Relevance of dividend to profitability of Nigerian firms

Ebiringa Oforegbunam Thaddeus; Okoroegbe Chris; Obi Henry Kenedunium

У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 11, 2014 г. SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014

RELEVANCE OF DIVIDEND TO PROFITABILITY OF NIGERIAN FIRMS

12 3

Ebiringa Oforegbunam Thaddeus , Okoroegbe Chris , Obi Henry Kenedunium

(PhD1,3; Lecturer2)

Federal University of Technology1 (Owerri, Nigeria)

Nnamdi Azikiwe University (Awka, Nigeria)

Ecobank Nigeria (Lagos, Nigeria)

Corresponding author: [email protected]

Abstract

This paper established that dividend policy is relevant to firm profitability. A combination of ordinary least square and vector autoregressive (VAR) model was used in analyzing short and long run relationships between dividend policy of firms quoted in the Nigerian stock exchange and their profitability. The results show that capitalized dividend has significant positive effect on profitability in the short run, while dividend payout has significant positive effect in the long run. The paper recommends that management of firms must adopt flexible dividend policies that grant shareholders fair and equitable share of profits made in order to build and sustain investors’ confidence and trust on management. This is necessary for profitability and sustainable growth of firms.

Keywords: Profitability; Dividend policy; dividend payout; Capitalized dividend; cointegration; shareholders.

Additional data:

UDC 338.22.021.1 GRNTI 06.56.31 JEL Code D51, E31, E43, E60 Received 11 June 2014 Accepted 30 June 2014

У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 11, 2014 г.

SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014

Introduction

The major responsibilities of corporate finance are investment, financing, and dividend decision (Pike and Neal, 2006; Amidu, 2007; Azhagaiah & Priya, 2008). Dividend policy has remains one of the most controversial issues in corporate finance (Farsio et al. 2004; Foong et al. 2007), as finance scholars have engaged in researches aimed at modeling the effect of dividend policy on profitability of firms (Al-Malkawi, et al. 2010). Dividend policy is crucial to sustainable growth and profitability of firms, as it is an expression of intention of management to either distribute to shareholders or retain profit for reinvestment within the firm (Hafeez & Attiya, 2009).

The primary motivation of shareholders investment in a firm is to earner reasonable returns on their investment in the short run by way of dividend as well as grow their wealth in the long run by way of share price appreciation (Papadopoulo and Charalambidis, 2007). Shareholder profitability and wealth is influenced by capital investment decisions, capital structure decisions, growth in sales and dividend policy (Frankfurter &Wood, 2002; Mohammed, 2007; Adefila, et al. 2008). Thus, sustainable corporate performance can be viewed as how consistent a firm maintains a steady trend of growth in shareholder’s profitability and wealth (Purmessur and Boodhoo, 2009). The above can only be achieved through effective and efficient capital investment decisions, capital structuring, sales revenue and profit maximization as well as equitable dividend policy. Dividend policy can have significant positive or negative impact on the performance of the firm (Kim and Wonsiksul, 2010). Accordingly Kashif (2011), is of the view that dividend policy equally has potential implications for share prices and hence returns to investors; financing of internal growth and shareholders fund through retained earnings together with its gearing and leverage effects. Firms ought to pay dividend to shareholders especially if it cannot identify suitable investments which would bring better and higher future returns than those expected by the shareholders (Kouki & Guizani, 2009).

Shareholders as rational investors usually expect to receive some income as return on their investments. No wonder Foong et al. (2007) posit that an investment made by a firm determines the future profitability and dividends as well as cost of financing future expansion projects. The ability of firm to pay dividend to her shareholders depends to a greater extent on their profitability during the period (Ruland & Zhou, 2005). Firms adopt diverse dividend policies depending on the provision of their article of association and prevailing economic situation which may encourage high or low cash dividend payment or stock dividends (bonus issues) in lieu of or in addition to cash dividend while others may pay cash only for the purpose of increasing the shareholders’ wealth. Modigliani and Miller (1961) demonstrated the irrelevance of dividend policy under a set of assumption and depicting that dividend policy has no effect on stock prices but collapses when the assumptions are relaxed. This therefore leaves us with a knowledge gap that is pertinent and a need further inquiry as to whether dividend policy by extension affect firm profitability on sustainable basis (Al-Malkawi et al. 2010). The paper adopts an econometric ISSN 2222-6532 www.meconomics.org

У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 11, 2014 г.

SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014 approach in investigating the nature of relationship between dividend policy and profitability of firm in the short and long runs. The aim being to see the extent to which the postulations of Modigliani and Miller (1961) remains empirically valid using financial data of quoted firms from the Nigerian stock market.

Theoretical Framework

Dividend policy has continued to attract more public and researchers interests especially as contemporary issue of study in the twenty-first century. Several theories have been proposed to explain the relevance of dividend policy and whether it affects firm value and profitability, but there has not been a universal agreement (Samuel & Edward, 2011; Azhagaiah & Priya, 2008; Pandey 2005). Empirical evidences suggesting that dividend policy is relevant to the performance of firms exist (Banerjee et al. 2007; Gillet et al. 2008; Gupta and Banga, 2010). Dividend policy has been found to have significant positive effect on share price volatility and profitability of firms (Hardin and Hill, 2008; Howatta et al. 2009; Samuel & Edward, 2011). Adefila et al. (2008) found significant positive relationship between dividend policy, sales growth and profitability of firm. Figure 1 summary the factors that influence dividend decision of firms.

Factors promoting stable Factors promoting a low payout:

dividend: • Tax system;

• Some clientele preferences; • Some Clienteles;

• Signalling; • High growth potential of the

• Owner control (agency theory); firms;

• Management desire to avoid the • Instability of underlying

risk of future dividend cut; earnings

• Stability of raises credit standing \ / • Management desire to avoid the

for debt issues. f risk of future dividend cut;

Dividend Decision • Lender agreement restrictions;

Factors promoting a fluctuating • Low liquidity of firm’s assets.

►

dividend: л Factors promoting a high payout:

• Dividend as a residual: only after • Some clienteles;

positive NPV projects are financed. • Owner control (agency theory);

• Uncertainity (‘bird-in-the hand’);

• Signalling.

Figure 1. Factors Influencing Dividend Decisions of Firms

Kim and Wonsiksul (2010) reported dividend policy as having significant positive effect on foreign capital inflow and investments decisions. However dividend policy seems to have mixed effect on capital investment and capital structure decisions (Samuel and Edward (2012).

Amidu (2007), Lie (2005), Ruland & Zhou (2005), Howatt et al (2009), all came up with different finding about the relationship between dividend payout and firm performance. Amidu (2007) revealed that dividend policy affects firm profitability. The study affirmed a strong positive significant relationship between return on assets,

У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 11, 2014 г.

SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014 return on equity, growth in sales and dividend payout. On the other hand, there is limited evidence suggesting that dividend paying firms experience improvements on their performance (Lie, 2005).

Taxation is one the critical factors that affect firm value and future expected profits. For example, discounted expected after-tax cash flows can be used as a determinant for the market value of a firm (Hardin and Hill, 2008). In this respect, differential tax treatment of capital gains relative to the dividends can influence the after-tax returns of investors and in turn affect the willingness of investors to receive dividends (demand for dividends). Economists have concluded that personal investment decisions and corporate dividend decisions are both affected or influenced by taxes (Howatta et al. 2009). Dividend yields and risk adjusted returns in the context of taxation has been found to be highly correlated (Lie, 2005). Based on the Capital Asset Pricing Model (CAPM), the pretax excess return on a security has been found to be positively and linearly related with the dividend returns and systematic risk of securities (Purmessur and Boodhoo, 2009).

Materials & Methods

The population of quoted firms in the Nigerian stock exchange at the time of this study in March, 2014 is 187. Judgmental sampling technique was used to identify firms that met the criteria of having complete financial information for the 30years period covered. However, only 61 firms meet the criteria; out of which, Fifty (50) was select based on quota sampling. This translates to 81.97% of the qualified population. Based on theoretical and empirical review of the literature, the paper hypothesizes that current profitability (NPAT) is a positive function of dividend policy, represented by cash-based dividend and capital-based dividend, revenue and the lag value of profitability.

Model Specification

In line with prior studies (Mohammed, 2007; Purmessur, 2009; Kashif, 2011) that have analyzed the effect of dividend policy on profitability of firms, the model for this study is specified as:

NPATi = F (dividend payout, Capitalized dividend and Revenue) (1)

The nature of the data allows us the use of panel techniques. The panel regression model differs from a normal time-series or cross section model by attaching the double subscript to each variable. The general form of the panel data model is written in multivariate model as:

NPATit = a + fiDivit + в2BShareit + e3Revit + eit (2)

Where NPAT is the net profit after tax,

Div is dividend payout, в Share is Capitalized dividend,

Rev is revenue and u is the stochastic disturbance or error term.

ISSN 2222-6532 www.meconomics. org

У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 11, 2014 г. SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014

The apriority signs are в; > 0, в2 >0, в3 > 0.

However, given that the firm is a going concern, whose management decisions including dividend decisions must have sustainable positive effects in achieving the long run objective of the firm, such as profitability, equation 2 is further re-specified in of form as:

NPATit = eiNPATit_j + e2Divit-1 + e3BShareit-1+ e4Revit-1 + ^it (3)

Where NPATt-1 is the one year lag value of net profit after tax.

The cointegrated relation between variables is interpreted as their long run equilibrium, is achieved using the Johansen co-integration method in conducting the co-integrating test.

Results & Discussions

Table 1.

Analysis of short run Effect

R-squared 0.646027 Mean dependent var 69.77000

Adjusted R-squared 0.469040 S.D. dependent var 10.76569

S.E. of regression 7.844635 Akaike info criterion 7.246711

Sum squared resid 369.2298 Schwarz criterion 7.367745

Log likelihood -32.23356 Hannan-Quinn criter. 7.113937

F-statistic 3.650145 Durbin-Watson stat 2.026882

Prob(F-statistic) 0.083062

Source: Result of Computer Analysis with Eview7.0

NPAT = 69.20 - 384.64Div + 1.93BShare - 7.47x10-5Rev (4)

(-1.029) (2.026) (-0.076)

Equation 1 is used to assess the short run relationship between firm profitability and dividend policy (dividend payout and bonus issues) as well as revenue. As shown on equation 4, dividend payout (DIV) and capitalized dividend (BShares) an inversely and directly related to net profit (NPAT). The implication being that in the short run dividend payout based on previous year profit is made out from current period earning, which reduces availability of funds to finance current operational needs, thereby reducing income yielding activities of current period. On the other hand capitalized dividend (BShare) distributed in the current period is retained within the firm and used to finance current operations, which leads to increase in current earnings and profitability. However the lvalue of Div (-1.029) is not significant at 5percent level, while that of BShare (2.026) is significant. The R-squared value calculated of 0.6460 implies that 64.62% of total variation in net profit in a given year is explained by variations in dividend policy (cash and bonus shares) and revenue as shown in equation 4. Equally, the F statistic of 3.650145 is not significant at 5percent level, implying that within error margin of at 5 percent, equation 4 is not significant.

У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 11, 2014 г. SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014

Table 2.

Analysis of Long run Effect

Vector Autoregression (VAR) Estimates

Standard errors in (*) & t-statistics in [*]

NPAT

NPAT(-1) 0.913377

(0.28698)

[ 3.18275]

NPAT(-2) -2.183789

(0.54454)

[-4.01031]

C 135.4206

(27.0257)

[ 5.01081]

Div 876.9806

(391.612)

[ 2.23941]

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BShare 0.280576

(0.74504)

[ 0.37659]

Rev -0.002345

(0.00094)

[-2.50667]

R-squared 0.965357

Adj. R-squared 0.878750

Sum sq. resids 34.59354

S.E. equation 4.158939

F-statistic 11.14638

Log likelihood -17.20841

Akaike AIC 5.802102

Schwarz SC 5.861684

Mean dependent 70.82500

S.D. dependent 11.94377

Source: Result of Computer Analysis with Eview7.0

VAR Model - Substituted Coefficients:

NPATt = 0.91NPATt-1 - 2.18NPATt_2 + 876.98Divt + 0.28BSharet - 0.002Revt + 135.42 (5)

[3.18275] [-4.01031] [2.23941] [0.37659] [-2.50667]

Equation 5 shows that in the long run the effect of dividend policy on firm’s net profit (NPAT) is positive, as dividend payout (Div) and Capitalized dividend (Bonus share: BShare) are all positive; though dividend payout is significant, while capitalized dividend is not significant at 5 percent level respectively given their t-values. The R-squared value calculated of 0.9654 implies that 96.54% of total variation in net profit in a given year is explained by two years lag values of profitability and current year dividend policy (cash payout and bonus shares) and revenue as shown in equation 5. The significance of equation 5 is tested using the Johansen cointegration test, whose results is shown below.

У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 11, 2014 г. SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014

Table 2.

Johansen Cointegration Test

Lags interval (in first differences): 1 to 2

Unrestricted Cointegration Rank Test (Trace)

Hypothesized Trace 0.05

No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None * 1.000000 257.1576 3.841466 0.0000

Trace test indicates 1 cointegratingeqn(s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level

**MacKinnon-Haug-Michelis (1999) p-values

Unrestricted Cointegration Rank Test (Maximum Eigenvalue)

Hypothsized Max-Eigen 0.05

No. of CE(s) Eigenvalue Statistic Critical Value Prob.**

None * 1.000000 257.1576 3.841466 0.0000

Max-eigenvalue test indicates 1 cointegrating (s) at the 0.05 level

* denotes rejection of the hypothesis at the 0.05 level

**MacKinnon-Haug-Michelis (1999) p-values

Unrestricted Cointegrating Coefficients (normalized by b'*S11*b=I):

NPAT

1.148460

Unrestricted Adjustment Coefficients (alpha):

D(NPAT) -0.242057

Source: Result of Computer Analysis with Eview7.0

The results shows that only one cointegration equation was found with a Trace statistics of 257.1576, which is significant at 0.05 level given the critical value of 3.841466. Figure 2 below equally present actual profitability and predicted profitability trends of firms in the Nigerian stock market based on equation 5. The fitted trend is a good fit of the actual profitability.

Residual -------Actual ------- Fitted ]

Figure 1. Trend of Actual Net profit with Fitted Net profit Based on Equation 5

У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 11, 2014 г.

SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014

Conclusions

Based on the findings made in this paper, we conclude that dividend policy is relevant to the profitability of quoted firms in the Nigerian stock market. In the short run capitalized dividend (bonus shares) has significant positive relationship with profitability, while dividend payout is insignificantly negative as shown in equation 4. However, in the long run, both dividend payout and capitalized dividend all have positive effect on profitability, though the nature of the effect becomes of the revise order with dividend payout becoming significant, while capitalized dividend is insignificant as shown in equation 5.

We therefore recommend that firms should ensure that the promote a flexible dividend policy that ensures equitable sharing of profits through a combination of dividend payout and bonus share in order to build and sustain the trust and confidence of the shareholders for enhanced performance and profitability.

У .У СОВРЕМЕННАЯ ЭКОНОМИКА: ПРОБЛЕМЫ, ТЕНДЕНЦИИ, ПЕРСПЕКТИВЫ, № 11, 2014 г.

SOVREMENNAA feKONOMIKA: PROBLEMY, TENDENCII, PERSPEKTIVY, vol. 11 : 2, 2014

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УМЕСТНОСТЬ ПОЛИТИКИ ДИВИДЕНДОВ К ПРИБЫЛЬНОСТИ НИГЕРИЙСКИХ КОМПАНИЙ

Эбайэрина Офорэгбинам Фаддей1 Окороегбе Крис Оби Г енри Кенеданиум

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Федеральный университет технологий (Оверри, Нигерия)1 У ниверситет Ннамди Азикве

2

(Авка, Нигерия)

Экобанк Нигерия (Лагос, Нигерия)

Аннотация. В статье указано, что дивидендная политика имеет строгое отношение к рентабельности. Сочетание обычного метода наименьших квадратов и векторной авторегрессии (VAR) было использовано в анализе краткосрочной и долгосрочной перспективы отношений между дивидендной политикой компаний, котирующейся на Нигерийской фондовой бирже и их рентабельностью. Результаты показывают, что капитализирующиеся дивиденды имеют существенное положительное влияние на рентабельность в краткосрочной перспективе, в то же время и выплаты дивидендов имеют значительный положительный эффект в долгосрочной перспективе. В статье рекомендуется руководству компаний принимать гибкую политику дивидендных выплат, которая предоставляет акционерам справедливую и равную долю прибыли в целях создания и поддержания доверия инвесторов и страстового управления. Это является необходимым для рентабельности и устойчивого роста компаний.

Ключевые слова: рентабельность; дивидендная политика; выплаты дивидендов; капитализированный дивиденды; коинтеграция; акционеры.

Relevance of dividend to profitability of Nigerian firms Текст научной статьи по специальности «Экономика и бизнес»

Аннотация научной статьи по экономике и бизнесу, автор научной работы — Ebiringa Oforegbunam Thaddeus, Okoroegbe Chris, Obi Henry Kenedunium

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