returns with respect to scrip dividend, this was in agreement with the signaling

hypothesis which stated that managers of companies‘ issues scrip dividend to act as a means

of passing information to stock holders and potential investors.

5.4 Recommendation for policy

The key assumption of the event study method was the ability to identify the event date. In

this case of scrip dividend issue, two key event dates did occur; the announcement date and

the effective date. The data of announcement date was not complete so the effective scrip

dividend issue date was defined as the event date. Although scrip dividend issue

announcement already contained information regarding future earnings and dividends

expectations by management, the inclusion of these firms could have resulted in an

overstatement of the effect of the scrip dividend issue announcement on stock prices. The

comparisons done were based purely on price trends and did not account for changes in the

overall market conditions. Other market conditions could have arisen, which had effects on

the general activity of shares in the market and on the returns, hence there was need to make

use of the market model.

44

5.5 Limitation of the study

In attaining its objective the study was limited to 31 firms listed companies in the NSE that

had issued scrip dividend in the between the year 2002 to year 2012. The study could not

therefore incorporate the impact of other companies that had issues scrip dividend in the

same period.

Secondary data was collected from the NSE reports. The study was also limited to the degree

of precision of the data obtained from the secondary source. While the data was verifiable

since it came from the Nairobi Securities Exchange publications, it nonetheless could still be

prone to these shortcomings.

The study was limited to investigate effects of scrip dividend on returns of Companies listed

at the Nairobi Securities Exchange. Secondary data was collected from the Nairobi security

exchange publications.

5.6 Suggestion for Further Research

Scrip dividends were found to be relatively new in the Nairobi Securities Exchange.

However, many companies intending to distribute their earnings do so by use of scrip

dividend. Scrip dividends are not so different from the bonus issue. This study made use of a

simple methodology based on the market model to determine abnormal returns. There is need

for further study in this area and a need to include more independent variables such as those

relating to firm size, growth and profitability of the firms so as to determine whether when

other factors are considered there market would still react positively to scrip dividend

announcements

45

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50

APPENDICES

Appendix I: Companies Listed at Nairobi Securities Exchange as at 31st Dec, 2012.

NAIROBI SECURITIES EXCHANGE LISTED COMPANIES

AGRICULTURAL

1 Eaagads Ltd Ord

2 Kapchorua Tea Co. Ltd OrdOrd

3 Kakuzi Ord.

4 Limuru Tea Co. Ltd Ord

5 Rea Vipingo Plantations Ltd Ord

6 Sasini Ltd Ord

7 Williamson Tea Kenya Ltd Ord

COMMERCIAL AND SERVICES

8 Express Ltd

9 Kenya Airways Ltd

10 Nation Media Group

11 Standard Group Ltd

12 TPS Eastern Africa (Serena) Ltd

13 Scangroup Ltd

14 Uchumi Supermarket Ltd

15 Hutchings Biemer Ltd

16 Longhorn Kenya Ltd

TELECOMMUNICATION AND TECHNOLOGY

17 AccessKenya Group Ltd

18 Safaricom Ltd

AUTOMOBILES AND ACCESSORIES

19 Car and General (K) Ltd

20 CMC Holdings Ltd

21 Sameer Africa Ltd

22 Marshalls (E.A.) Ltd

51

BANKING

23 Barclays Bank Ltd

24 CFC Stanbic Holdings Ltd

25 I&M Holdings Ltd

26 Diamond Trust Bank Kenya Ltd

27 Housing Finance Co Ltd

28 Kenya Commercial Bank Ltd

29 National Bank of Kenya Ltd

30 NIC Bank Ltd

31 Standard Chartered Bank Ltd

32 Equity Bank Ltd

33 The Co-operative Bank of Kenya Ltd

INSURANCE

34 Jubilee Holdings Ltd

35 Pan Africa Insurance Holdings Ltd

36 Kenya Re-Insurance Corporation Ltd

37 CFC Insurance Holdings

38 British-American Investments Company ( Kenya) Ltd

39 CIC Insurance Group Ltd

INVESTMENT

40 Olympia Capital Holdings ltd

41 Centum Investment Co Ltd

42 Trans-Century Ltd

43 MANUFACTURING AND ALLIED

B.O.C Kenya Ltd

44 British American Tobacco Kenya Ltd

45 Carbacid Investments Ltd

46 East African Breweries Ltd

47 Mumias Sugar Co. Ltd

48 Unga Group Ltd

52

49 Eveready East Africa Ltd

50 Kenya Orchards Ltd

51 MANUFACTURING AND ALLIED

A.Baumann CO Ltd

52 CONSTRUCTION AND ALLIED

Athi River Mining

53 Bamburi Cement Ltd

54 Crown Berger Ltd

55 E.A.Cables Ltd

56 E.A.Portland Cement Ltd

57 ENERGY AND PETROLEUM

KenolKobil Ltd

58 Total Kenya Ltd

59 KenGen Ltd

60 Kenya Power & Lighting Co Ltd

53

Appendix II: Average Abnormal Returns (AAR)

Days AAR T Sig. (2-tailed)

-30 .4375 .816 .451

-29 1.3938 2.180 .081

-28 .5875 1.342 .237

-27 .7102 -1.000 .363

-26 1.0529 -.267 .800

-25 .3839 .951 .385

-24 .2612 1.410 .218

-23 .4774 .866 .426

-22 .3698 -.635 .554

-21 .3845 -1.230 .273

-20 .6196 .361 .733

-19 .4158 -.523 .623

-18 .3621 2.191 .080

-17 .4290 1.210 .280

-16 .2057 .735 .495

-15 .1673 .261 .805

-14 1.0176 .565 .596

-13 1.7646 1.066 .335

-12 1.2849 4.912 .004

-11 .3819 2.378 .063

-10 2.6129 2.938 .032

-9 .5799 3.022 .029

-8 1.4308 1.120 .314

-7 .5264 2.515 .053

-6 1.2743 .059 .955

-5 .3490 .262 .804

-4 .2696 1.926 .112

-3 .8296 1.390 .223

-2 1.0894 2.629 .047

-1 2.3329 1.967 .106

0 4.5166 1.834 .126

1 3.2317 -1.841 .125

2 .8559 -2.758 .040

3 .2945 -1.660 .158

4 .2251 -1.346 .236

5 .1447 .656 .541

6 .0607 -1.318 .245

7 .1299 .365 .730

8 .0411 -1.637 .163

9 .0692 -1.380 .226

10 .1885 -.131 .901

11 3.0224 .993 .366

54

12 1.5179 .171 .871

13 .1160 .974 .375

14 .2478 -.869 .424

15 1.1385 -1.404 .219

16 2.3328 -.104 .921

17 .7888 -1.196 .285

18 .2792 -.537 .614

19 .2432 .756 .483

20 .3464 1.020 .355

21 .2046 .438 .680

22 .7916 -1.897 .116

23 .1092 -1.144 .304

24 .8801 .081 .939

25 .0676 -.167 .874

26 .9100 -.024 .981

27 .4095 -.217 .837

28 1.2688 1.869 .121

29 17.2388 .716 .506

30 .2198 -.280 .790


55

Appendix III: Average Security Returns Variability

Day Mean (ASRV) STDEV T-stat Sig

-30 0.4375 0.5234 2.047 0.096

-29 1.3938 1.8582 1.837 0.126

-28 0.5875 0.6349 2.267 0.073

-27 0.7102 0.5702 3.051 0.028

-26 1.0529 1.1117 2.320 0.068

-25 0.3839 0.4850 1.939 0.110

-24 0.2612 0.2629 2.434 0.059

-23 0.4774 0.4699 2.488 0.055

-22 0.3698 0.3010 3.009 0.030

-21 0.3845 0.5874 1.603 0.170

-20 0.6196 0.7380 2.057 0.095

-19 0.4158 0.5269 1.933 0.111

-18 0.3621 0.5936 1.494 0.195

-17 0.4290 0.5200 2.021 0.099

-16 0.2057 0.1282 3.932 0.011

-15 0.1673 0.1663 2.465 0.057

-14 1.0176 1.2111 2.058 0.095

-13 1.7646 3.4017 1.271 0.260

-12 1.2849 2.0187 1.559 0.180

-11 0.3819 0.6810 1.374 0.228

-10 2.6129 3.4394 1.861 0.122

-9 0.5799 0.5939 2.392 0.062

-8 1.4308 1.4331 2.446 0.058

-7 0.5264 0.5191 2.484 0.056

-6 1.2743 1.7801 1.754 0.140

-5 0.3490 0.3457 2.473 0.056

-4 0.2696 0.4164 1.586 0.174

-3 0.8296 0.7799 2.605 0.048

-2 1.0894 0.8281 3.222 0.023

-1 2.3329 2.7111 2.108 0.089

0 4.5166 3.9164 2.825 0.037

1 3.2318 4.1131 1.925 0.112

2 0.8559 0.5396 3.886 0.012

3 0.2945 0.1820 3.962 0.011

4 0.2251 0.2760 1.997 0.102

5 0.1447 0.2029 1.747 0.141

6 0.0607 0.0271 5.491 0.003

7 0.1299 0.0981 3.244 0.023

8 0.0411 0.0397 2.540 0.052

9 0.0692 0.1027 1.651 0.160

10 0.1885 0.1639 2.817 0.037

11 43.0224 85.8135 1.228 0.274

56

12 1.5179 2.3342 1.593 0.172

13 0.1160 0.1066 2.666 0.045

14 0.2478 0.3888 1.561 0.179

15 1.1385 1.5994 1.744 0.142

16 2.3328 4.4154 1.294 0.252

17 0.7888 0.6696 2.886 0.034

18 0.2792 0.3248 2.105 0.089

19 0.2432 0.2181 2.732 0.041

20 0.3464 0.5638 1.505 0.193

21 0.2046 0.0673 7.444 0.001

22 0.7916 1.0715 1.810 0.130

23 0.1092 0.0663 4.038 0.010

24 0.8801 1.5974 1.350 0.235

25 0.0676 0.0470 3.521 0.017

26 0.9100 1.5537 1.435 0.211

27 0.4095 0.4468 2.245 0.075

28 1.2688 1.3201 2.354 0.065

29 17.2388 33.5374 1.259 0.264

30 0.2198 0.2115 2.546 0.052


57

Appendix IV: Summary of Data

β0 β1

Access Kenya 0.050 -0.021

Barclays 0.025 0.004

C.F.C Bank 0.024 -0.007

Car & General 0.016 0.002

Carbacid 0.018 -0.014

Centum Investment 0.033 0.013

City Trust 0.052 0.001

Cmc Holdings 0.037 -0.003

Co-Operative Bank -0.050 -0.018

Crown Berger -0.040 0.003

Diamond Trust -0.012 -0.008

Ea Breweries 0.022 -0.007

Ea Breweries 0.008 0.002

Ea Cables 0.022 0.002

Eaagads 0.023 0.015

Equity Bank 0.011 0.014

Express Kenya 0.034 0.013

Jubilee Holdings 0.026 -0.007

Kenya Reinsurance 0.021 0.032

Kplc -0.001 -0.030

Limuru Tea 0.021 0.000

Mumias Sugar 0.016 0.017

Nation Media Group -0.007 0.027

National Bank 0.014 0.017

Nic Bank -0.015 0.031

Nic Bank 0.001 0.026

Pan Africa Ins. -0.015 0.016

Sasini 0.052 0.020

Scangroup 0.071 0.076

Scbk 0.228 0.054

Standard Group -0.006 0.036

Standard Group -0.073 -0.164

Tps Serena -0.073 -0.029

Unga Group -0.026 -0.025


58

Appendix V: Data Collection Sheet

Company Name

Date Share prices Market return

1.

2.

3.

4.

5.

6.

7.

8.

9.

10.

11.

12.

13.

14.

15.

16.

17.

18.

19.

20.

21.

22.

23.

24.

25.

26.

27.

28.

29.

30.

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