The Impact of Financial Leverage and Earnings on Dividend Policy: A Study of Banking Sector in India

 

Ruchi Mangla¹*, Dr. Manisha Goel²

¹Research Scholar at YMCA University of Science and Technology, Faridabad, Haryana and Assistant Professor in Faculty of commerce and Business Studies, Manav Rachna International University, Faridabad, Haryana

²Associate Professor ,Department of Management, YMCA University of Science and Technology, Faridabad, Haryana

 

ABSTRACT:

Banking is one of the important support services for business but today it has become an industry in itself and investors look upon it as a profitable sector.  Indian banking industry is thought to become 5^th largest banking industry of the world by 2020. Now it becomes important to know what this sector is paying back to its equity investors in the form of dividends. As far as dividend is concerned, it has always been a puzzle in financial management and there are number of factors that influence the dividend payment. This paper is an attempt to find out the relation of dividend with other factors which can affect it. Researchers have tried to know the impact of earning, financial leverage and book value of shares as a major component on the dividend policy of banks in India. The study is based on the data for 33 banks in total for a period of 12 years. Both the nationalized and private banks are considered for the study. The various statistical tools have been applied using SPSS.

 

 

 

1. INTRODUCTION:

As generally understood the bank is financial institution that provides the banking services of accepting deposits and providing loans in addition to other services to its customers. Banking system is actually the backbone of industry and economic development of the country. Today banking is not only the support service for business but it has become an industry in itself which investors look upon as a profitable sector, with the potential of becoming 5^th largest banking industry in the world by 2020. India’s banking sector is expanding at a very fast pace. In such a scenario it becomes important to know what this sector is paying back to its equity investors in the form of dividends and the correlation of the dividend with other factors which can affect it.

 

Dividend refers to that portion of earning which is distributed to shareholders (here equity shareholders). Dividend policy decides the amount and process of the distribution of profits. A business can choose to give a large share or a smaller part of its earning to the shareholders and decide the amount it wants to reinvest. There is an inverse relationship between the retained earnings and the dividend paid to shareholders. Dividend policy sets the guidelines to be followed while deciding the amount of dividend to be paid out to the shareholders. The business needs to adhere to the dividend policy while deciding the proportion of earnings to be distributed and the frequency of the distribution. There are various types of dividend policies – regular, stable, constant and irregular. The payment of dividend can be made in the form of cash or stock dividends. As far as dividend payment is concerned there are number of factors that influences the dividend. Few of them are agency costs, price volatility, dividend yield, market value, long term debt, size of the business, profitability, growth and investment opportunities, accessibility and price of alternate means of capital and financial leverage etc.

 

 Profitability or earnings is one of the important factor determining dividends as it is only the portion of the earnings which is to be distributed. So naturally to the great extent it has an impact on dividend. Leverage allows a business to increase the potential gains or losses on a position or investment beyond the point that would be possible through a direct investment of its own funds. Financial leverage refers to the extent to which an investor utilizes the money that has been borrowed for the business, indicating the existence of debt in its capital structure. It enhances the return on equity. Financial leverage sometimes has its own advantages; it can increase the return on investment for the shareholder and also provides tax benefits associated with borrowing. On the other hand, it increases the risk quotient of the business, due to which it pays out less dividends to its investors and retains a higher portion of the profits to reinvest in the investment projects that would eventually decrease the debts of the company, so making the dividend payouts lesser in value. The most widely used measure of leverage for regulatory purposes is the leverage ratio. Financial leverage ratio is defined as the debt to equity ratio, that is, total debt/shareholders’ equity. It is the amount of debt taken for every rupee of equity. The financial leverage ratio is a measure of how much assets a company holds relative to its equity. In essence, the financial leverage ratio is a variation of the debt to equity ratio and would move in tandem with debt to equity.

 

This paper is an attempt to find out the impact of earning, financial leverage and book value of shares as a major component on the dividend policy of banks in India.

 

LITERATURE REVIEW:

Dividend policy is a crucial decision for any business as it decides how much it needs to pay out as dividends to its shareholders. A lot of research has been done regarding the dividend policy in general and banks in particular. Few researches about dividend policy in banks are mentioned here:-

 

In 2008, Matthias A. Nnadi and Meg Akpomi studied the impact of taxes on the dividend policy in Nigerian banks. The research was conducted by considering various factors that affects the dividend policy of a bank which comprised mainly of dividend payment pattern of the bank, complying with a preset capital structure, leverage of the bank, taxes etc. They concluded that the profits retained by the banks influence the dividend payments positively as the banks function with more stability attracting more investors. Also an affirmative relationship was realized between the profits, taxes and the dividend payout. (Nnadi and Akpomi 2008).

 

Another research was conducted on the banking sector in Amman stock exchange measuring the effects of the dividend policy on the performance of the banks. This study was done by four researchers; Dr. Waseem Al- Haddad, Dr. Saleh Al- Zorqan, Dr. Shukairi – Musa and Dr. Mahmood – Noor in the year 2011. The dividend payout ratio and the stability of the dividend policy were also examined for the selected banks. The methodology adopted in performing the research was the use of a balanced panel data which was used to derive at significant statistical results. It was found that the Central Bank of Jordon (CBJ) exercise a control over the commercial banks functioning in Jordon and  imposed a restriction on the cash dividends paid out to its shareholders. CBJ also had a constant supervision on the banking sector to preserve and maintain the interests and rights of the investors in the banks in Jordon. This led to the conclusion that the banks in Amman stock exchange conform to unsteady and changeable cash dividend policies (Haddad et al. 2011).

 

Four researchers; Sajid Gul, Sumra Mughal, Syeda Asma Bukhari and Nabia Shabir in the year 2012 tried to determine the indicators which affect the dividend policy of the banks in Pakistan. The data was collected for 18 banks for the period 2006 to 2011 which were mentioned in Karachi Stock Exchange. The factors that were tested comprised of the size of the bank, profits earned by the bank, financial leverage of the bank and the risk associated with it and the growth rate of the bank. The methodology adopted was finding the correlation coefficient for the factors influencing the dividend policy of the banks in Pakistan. It was concluded that the financial leverage and the risk associated with it showed an inverse impact on the dividend payments made by the bank whereas profits earned, size of the bank and the growth rate of the bank expressed an affirmative relation with the dividend pay-out ratio of the bank. (Gul et al. 2012).

 

Further in 2012, a study was conducted for the private banks in USA to estimate the propensity to pay cash dividends. The research was done by Jamal Al-Khasawneh, Mohammad Shariff and Khalid Al-Zubi with the purpose to provide different choices for the shareholders looking for dividend payments in the banking industry. The study comprised of studying 759 commercial banks over the years ranging from 1993 to 2000. The methodology adopted consisted of conducting a regression analysis using a descriptive approach. They studied the indicators that predicts the cash dividend given out by the banks in US and concluded that the indicators consists of total assets, equity returns and the ratio of equity to liability. It was also estimated that a large number of banks pay cash dividends at an augmenting rate, some have initiated making dividend payments and some have chosen to stop giving out cash dividends. The results showed that banks with large equity make higher dividend payments indicating an affirmative relationship between the dividend payments and the total assets of the banks and the return it gets on the equities. It was also realized that equity to liability ratio had an inverse relation with the dividend payments made by the banks of US (Al-Khasawneh et al. 2012)

 

Another study was carried out by Hashim Zameer, Shahid Rasool, Sajid Iqbal and Umair Arshad in the year 2013 in which the Pakistani banking sector was studied to establish the factors that determine the dividend policy of the banks in Pakistan. The study was conducted by doing a regression analysis by applying SPSS in which the data of 27 domestic and foreign banks was used. The approach of the research was explanatory. It was found that the profits realized by the bank, the past dividend payments given by the bank to its investors and the ownership structure of the bank had a significantly positive effect on the dividend policy within the banks of Pakistan. On the other hand the liquidity of the bank exhibited an inverse relationship with the dividend policy of the banks. It was also concluded that the factors such as size, agency costs etc. did not affect the dividend policy of the banks in Pakistan. (Zameer et al. 2013).

 

The study by M Sudhahar and T Saroja analyzed the trends and determinants of the dividend policy of banks in India.  They studied the banks actively traded under group A and B of Bombay Stock Exchange (BSE). A multiple regression model was used for testing the independent variables. The data was taken for 10 years i. e. from 1997-98 to 2006-07. They concluded that Brittain’s explicit depreciation model best explains the dividend policy of the banks. According to them, in case of Indian banking sector, the last year divided followed by current year depreciation and current year profit after tax are the major determinants in the dividend policy.

 

OBJECTIVE:

The objective of the study is to analyze the impact of earning per share, financial leverage and book value of share on dividend paid by banks in India.

 

RESEARCH METHODOLOGY:

A Co relational Research design is used in the study. This research is having focus on study of impact of Earnings, Financial Leverage and Book Value of share on dividend of banks in India. The period of study is from 2004 to 2015.The data has been collected for 33 banks in total for a period of 12 years. It includes 19 nationalized banks and 14 private banks. For the purpose of the study the banks have been selected on the basis of two criterions--banks which are listed on Bombay Stock Exchange, banks which have paid quite regular dividend during this period under consideration. Secondary data has been used for the study i.e. reports of various Financial Institutions, reports of Bombay Stock Exchange, Journals, magazines and other research publications. The annual reports of the selected banks has been examined to find out the dividend, debt equity ratio, book value of share and the earning per share of the bank. For Analysis the regression model has been applied which represents the impact of financial leverage, earnings, book value on the dividend of the bank. DPS is taken as measure of Dividend. Only the cash dividend is considered. Financial leverage is measured as the debt to equity ratio, that is, total debt/shareholders’ equity. The book value per share is adjusted wherever the split in share value has taken place. The various statistical tools have been applied using SPSS.

 

HYPOTHESIS:

Hypothesis 1. There is significant relationship between the financial leverage on dividend per share.

Hypothesis 2. There is significant relationship between earnings per on the dividend per share.

Hypothesis 3. There is significant relationship between Book Value per share on the dividend per share.

 

ANALYSIS AND INTERPRETATION:

Descriptive Statistics:

On the basis of study of financial data of selected banks over the period of 12 years the details of financial leverage, earnings, book value and dividend has been presented in table 1.

 

TABLE 1 Descriptive Statistics

 

Descriptive analysis of data shows that the banks paid a dividend of approximately Rs.5 to the shareholders on an average during the period. The maximum value for dividend paid was Rs. 27 in this duration.  Looking at the mean book value which is Rs. 177 approximately we can say that banks are paying very less dividend to their shareholders. The average value for Debt Equity ratios of the banks is about 15 times.

 

 

Relationship between Financial Leverage and Dividend

As suggested by various studies there exists a strong relationship between Leverage and Dividend. To know the relationship between Financial Leverage and Dividend the correlation between the two has been calculated for the selected banks. The correlation results are presented in Table 2

Table 2 Correlation between Dividend and Debt Equity Ratio

 

As far as correlation is concerned the results show that the dependent variable (DPS) is moderately correlated to Debt Equity Ratio. (-0.342). The relationship is negative which suggests that in case of banks in India the dividend decreases with increase in debt equity ratio. So the hypothesis 1 “There is significant relationship between the financial leverage on dividend per share.” is rejected. Though there is a negative relationship between the two but that is moderate. We can interpret that the two are not highly but moderately related to each other.

 

Relationship between Earning and Dividend:

It is quite logical that dividend should increase with increase in Earnings. In order to understand this relationship the correlation between Earning per share and Dividend per share has been calculated for the selected banks for the period of study. The Results are as per Table 3.

 

Table 3 correlation between Dividend and Earning Per Share

 

We look at the correlation between Dividend and Earnings per share we find a significant correlation which is positive. ( +.911 ) As hypothesized the dividend increase with increase in earnings per share in Indian banking sector.  The positive value of 0.911shows a strong uphill correlation. Hypothesis 2 “There is significant  relationship between earnings per on the dividend per share.” is also accepted.

 

Relationship between Book Value of Share and Dividend:

On the similar lines the researchers have tried to find out the relationship between Book Value of Share and Dividend paid by the selected banks through correlation analysis. The results are presented in Table 4.

 

Table 4 Correlation between Dividend and Book Value per Share

		DPS	Book Value
DPS	Pearson Correlation	1	.767**
	Sig. (2-tailed)		.000
	N	347	347
Book Value	Pearson Correlation	.767**	1
	Sig. (2-tailed)	.000
	N	347	389

 

When we analyses the correlation between Dividend and book value of shares we again find a high positive correlation(+0.767) which suggests that dividend increases with increase in book value of share.  Book value per share also shows a strong positive correlation with dividend. Hypothesis 3 “There is significant relationship between Book Value per share on the dividend per share.” is accepted. So the results show that the dependent variable i. e. Dividend is significantly correlated with the independent variables, i. e. Debt Equity Ratio, Earning per share and Book Value per share.

 

Impact of Financial Leverage, Earnings and Book Value on Dividend of Banks:

The researchers have tried to find out the impact of Financial Leverage, Earnings and Book Value of Shares on Dividend with the help on regression analysis. Dividend has been taken as dependant variable and debt equity ratio, earning per share and book value of the share as independent variables. The regression results are as per Table 5. has been developed as an equation. Regression results  show the following coefficients.

 

Table 5 Regression results

Model		Unstandardized Coefficients		Standardized Coefficients	t	Sig.	95.0% Confidence Interval for B
		B	Std. Error	Beta			Lower Bound	Upper Bound
1	(Constant)	1.701	.387		4.394	.000	.940	2.463
	Debt equity ratio	-.068	.020	-.076	-3.338	.001	-.109	-.028
	EPS	.151	.007	.810	22.441	.000	.138	.164
	Book Value	.002	.001	.098	2.724	.007	.001	.004

 

 

 

 

The relationship between the dependant and independent variables  has been developed as an equation .

 

Model Equation:

DPS = 1.701 - 0.068*(DER) + 0.151*(EPS) + 0.002*(BV)

 

DPS=      Dividend per share (only cash dividend)

DER=      Debt Equity ratio (measures as total debt/shareholders’ equity)

EPS=        Earnings per share

BV=        Book Value

 

The regression equation between dependant and independent variables show that  financial leverage has negatively affected the dividend per share while earnings and book value have positively affected the  dividend per share of the banks The change of one unit in  the financial leverage of the bank has decreased the dividend per share by 0.068 units. In general it is assumed that dividend increases with increase in financial leverage  but in the case of banks in India the results are different as banks are having high debt so it has resulted in the decrease in the dividend per share of the company. Earnings have positively affected  the dividend per share, to the tune of 0.151for every unit increase in earnings. With the increase of 1 unit in book value the dividend per share increases by 0.002 units which is not so considerable.

 

Table 6 Model Summary

Model	R	R Square	Adjusted R Square	Std. Error of the Estimate
1	.916a	.839	.838	2.12373

 

The values of R Square depict that approximately 84% of variation in dependent variable are explained by independent variables in the equation. So model seems to be a good fit.

 

CONCLUSION:

The study concludes that the dividend payment of the banks is not satisfactory and quite low. The banks are suffering with the high debt, NPAs and pressure from major stakeholders. The banks were able to increase their earning till 2012-13 but after that it has declined and so the dividend.  Few banks have not declared or declared low dividends in past two years. Because of it the investor who is looking forward to dividend might not be happy. This is not a good sign for growth and development of banking industry. As far as the financial leverage is concerned it is having a negative impact on the dividends of banks in India to the noticeable level.

 

REFERENCES:

1.     Abubakar, N. (2011). The Determinants of Dividend Payout in The Nigerian Banking Industry (Doctoral dissertation).

2.     Al-Khasawneh, J., Shariff, M., and Al-Zubi, K. (2012). Propensity to Pay Dividends: Evidence from US Banking Sector. International Journal of Economics and Finance, 4(9), 130.

3.     Allen, F., and Michaely, R. (2003). Payout policy. Handbook of the Economics of Finance, 1, 337-429.

4.     Al‐Najjar, B. (2011). The inter‐relationship between capital structure and dividend policy: empirical evidence from Jordanian data. International Review of Applied Economics, 25(2), 209-224.

5.     Alzomaia, T. S., and Al-Khadhiri, A. (2013). Determination of dividend policy: The evidence from Saudi Arabia. International Journal of Business and Social Science, 4(1).

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7.     Gul, S., Mughal, S., Bukhari, A. S., and Shabir, N. (2012). The Determinants of Corporate Dividend Policy: An Investigation of Pakistani Banking Industry. European Journal of Business and Management, 4(12), 1-5.

8.     Gupta, S. (2012). Analysis of leverage ratio in selected Indian public sector and private sector banks. Asian Journal Of Management Research, 3(1).

9.     Hashemi, S. A., and Zadeh, Z. K. (2012). The impact of financial leverage operating cash flow and size of company on the dividend policy (case study of Iran). Interdisciplinary Journal of Contemporary Research in Business, 3(10), 264-270.

10.  Lalu Candra Karami, S. E. (2012). The Influence of Leverage and Liquidity on Dividend Policy (Empirical Study on Listed Companies in Indonesia Stock Exchange of LQ45 in 2008-2010). Jurnal Ilmiah Mahasiswa FEB, 1(1).

11.  Malik, F., Gul, S., Khan, M. T., Rehman, S. U., and Khan, M. (2013). Factors influencing corporate dividend payout decisions of financial and non-financial firms. Research Journal of Finance and Accounting, 4(1), 35-46.

12.  Manos, R. (2001). Capital structure and dividend policy: Evidence from emerging markets (Doctoral dissertation, University of Birmingham).

13.  Nnadi, M. A., and Akpomi, M. E. (2005). The effect of Taxes on dividend policy of banks in Nigeria. Available at SSRN 873828.

14.  Sudhahar, M., and Saroja, T. (2010). Determinants of dividend policy in Indian banks: An empirical analysis. IUP Journal of Bank Management, 9(3), 63.

15.  Zameer, H., Rasool, S., Iqbal, S., and Arshad, U. (2013). Determinants of Dividend Policy: A case of Banking sector in Pakistan. Middle-East Journal of Scientific Research, 18(3), 410-424.

 

 

 

 

 

Accepted on 21.06.2017          © A&V Publications all right reserved