INTRODUCTION:

Dividends are payments by a corporation to shareholders and represent a return on the capital directly or indirectly contributed by the shareholders. Sound dividend decision making is important for any company as it influences its share prices in the market, maximizes its shareholders’ welfare and enhances its reputation in the market. So, company has to be very cautious in dividend decision. Retained earnings help the firm to concentrate on the growth, expansion and modernization of the firm. Thus, the alternative uses of net earnings- dividends and retained earnings- are competitive and conflicting. Consequently the firm has to balance between the growth of the company and the distribution to the shareholders.

The amount of dividend payable to the shareholders depends upon the kind of dividend policy being pursued by the company.

During the first part of the twentieth century, dividends were the primary reason for which investors purchased stock. It was literally said on Wall Street, “the purpose of a company is to pay dividends”. Today, the investor’s view is a bit more refined. As per this view, “the purpose of a company is to increase shareholders' wealth.” Indeed, today’s investor looks to dividends and capital gains as a source of increase in his wealth. The board of directors holds a fiduciary position both with regard to the company as well as shareholders. The board of directors must make inter-alia the three decisions pertaining to investment, financing and dividends simultaneously as these three decisions are interrelated.

Depending upon the requirement of funds, the companies may follow stable dividend policies or flexible dividend policies. A stable dividend policy refers to consistency in the stream of dividends. The stability of dividends can take any of the two forms (i) constant dividends per share: according to this form, a company pays a certain fixed amount per share as dividend year after year, irrespective of the level of earnings, (ii) constant payout ratio: according to this form a company pays a constant percentage of net earnings as dividend to the shareholders. With this policy, the amount of dividend will fluctuate in direct proportion to earnings. On the other hand, by establishing flexible dividend policy, the firm can flexibly handle a period of temporarily high earnings by declaring an extra dividend in addition to regular payments. This allows a larger distribution of earnings without raising the expectations of investors.

REVIEW OF LITERATURE:

A lot of studies have been conducted on dividends till today. The studies conducted by the researchers both in developed as well as in developing countries has thrown light on different aspects of a dividend decision.

Linter (1956) conducted a classic study on how U.S. managers make dividend decisions. According to him the dividend payment pattern of a firm is influenced by the current year earnings and previous year dividends. Baker, Farrelly and Edelman (1986) surveyed 318 New York stock exchange firms and concluded that the major determinants of dividend payments are anticipated level of future earnings and pattern of past dividends. Pruitt and Gitman (1991) then asked financial managers of the 1000 largest U.S. and reported that, current and past year’ profits are important factors influencing dividend payments. Mahapatra and Sahu (1993) found that cash flow is a major determinant of dividend followed by net earnings. Bhat and Pandey (1994) found that managers perceive current earnings as the most significant factor, whereas Alli et.al (1993) reveal that dividend payments depend more on cash flows, which reflect the company’s ability to pay dividends, than on current earnings, which are less heavily influenced by accounting practices and Baker and Powell (2000) concluded from their survey of NYSE-listed firms that dividend determinants are industry specific and anticipated level of future earnings is the major determinant.

Miller and Modigliani (1961) in their most celebrated articles, “Dividend Policy Growth and the Valuation of Shares,” advanced the view that the value of a firm depended solely on its earnings’ power and is not influenced by the manner in which its earnings were split between dividends and retained earnings. Survey of 562 New York Stock Exchange (NYSE) firms with “normal” kinds of dividend polices in 1983 by Baker, Farrelly, and Edelman (1985) and Farrelly, Baker, and Edelman (1986), found that the major determinants of dividend payments were the anticipated level of future earnings and the pattern of past dividends. Karak (1993) examined “the policy decision regarding divisible profit and dividend decision” and concluded that corporate management in India, as a rule, had recently followed conservative policies with regard to dividends. The study conducted by Chihwa and Chunchi (1994) indicate that dividends reflect past, current and future earnings information. Garrett and Priestley (2000) suggest that managers retain a large proportion of unexpected permanent earnings and also, the dividends convey information regarding higher current permanent earnings.

In Malaysia, Annuar and Shamsher (1993) found that the dividend decisions of the firms partially depended on their current earnings and past dividends, and firms have long-term target dividend which is conditioned upon their earnings ability. DeAngelo et al. (2004) posited that the high/increasing dividend concentration may be the result of high/increasing earnings concentration. Goergen et al. (2005) analysed the decision to change the dividend for 221 German firms over 1984–1993. Their results showed that net earnings were the key determinants of dividend changes.

All the above studies are concentrating on dividend payout affected by current as well as earnings and past year dividends. Studies concentrating on other factors of dividends are also reviewed for the present study. Gillepie (1971) studied the difference between firms which increased their dividend payments and firms which maintained the same payment and concluded that firms which increased their dividend payment showed a smaller change in earnings in the period after the dividend increase than firms which maintained the same payment. Jayadev (1992) attempted to study “the dividend determinants- earnings, cash flows, investment demand, debt, interest payment and liquidity” and found that earnings, cash flows, flow of debt and liquidity had direct and positive affects on dividends. Reddy (2002) concluded that firms appear to prefer the pecking order of funds in building their larger asset base. Kanwal and Kapoor (2008) concluded that there is significant correlation between two variables- dividend payout ratio and cash from operations while weak correlation between other variables. Moreover, liquidity is an important determinant of dividend payout ratio thereby indicating that a good liquidity position increases firms’ ability to pay dividend. Gill et al. (2010) seeks to find out whether several factors as per available literature influence the dividend payout ratio of American service and manufacturing firms or not. Results found a positive relationship between profitability and payout in the entire sample, between cash flow and dividend payout ratios, between tax and dividend payout ratio, but a significantly negative relationship between historical sales growth and dividend payout and other factors. As different results were found for the two different industries, study concludes that dividend determinants are industry specific.

Dobrovolsky (1951) analyzed the factors influencing retained earning by using regression analysis and reported that the amount of retained income of large Manufacturing Corporations depended to a large extent, on current profitability, continuity of dividend policies and rate of operating asset expansion. Linter (1956) tested the dividend pattern of 28 companies for the period of 1947 – 1953 with the help of regression analysis. He concluded that a major portion of dividend of a firm would be expressed in terms of firm’s desired dividend payment and target payout ratio. Paul (1957) undertook a study on dividend behavior with the help of multiple regression analysis and reported that the dividends tended to vary directly with current profit, lagged profits, the rate of amortization recoveries and shift in anticipation of future earnings; and inversely with persistent changes in level of sales.

Fama and French (2001) found that payers and non-payers differ in terms of profitability, investment opportunities, and size. Their evidence suggests that three fundamentals profitability, investment opportunities, and size – are factors in the decision to pay dividends. The salient characteristics of former dividend payers are low earnings and few investments. Mitton (2004) wrote that size and growth, in addition to profitability has been proven to be positively correlated with dividend payouts. Li and Lie (2006) reported that firms are more likely to raise their dividends if they are large and profitable and the past dividend yield, debt ratio, cash ratio, and market-to-book ratio are low. Firms are more likely to cut their dividends if they have poor operating income, low cash balances, and a low market-to-book ratio. Liu and Hu (2005) in his study of Chinese listed firms found that cash dividend payment was higher than the accounting profit. Agency theory has also been a popular view in the discussion of dividends relevancy, as been advanced by Jensen and Meckling (1976), and later extended by Rozeff (1982) and Easterbrook (1984).

Literature available reveals that there have been a lot of studies across the world to determine the factors affecting dividend behaviour of firms but studies where dividend payout ratio is associated with current earnings and past dividends have not been conducted from last few years. Moreover, studies on these determinants are performed industry-wise, not in overall economy. It is with this consideration in mind that the present study has been conducted.

OBJECTIVE OF THE STUDY:

The core objective of the present study is to examine the relevance of Lintner’s Model in the Indian context. The study aims to fulfill some additional objectives which are as follows:

· To understand and analyze the trends in dividend payout among sample companies.

· To categorize the companies on the basis of Dividend Payout Ratio.

· To find out average dividend paid by all the firms each year and the total payout.

REEARCH METHODOLOGY:

Scope of the Study:

The scope of the study is limited to examine the relevance of Lintner’s model in the Indian context by taking the companies listed on BSE (Bombay Stock Exchange) 500 as on March, 2012 as the sample of the study.

Sample Selection and Period of the Study:

The analysis has been confined to the companies included in the BSE 500 index of Bombay Stock Exchange as on March, 2012 for ten latest financial years from FY 2002-2012 i.e. Dividend behavior of sample companies has been analysed for the period of 10 years.

To construct the sample for the present study, companies incorporated after year 2000 were excluded from BSE-500 companies. From the remaining 461 companies, only 342 companies were selected for which data was available over the period of study. Size of the sample is now 342 companies which constitutes the companies from all the sectors in India.

Data Collection for the Study:

The data for the study has been collected through secondary sources. It has been gathered from PROWESS – a database of Center for Monitoring Indian Economy. Other sources include related published and unpublished reports.

Variables of the study:

a) Dividend Payout Ratio:

For the purpose of analyzing the dividend trend of the companies, Dividend Payout Ratio has been used as the main variable. The percentage share of Profit after Tax (PAT), which is distributed to the shareholders as dividend is referred to as dividend payout ratio (DPR). DPR is computed as:

DPR_j,t = DPS_j,t

EPS_j,t

Where,

DPR_j,t = Dividend Payout Ratio

DPS_j,t = Amount of dividend paid per share by company j in year t. i.e. dividend paid/ No. of paid up shares

EPS_j_, = Earnings per share at the period end for company j in year t.i.e. Net Earnings/ Outstanding Shares

b) Dividend per share:

Dividend per Share (DPS) is the amount of dividend that shareholders receive, over a year, for each share they own.

DPS = Total dividends paid

No. of shares issued

c) Lagged Dividend per share:

This refers to the dividend of the previous year. This is taken as an explanatory variable as it represents a possible reluctance on the part of management to reduce the dividend already declared. If the company’s dividend policy is stable, current year’s dividend may be taken as a function of previous year’s dividend. Thus, lagged dividend per share is considered as a variable in this context in the study.

d) Earnings per share:

Earning per share (EPS) serves as an indicator of a company’s profitability. It refers to that portion of the total profit reported by a company for a specified accounting period that may be allotted to each share of common stock outstanding.

EPS = Net income – dividends on Preference shares

Average outstanding shares

While calculating EPS, it is more accurate to use a weighted average number of shares outstanding over the reporting term, because the number of shares outstanding can change over time. This variable is also used as an explanatory variable for the study as it is considered that EPS affects the dividends most.

Tools for analysis:

In order to find out the validity of lintner’s model for dividends, step-wise multiple linear regression model has been used. A brief explanation of the model and the tool is as follows:

a) Step-wise linear multiple regression model:

To investigate the relationship between dividend and explanatory variables, multiple regression analysis was used. It was observed that dividend could be modeled using a multiple regression analysis that links dividend to previous year dividend and current year earnings. In order to facilitate the analysis, a stepwise regression was performed. A stepwise regression is a useful tool when dealing with many explanatory variables. It is an attempt to find the best regression model without testing all possible regressions. In such regression, variables are either added to or deleted from the regression model at each step in the model development process. The regression ends with the selection of the best fitting model where no variable can be added or deleted from the last fitted model. It was recognized that the use of all explanatory variables to predict dividend might give rise to some redundant variables and multicollinearity problems. A stepwise regression was, therefore, employed to remove a previously entered variable that became redundant. General form of step-wise linear equation is as follows:

Step 1: Y = b₀ + b₁X₁

Step 2: Y = b₀ + b₁X₁ + b₂X₂

Step 3: Y = b₀ + b₁X₁ + b₂X₂ + b₃X₃

Step n: Y = b₀ + b₁X₁ + b₂X₂ + b₃X₃ + ……….+ b_nX_n

Where,

Y = dependent variable

b₀ = Regression constant

b_i = b₁, b₂,….,b_n are regression coefficients of explanatory variables X₁, X₂, X₃,.., X_n

The statistical significance of regression coefficients was worked out and tested by applying students ‘t-test distribution’. The coefficient of determination (R²) was computed to determine the percentage variation in the dependent variable explained by independent variables.

b) Lintner’s Model:

According to Lintner model of dividend, dividends of current year are affected by the dividends of previous year as well as the earnings available (EPS) in the current year. Lintner’s model is explained with the help of formulation as follows:

D_t = a + b₁ * D_t-1 + b₂ * E_t + e_t

Where,

D_t = Dividend per share at time t

D_t-1= Dividend per share at time t-1 (lagged dividend per share)

E_t = Earnings per share at time t

e_t = Error term

a, b₁, b₂ = Regression parameters

In the above model, D_t is dependent variable whereas D_t-1 and E_t are explanatory variables.

FINDINGS OF THE STUDY:

Findings of the study are divided in two major parts:

1) Analysing the trend of Dividend Payout Ratio for the sample companies

2) Relevance of Lintner’s model in India

1) Analysing the trend of Dividend Payout Ratio for the sample companies:

Dividend payout ratio has been studied to analyze the trends in dividend payout for sample companies over the period of study. Dividend payout ratio relates dividend paid to the capacity to pay dividends, which is determined by profits. The sample companies have been classified according to the payout ratio for each financial year. The categories for the dividend payout ratio consist of <0%-0%, 0%-25%, 25%-50%, 50%-75%, 75%-100% and >100%. The classification of sample companies according to Dividend Payout Ratio over the period of study has been made in Table-1 as follows:

An analysis of distribution of companies shows that maximum number of sample companies fall in the category of 0-25% in all the years followed by 25-50%. This is the indicative of the fact that a major proportion of companies follow a dividend policy of part retention and part distribution of profits as dividends. Number of companies falling in each category has increased from 2002 to 2012 except <0-0%, which highlighted the fact that sample companies are now changing their attitude towards dividend payment i.e. the companies are becoming dividend payers rather than profit retainers.

Table- 1: Distribution of Companies in terms of Dividend Payout Ratio in 2002- 2012

Year DPR	Number of Companies- paid
Year DPR	2002- 2003	2003-2004	2004- 2005	2005- 2006	2006- 2007	2007- 2008	2008- 2009	2009- 2010	2010- 2011	2011- 2012
<0-0%	77	65	47	40	41	34	40	32	27	22
0-25%	118	117	127	124	126	153	150	162	154	142
25-50%	97	111	119	121	124	113	108	109	106	113
50-75%	28	26	28	36	27	25	30	22	28	32
75-100%	15	16	16	15	19	12	10	10	19	17
>100%	7	7	5	6	5	5	4	7	8	16
Total	342	342	342	342	342	342	342	342	342	342

Source: Compiled from data

Table- 2: Results of Step-wise linear multiple regression model

Year final	a	b₁(DPS_t-1)	b₂(EPS_t)	R²	Adj. R²	F value
2002-2003	.377*	.935***	.030***	.857	.856	473.905 [0.000]
2003- 2004	.325	.694***	.071***	.672	.670	343.798 [0.000]
2004- 2005	.324	.143***	.173***	.820	.819	466.580 [0.002]
2005- 2006	.298	.247***	.135***	.913	.913	372.90 [0.000]
2006- 2007	.402	.412***	.133***	.657	.656	549.217 [0.000]
2007- 2008	.915*	.644***	.053***	.839	.838	577.568 [0.000]
2008- 2009	1.112***	.178***	.099***	.503	.500	171.239 [0.000]
2009- 2010	.804***	.796***	.028***	.771	.770	572.289 [0.001]
2010- 2011	.410**	.979***	.020	.618	.617	549.298 [0.000]
2011- 2012	.054	.717***	.026***	.677	.675	355.389 [0.000]

Note: Figures in brackets [ ] shows significance level of F values

*** Significant at 1% level; ** Significant at 5% level; * Significant at 10% level

2) Relevance of Lintner’s model in India:

Lintner considered that divided per share in the previous year (D_t-1) and earnings per share in the current period (E_t) are two significant variables affecting dividend decision of the firm. Relationship analysis over the period of study (from year 2002 to 2012) taking dividend of current year as dependent variable and earnings of current year and dividend of previous year as independent variables are presented in Table-2 as follows:

To examine the fit of the regression model and to identify the best predictors of dividend, stepwise regression was used with the explanatory variables as the predictors. Preliminary analysis revealed no violation of the assumption regarding sample size, multi-collinearity and outliers.

Table-2 above reports the strength of the relationship between the model and the dependent variable through R square (R²) and adjusted R². R Square, the coefficient of determination which is the squared value of the multiple correlation coefficients, tells that how much variance is explained by the model. It can be seen that the regression model explained 85.7%, 67.2%, 82.0%, 91.3%, 65.7%, 83.9%, 50.3%, 77.1%, 61.8% and 67.7% of the variance in the dividend construct starting from year 2002-2003 to 2011-2012. It can also be seen that the dividend model fits the data very well (adjusted R²= 0.856, 0.670, 0.819, 0.913, 0.656, 0.838, 0.500, 0.770, 0.617 and 0.675) for all the years. Further, it was found that the regression sum of squares is higher than the model explained residual sum of squares, which indicate that most of the variation in dividend is explained by the above variables. The significance value of the F statistic is less than 0.05, which means that the variation explained by the model is not due to chance. Also, all the explanatory variables were found to be significant which suggests that, in selected companies, dividend is driven by both the dimensions taken. A closer scrutiny of the results in table-2 show that the both the explanatory variables in the dividend, namely, dividend of previous year (DPS_t-1) and earnings of current year (EPS_t) are significant predictors of dividend of current year in Indian companies. Therefore, it can be concluded that previous year dividend and earnings of current year are significant predictors of dividend of current year. Moreover, it was also found that significance level of previous year dividend and current year earning for dividend of current year is very high for all the years over the period of study.

Dividend = 0.337 + 0.935 * previous year dividend + 0.030 * current year earnings

This equation (for year 2002-2003) shows that previous year’s dividend and current year’s earning are positively associated with dividend of current year. Similarly we can form the equations for all the years over the study period. It is very clear from Table-2 that previous year’s dividend and current year’s earning are positively associated and highly significant with dividend of current year for all the years.

At each stage of a regression analysis SPSS provides a summary of any variables that have not yet been entered into the model. The summary gives an estimate of each predictor’s b value if it was entered into the equation at this point and calculates a t‐test for this value. SPSS enter the predictor with the highest t‐statistic and will continue entering predictors until there are none left with t‐statistics that have significance values less than 0.05. Therefore, the final model might not include all of the variables you asked SPSS to enter. But there are no excluded variables found during the analysis.

CONCLUSION AND SUGGESTIONS:

Study concludes that dividend of current year is positively associated with the dividends distributed in the previous year as well as with earnings of current year (i.e. earnings available in current year to be distributed as dividends as well as to reinvest for the growth of the company), which states that Lintner’s model is relevant in Indian context. Moreover, the study concludes that a major proportion of companies follow a dividend policy of part retention and part distribution of profits as dividends. Also the present study highlights the fact that sample companies are now changing their attitude towards dividend payment i.e. the companies are becoming dividend payers rather than profit retainers.

The scope of the study is limited to examine the relevance of Lintner’s model in the Indian context; a study can be conducted worldwide and a study considering other models than the one examined in this study can also be conducted. The sample of the present study constitutes a small sample; a similar study for a large sample size can also be conducted. The study covers the period of ten years; study for a larger time period can also be conducted. Moreover, other determinants affecting the dividend decision of a firm can also be studied.

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Received on 15.11.2013 Modified on 10.12.2013

Asian J. Management 5(1): January–March, 2014 page 84-89