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Impact of Dividend Policy on Market Prices of Shares: Evidence from Pakistan

Article  in  Journal of Business Strategies · December 2020

DOI: 10.29270/JBS.11.2(17).004

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Journal of Business Strategies, Vol.11, No.2, 2017, pp 57–72 DOI:10.29270/JBS.11.2(17).004

iMPaCt of DiViDenD PoliCY on Market

PriCes of sHares: eViDenCe froM
Pakistan
noor ahmed Memon, Dr. nizamuddin Channa,
and Dr. imamuddin khoso
aBstraCt
This research intends to observe the impact of dividend
policy on market prices of firms’ stocks of the non-
financial sectors of Pakistan during the time period
from 2006 to 2015, after controlling some other
variables. Data is taken from sixty seven non-financial
firms listed in KSE (PSX). The outcome of fixed effect
Regression model exposed that there is the significant
negative impact of dividend yield and significant
positive impact of dividend payout on stocks market
prices. The result of control variables showed that
growth in assets, growth in earnings, growth in sales
and size have a significant positive impact on stock
market prices while liquidity, leverage and profit after
tax have no significant impact on stock market prices
during our study period. Therefore, all outcomes of this
research signify that the dividend policy has a
significant impact on market prices of stocks in
Pakistan.
Keywords: Dividend Policy, Stock Prices, Karachi Stock Exchange, Non-Financial Firms

introDuCtion
Management science is different from the natural science in the sense
that it has multiple views on particular subject or point because individual
judgments, perceptions, and observations vary from one person to another.
Dividend policy is one of the topics which is much debated for many
decades, but some circumstances and facts have entangled the topic. Black
(1976), argued that dividend policy is like a puzzle with pieces that don’t
fit together, the more we look into it more we get confused (Brealey &
Myers, 2003). Describe that dividend policy is top ten difficult unsolved
issues of financial economics. When companies earn a profit, they have
two options, either to pay the dividend or to retain the amount for their
future project needs. Now the puzzle is, whether to pay the dividend or

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Memon, N.A., Channa, N., and Khoso, I.

not? If yes, then how much dividend is to be paid? Companies pay a

dividend for the purpose to satisfy the shareholders, but at the same time,
they have to borrow money from outside to fulfill their future projects’
needs. Dividend policy also has a severe impact on other decisions like
investment and financing, so the optimum dividend policy will expand the
abundance of shareholders who are keen to get dividend and capital gain
at the same time.
The choice to pay the dividend is also affected by the accessibility of
profit in the organization and the capacity of the organization to gain extra
income later. Lintner (1956), and Gordon (1959), believed that shareholder
prefer immediate gain (dividend) as compare to future gain or capital gain
(increase in the prices of shares) to minimize the risk, because one thing
which is received immediately would be better than the two things
received in future. Contrary to this, dividend irrelevance theory was given
by Miller & Modigliani in 1961. Theory of MM present that firms’
dividend has no significant effect on its’ share prices, but it depends on
its riskless investment and future earning capacity. Much work has been
done on this topic, but in the absence of consistent results, it opens the
door for future researchers, especially in country like Pakistan, where
limited research is available on corporate dividend policy arises a need
for further research on the subject matter. Developing economy like
Pakistan has different nature, characteristics, and efficiency as compared
to other developed nations.
ProBleM stateMent
Firms of non-financial sectors of Pakistan are confronted with the issue
of whether to pay a significant, little or zero rate of their earning as a
dividend or retain their earning for future financing ventures. This issue
is persistant, because financial managers also want to fulfill the needs of
shareholders to satisfy them. As we know that shareholders are the part
owners of the company, so it is crucial for managers to take such steps
which satisfy the shareholders. Some shareholders need money on a
continuous basis, so they prefer a dividend; while others are interested in
following payments and would favor capital gain. Because of the reality
of dealing with contending interests of different shareholders and the sort
of dividend policies, companies embrace either immediate positive or
negative consequences for the share prices of the organizations.
Consequently, managers are not able to conjecture with assurance at what
degree the strategy will influence the share prices of the organizations.

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 Impact of Dividend Policy on Market Prices of Shares

This study would help the managers of the firms of non-financial sectors
of Pakistan to formulate their policies regarding dividend issuance.

researCH oBJeCtiVes
There are numerous reasons to study dividend policy in Pakistan. Much
work has been done so far around the world, but the theoretical work is
done in Pakistan regarding dividend policy is unsubstantial, thus,
consequently need arises of a comprehensive evaluation of the impact of
dividend policy on the share prices in Pakistan. According to Federal
Board of Revenue (FBR), up to 2010, there was tax immunity on capital
gain in Pakistan, even though firms announced a dividend. So the question
arises why they announced dividend if there was tax immunity on the
capital gain. This invites us to investigate further on dividend policy in
Pakistan’s perspective. Most of the firms of these sectors continuously
announce a dividend, so it is to investigate the factors which influence
these sectors to announce dividend continuously. This research intends to
observe the impact of dividend policy, dividend payout and dividend yield,
on market price of shares of the non-financial firms during 2006 to 2015.
The impact is examined after controlling some variables such as growth
in assets, growth in earning, growth in sales, leverage, liquidity, profit
after tax, and the size of the firm.

In the perspective of this study, the following research questions are

formulated:

Q1: Is there any significant association between the market price of

shares and dividend yield?

Q2: Is there any significant association between the market price of

shares and dividend payout?

literature reVieW
In past, many studies have been conducted in corporate finance
literature to explain the positive, negative or no relation between dividend
policy and stock prices. In this section, we would discuss reasonable
evidence conducted by the researchers across the world.

Dividend irrelevance theory

In 1961 the new debate started after MM theory. A new perspective was
presented regarding dividend policy which assets that the stock price of
the company does not depend on its dividend announcements, but it only

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Memon, N.A., Channa, N., and Khoso, I.

depends upon its earning ability and future activities. According to the
theory, under certain conditions, a shareholder can make their dividend
policy by purchasing and selling shares.

Bird in Hand theory

Gordon (1963), and Lintner (1964), proposed a theory which has an
opposite perspective of Miller and Modigliani irrelevance theory. They
have a view that shareholder would prefer dividend payments as compared
to capital gain.

tax Preference theory

This theory was given by Litzenberger and Ramaswamy, (1979), in
which they viewed that investors would like those firms who pay lower
dividends which is due to tax evasion purpose. It is evident that when
companies earn profit it has two options, whether to announce a dividend
or retain this amount for future investments. When companies pay
dividends, the shareholders in return have to pay taxes at two levels, first
at the dividend income level and second in the shape of income tax. In
this theory, the researchers assumed that investor prefer those companies
which have low payouts in the shape of the dividends because in dividend
share the investors have to pay taxes twicw. When investors receive the
benefit of profit in the shape of capital gain they pay less tax. Additionally,
taxes on capital gain are not paid until shares have been sold by the
investors. In this sense, an investor can control the taxes paid on capital
gain but cannot control taxes paid on dividends.

agency theory
This theory state that if the managers want to please the shareholders,
they should pay high dividend payouts to minimize the agency problem,
otherwise shareholders may think that their money may be wasted on
unnecessary project and compensation for the management.

Clientele effect theory

According to this theory a company should make such dividend policies
which may attract maximum investor (clientele). The theory postulates
that the company stock prices change according to the demand and goals
of the investors, in a reaction to company’s dividend policies, tax policies
or any other related policies. This theory thus assumes that shareholders
are attracted towards the company policy and make the investments
accordingly. When a company changes their policy, shareholder also

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 Impact of Dividend Policy on Market Prices of Shares

changes its stock, and hold stock which would satisfy their needs. As a
result of these changes, the stock price fluctuates in the market.

Dividend signaling theory

Management of organization has more information about company
policy and future performance of the company as compared to the
investors and other market players. This creates the problem of
information asymmetry. Through dividend payouts, the organization may
send positive signals to the shareholders, and market assumes that the
firm is performing well, because it’s obvious that dividends are paid out
from profits earned. Therefore, more payouts mean more positive signals
and less or no signals generate negative signals towards the firm
performance.

Catering theory of Dividend

This theory was given by Baker & Wurgler in 2004, which emphasis
to meet the requirement of investor dividends. This theory states that
Companies’ stock prices would increase with the dividend requirement
of the investor. According to this theory, the manager would announce
dividend if they see investor is paying the high price of shares to
dividend-paying companies and if not, then they may not pay the
dividends.

transaction Cost theory

When companies pay a low dividend or no dividend, then shareholders
have two options, whether to sell their stock to satisfy their money
requirements or hold it for next periodic dividend. When shareholders go
to sell their stocks in the market, they must pay a transaction cost, which
makes the selling of stock more expensive, thus the income from capital
gain cannot fully replaced by the dividend income. Therefore, the
shareholders want a higher payout of the dividend to reduce transactional
cost which arises from capital gains (Alli, Khan, & Ramirez, 1993).

life Cycle theory of Dividend

This theory was established by DeAngelo, DeAngelo, and Stulz in
2006. The theory stated that the firm’s decision to pay or not to pay a
dividend depends on different life cycles of the firm. According to the
theory young and, growing firms pay no dividend whereas old and stable
firms pay a significant portion of the retained earnings as a dividend. It
means that older the and stable the firm is, more it pays the dividend.

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Memon, N.A., Channa, N., and Khoso, I.

impact of Dividend Policy on stock returns

To analyze the data of 198 banks were taken by Mukherjee & Austin
(1980). Their results reveal that dividend policy was not affected by bank
size during their research tenure. Their result also revealed that except
dividend payout all other factors affect share prices. In another study, data
of 160 Pakistani companies were taken by Nishat and Irfan (2004). A
significant positive relation was identified between dividend policy and
share prices (Nishat & Irfan, 2004). They also found that some control
variables like size of the firm and leverage have a strong and positive
effect on overall stock prices.

Data of 500 Indians’ firms were taken by Pani (2008). Their results
presented that stock prices were significantly affected by the dividend
retention ratio; size and debt to equity ratio. In another study, data of 73
firms were taken by Nazir, Abdullah and Nawaz (2012). A strong relation
was proved between dividend policy and prices of stock in Pakistan by
the researchers. Data of United kingdom firms were taken by Hussainey,
Oscar Mgbame, and Chijoke-Mgbame in 2011. A positive result was
identified between dividend payout and dividend yield whereas, a negative
result was identified between dividend payout and stock prices in their
study. Their results also proved that stock prices were also affected by
firm size, earning and debt ratio. Asghar, Shah, Hamid, and Suleman
(2011), studied on five sectors. Their findings disclosed that stock price
and firm size are significantly and positively affected by dividend payout
and yield. Data of 29 firms were taken by Khan (2012), from 2001 to 2010.
Results of the study revealed that the dividend, EPS, and PAT had a
positive impact on share prices, whereas RR and ROE had negative
insignificance impact on stock prices. Data of Zimbabwe’s firms were
taken by Jakata and Nyamugure (2012), their results revealed that there is
no significant change in share price due to dividend announcement and
the earnings per share also had no impact on stock prices. Thus , their
findings support dividend irrelevance theory. Data of Kenyan firms were
taken by Kenyoru, Kundu, and Kibiwott (2013). Their results showed that
there was a substantial relation of stock price volatility and dividend
policy in Kenya. Furthermore, data of 17 banks were taken by Nazir, Ali,
and Sabir (2014). Their research outcomes confirmed that there was a
definite relationship between stock prices and dividend policy in Pakistan.
Their findings also revealed that there was a negative relationship between
dividend payout and share prices. Moreover, there was a positive relation

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 Impact of Dividend Policy on Market Prices of Shares

between asset growth, and stock prices and no significant effect was
identified between earning, leverage, and size with share price volatility.
Data of 11 firms was taken by Abrar-ul-haq, Akram, and Imdad Ullah in
2015. According to their research no significant impact of dividend
announcement on share prices in Pakistan was found. Further, Data of 45
non-financial firms were taken by Adnan, Jan, and Sharif in 2015. Their
research findings showed that share price was positively affected by
dividend payout ratio which supports bird in hand theory and rejects the
dividend irrelevance theory in case of Pakistan. They further revealed that
the share price is insignificantly affected by profit after tax, retention ratio,
and dividend per share, whereas, positively affected by Earning per share
and negatively affected by return on equity. In another study, data of 50
firms were taken by Shah and Noreen in 2016. Their findings reveal that
there was significant negative association of stock price volatility and
dividend policy, whereas stock price volatility was positively affected by
asset growth and Earnings per share.

researCH MetHoDologY
A sample of 67 non-financial firms of 6 sectors is taken from Karachi
Stock Exchange for the period of ten years from 2006 to 2015. Only
those firms were selected which at least paid three dividend payments
during the research period. State bank of Pakistan divide the non-
financial firms into 14 sectors out of which six sectors were selected for
this study. As per our observation, these six sectors cover almost 87.5
percent of average dividend amount paid during the study period.
Selected sectors of this study are: 1) fuel and energy sector, 2) oil and
refined petroleum products, 3) chemicals, chemical products, and
Pharmaceuticals, 4) Other food products, 5) Information, Comm. and
Transport Services, 6) Motor Vehicles, Trailers & Auto parts. Data is
secondary in nature, which has been collected from the FSA of (non-
financial) firms listed in KSE by the State Bank of Pakistan from 2006
to 2015. Market prices of shares have been collected from KSE website.
As a result, our sample consists of 67 cross sections balanced panel for
ten years with 670 observations. To observe the association between
dependent and independent variables, multiple regression analysis was
used. Cross-section Fixed effect model or cross-sectional random effect
model was employed after Hausman test result. Unit root test, F
statistics, descriptive statistics, Pearson correlation and Granger
Causality Test, is also used to analyze the data.

63
Memon, N.A., Channa, N., and Khoso, I.

econometric Model
To answer our primary research questions, regression model is
developed as follows.

SMP = a1 + b 1D_Yj + b 2D_Pj +ej (1)

But as here are some other control variables which may impact both stock
market price as well as dividend policy, so the regression model modified as:

SMP = a1 + b1D_Yj + b2D_Pj + b3G_Aj + b4G_Ej + b5G_Sj + b6Lj +

b7LIQj + b8PATj + b9SZj + ej (2)

Measurement of Variables

stock Market Price. Previous studies have taken stock price volatility
as the dependent variable, but this study has taken stock market price as
the dependent variable. Masum (2014), also took stock market price as the
dependent variable. This is calculated by taking an average of annual
opening price and the closing price of the stock, and after taking its log 10.

Dividend Yield. Dividend yield is the primary independent variable of

study. This variable is calculated by the total paid amount of cash dividend
divided by the average market price of the shares.

Dividend Payout. Dividend payout is one of the two primary variables of

64
 Impact of Dividend Policy on Market Prices of Shares

this study. This could be obtained by dividing dividends per share to

earnings per share.

growth in assets. Growth in sales is also a control variable of this study,

which is the ratio of total assets ending to total assets beginning.

growth in earnings. Growth in Earnings: Growth in earning as a control

variable, is the ratio of net profit after tax of current year to shareholders
equity.

growth in sales. Growth in sales is a control variable, and is calculated

by current sales minus previous sales then divided by previous sales.

leverage. This control variable is obtained by dividing debt (long-term

plus short-term liabilities) to owners’ equity.

liquidity. Liquidity is calculated by taking the ratio of current assets to

current liabilities.

Profit after tax. The profit after tax as a control variable is calculated by
taking net profit of current year minus taxes for the year.

size of the firm. Size of the firm is calculated by total ordinary shares
multiplied by the average market price of the stock and then taking its log10.
results anD DisCussion
The data analysis signifies that the SMP, G_A, PAT and S have mean
value of (2.11), (1.14), (5.45), (6.82) with standard deviation of (0.57),
(0.35), (1.62), (0.84) respectively. Which means that SMP, G_A, PAT, S
remained low volatile during the period while D_P, D_Y, G_E, G_S, L,
and LIQ remained highly volatile during the research period. Liquidity is
recorded as a highest volatile variable of the study.

Table 1. Descriptive Statistics

D_P D_Y g_a g_e g_s l liQ Pat s sMP

Mean 0.49 0.05 1.14 0.20 0.22 1.83 2.40 5.45 6.82 2.11
Median 0.34 0.04 1.11 0.18 0.12 1.04 1.51 5.73 6.88 2.10
Max: 10.17 0.94 5.94 3.75 36.11 58.26 138.52 8.08 9.45 4.01
Min: -6.55 -0.14 -0.23 -2.60 -0.98 0.01 0.22 0.00 4.84 0.55
std. Dev: 0.91 0.06 0.35 0.32 1.53 3.94 7.16 1.62 0.84 0.57
sum 325.60 34.16 759.34 135.53 147.48 1219.98 1602.03 3641.28 4555.06 1409.58
sum sq. Dev. 548.30 2.37 80.96 68.18 1551.77 10366.19 34186.42 1750.39 472.29 213.84

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Memon, N.A., Channa, N., and Khoso, I.

Before conducting the regression analysis, the stationary of the

variables is scrutinized. To evaluate the stationary of the variables, unit
root test is conducted. For this reason, two methods of unit root test are
used, i.e., Levin, Lin, and Chu test (for the standard unit root) and Philips
– Prawn Fisher test (for cross-section unit root).

The results of table 2 & 3 of unit root tests show that the probability of
all variables is 0.00 which is less than 0.05. It means that all variables are
stationary and could be used for further analysis.
Table 2. Unit Root Test Summary
Variables Method statistics Probability
Stock Market Price -11.52 0.00
Dividend Yield -40.28 0.00
Dividend Payout -70.63 0.00
Growth in Assets -24.31 0.00
Growth in Earnings Levin, Lin, and Chu -44.84 0.00
Growth in Sales test -25.28 0.00
Leverage -9.63 0.00
Liquidity -6.58 0.00
Net Profit after Tax -19.08 0.00
Size of the firm -16.20 0.00

Table 3. Unit Root Test Summary

Variables Method statistics Probability
Stock Market Price 208.87 0.00
Dividend Yield 236.59 0.00
Dividend Payout 307.16 0.00
Growth in Assets 525.23 0.00
Growth in Earnings PP - Fisher 231.31 0.00
Growth in Sales 459.35 0.00
Leverage 195.92 0.00
Liquidity 198.05 0.00
Net Profit after Tax 476.86 0.00
Size of the firm 295.69 0.00

In addition, F statistics test are conducted to see if the independent

variables jointly affect the dependent variable. The result of the table no
5 showed that the probability of F-statistics is 0.00 which is less than 0.05
% which indicates that the independent and control variables have joint
impact on the dependent variable.

66
 Impact of Dividend Policy on Market Prices of Shares

Table 5. F-Statistics Test

f-statistics 163.75
Prob (f-statistics) 0.00

Furthermore, the Hausman test is used to find best fit model for the
study among the fixed effect or Random effect. The guideline for
Hausman test directs that if probability value is less than 0.05 it means
that cross-sectional fixed effect model is fit but if probability value is
higher than 0.05 than cross-sectional random effect model is suitable for
the study. According to Table 6 the probability value of Hausman test is
0.00, which means that cross-sectional fixed effect model is better for the
study analysis.
Table 6. Random Effects-Hausman Test
test summary Chi-sq. statistic Chi-sq. d.f. Prob.
Cross-section random 48.44 9 0.00

Table 7 shows the result of multiple regression analysis of fixed effect

model. The R Square value revealed that 95.4 % of the stock market price
variation could be explained by the model. The Durbin-Watson value is
2.24, which show that the errors are not correlated. Since the p values of
Dividend Payout and Dividend Yield is less than 0.05, it indicates that
dividend policy has a significant effect on stock market price in Pakistan.
T- Statistics show that the Dividend Payout has positive, while the
dividend yield has a negative impact on stock market price. Growth in
Assets, growth in earnings, growth in sales and size have a significant
positive impact on stock market prices, while the Leverage, Liquidity, and
profit after tax have no impact on stock market prices.
Table 7. Result of cross-sectional fixed effect model
Variable Coefficient std. error t-statistic Prob.
C -2.5839 0.1289 -20.0428 0.0000
D_P 0.0271 0.0072 3.7742 0.0002
D_Y -0.5904 0.1194 -4.9451 0.0000
g_a 0.0720 0.0196 3.6665 0.0003
g_e 0.1045 0.0255 4.0999 0.0000
g_s 0.0164 0.0042 3.9367 0.0001
l 0.0012 0.0018 0.6341 0.5263
liQ 0.0000 0.0008 0.0196 0.9844
Pat 0.0045 0.0053 0.8490 0.3962
s 0.6796 0.0185 36.6501 0.0000

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Memon, N.A., Channa, N., and Khoso, I.

effects specification
Cross-section fixed (dummy variables)
r-squared 0.9540 Mean dependent var: 2.1102
adjusted r-squared 0.9482 s.D. dependent var 0.5662
s.e. of regression 0.1289 akaike info criterion -1.1530
sum squared resid 9.8339 schwarz criterion -0.6406
log-likelihood 461.1106 Hannan-Quinn criteria. -0.9545
f-statistic 163.7494 Durbin-Watson stat 2.2428
Prob(f-statistic) 0.0000

To analyze the short-term impact of primary independent variables of

dividend policy on stock market price, a pair-wise Granger causality test
was carried out. Table 8 indicates the short-term relationship between stock
market price and dividend yield. Since the p-values of the first direction are
greater than 0.05 but p-value of the second direction is less than 0.05 which
means that dividend yield has a short-term impact on stock market price but
the stock market does not have a short-term impact on dividend yield.
Table 8. Granger causality test between stock market price and dividend yield
null Hypothesis: f-statistic Prob.
SMP does not Granger Cause D_Y 12.9380 3.00E-06
D_Y does not Granger Cause SMP 8.97814 0.0001

Table 9 shows the short-term relationship between stock market price

and dividend payout. According to the result of Granger causality test, the
P value of both directions is less than 0.05, which means that stock market
price has a short-term positive impact on dividend payout, while dividend
payout also has a short-term positive impact on stock market price.
Table 9. Granger causality test between stock market price and dividend payout
null Hypothesis: f-statistic Prob.
sMP does not granger Cause D_P 5.90485 0.0029
D_P does not granger Cause sMP 7.78877 0.0005

ConClusion
This research intends to observe the impact of dividend policy on
market prices of stocks. For this, nine questions including two primary
and seven secondary questions were developed. Firstly, two primary
questions were related to the relationship of dividend policy and stock
market price, and other seven questions were related to the relationship of
control variables with the stock market prices. After the empirical result
findings, it is concluded that two proxies of dividend policy (dividend

68
 Impact of Dividend Policy on Market Prices of Shares

yield and dividend payout) have a significant impact on stock market

prices in Pakistan during the study period. Granger Causality test between
stock market price and dividend policy was also conducted, which
indicated that proxies of dividend policy (dividend payout, dividend yield)
have also short-term impact on stock market price. The results of control
variables demonstrated that growth in assets, growth in earnings, growth
in sales and size of the firms have a significant positive impact on stock
market price while liquidity, leverage, profit after tax have no significant
impact on stock market prices.

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Memon, N.A., Channa, N., and Khoso, I.

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