CHAPTER 1 INTRODUCTION Dividend policy is the decision for the firm to pay out earnings verses retaining and reinvesting them. Dividend decision has remained one of the tough challenges for financial economists. We are yet to understand completely the factors that influence dividend decision and the manner in which these factors interact. From the practitioner’s viewpoint dividend policy of a firm has an implication for investors, managers, lenders and other stakeholders.
For investors, dividends whether declared today or accumulated and provided at a later date are not only a means of regular income, but also an important input in valuation of a firm. Similarly, manager’s flexibility to invest in projects is also dependent on the amount of dividend that they can offer to shareholders as more dividends may mean fewer funds available for investment. Lenders may also have interest in the amount of dividend firm declares, as more the dividend paid less would be the amount available for servicing and redemption of their claims.
At the end of each year, every publicly traded company has to decide whether to return cash to its stockholders, and if yes, and how much in the form of dividends. The owner of a private company has to make a similar decision about how much cash he plans to with draw from the business, and how much he has to reinvest, this we called the dividend decision. Factors That Influence Dividend Following are the factors involved in formulating dividend policy. 1. Legal Constraints: Most states prohibits companies from paying out as cash dividends any portion of the firm’s legal capital, which is measured by the par value of common stock.
Other states define legal capital to include not only the par value of the common stock, but also any-paid in –capital in excess of par. These capital impairment restrictions are generally established to provide a sufficient equity base to protect creditor’s claims. 2. Contractual Constraints: Often, the firm’s ability to pay cash dividends is constrained by restrictive provisions in a loan agreement. Generally, these constraints prohibit the payment of cash dividends until a certain level of earnings have been achieved, or they may limit dividends to a certain amount or a percentage of earnings.
Constraints on dividends help to protect creditors from losses due to the firm’s insolvency. The violation of a contractual constraint is generally grounds for a demand of immediate payment by the funds supplier. 3. Internal Constraints: The firm’s ability to pay cash dividends is generally constrained by the amount of excess cash available rather than the level of retained earnings against which to charge them. Although it is possible for a firm to borrow funds to pay dividends, lenders are generally reluctant to make such loans because they produce no tangible or operating benefits that will help the firm repay the loan.
Although the firm may have high earnings, its ability to pay dividends may be constrained by a low level of liquid assets. (Cash and marketable securities). 4. Growth Prospects: The firm’s financial requirements are directly related to the anticipated degree of asset expansion. If the firm is in a growth stage, it may need all its funds to finance capital expenditures. Firms exhibiting little or no growth may never need replace or renew assets. A growth firm is likely to have to depend heavily on internal financing through retained earnings, as dividends. 5. Owner Considerations:
You know that in establishing a dividend policy, the firm’s primary concern should be to maximize shareholder’s wealth. One such consideration is then tax status of a firm’s owners. Suppose that if a firm has a large percentage of wealthy stockholders who are in a high tax bracket, it may decide to pay out a lower percentage of its earnings to allow the owners to delay the payments of taxes until they sell the stock. Of course, when the stock is sold, the proceeds are in excess of the original purchase price, the capital gain will be taxed, possible at a more favorable rate than the one applied to ordinary income.
Lower-income shareholders, however who need dividend income will prefer a higher payout of earnings. 6. Market Considerations: The risk-return concept also applies to the firm’s dividend policy. A firm where the dividends fluctuate from period to period will be viewed as risky, and investors will require a high rate of return, which will increase the firm’s cost of capital. So the firm’s dividend policy also depends on the market’s probable response to certain types of policies. Shareholders are believed to value a fixed or increasing level of dividends as opposed to a fluctuating pattern of dividends.
Dividend policy is at the theory core of corporate finance. It is one of the most debated topics in the finance literature and still keeps its prominent place. Many researchers have devised theories and provided empirical evidence regarding the determinants of a firm’s dividend policy. The dividend policy issue, however, is yet unresolved. Clear guidelines for an “optimal payout policy” have not yet emerged despite the voluminous literature. Yet we still do not have an acceptable explanation for the observed dividend behavior of companies.
We are yet to understand completely the factors that drive dividend decision and the manner in which these factors interact. This is known as the dividend puzzle in the finance literature. Several hypotheses have been put forward to shed some light on this puzzle but in vain. More recently Brealey, Myers, Sick, and Giammarino  list dividends as one of the top ten important unsolved problems in finance. Three decades ago, Fisher Black  wrote that, “The harder we look at the dividend picture, the more it seems like a puzzle, with pieces that just don’t fit together”.
The situation is pretty much the same today. In a recent survey of literature on dividend policy, Allen and Michaely  conclude that, “Much more empirical and theoretical research on the subject of dividends is required before a consensus can be reached”. Dividend pay out decision is among the basic policy choices confronting corporate financial officers. However, the academic finance community has been less helpful in offering meaningful guidance on these issues. The choice of the amount of dividend is left to managerial discretion; there are no obligations to pay out dividends on common stock.
How much to pay is still an open issue. Over the past several decades, finance scholars have engaged themselves in extensive theorizing about factors that might be important in determining a firm’s dividend policies. In developed countries the decision between paying dividend and retaining earnings has been taken seriously by both investors and management, and has been subject of considerable research by economists in the last four decades. Variable Definitions Payout Ratio (POR): Dividend Pay out Ratio which is calculated as the dividend declared divided by the Net Income.
AS the inconsistent trends in dividend payout have been noticed this brings us to the conclusion that companies have instability in dividend payments. It indicates that when firms have more investment opportunities, they pay fewer dividends. Liquidity (CR): Liquidity of the firms is calculated by using the Current Ratio for the firms as current assets divided by the current liabilities. It shows the liquidity position of the firms that how much the firm is capable to meet its obligations. Financial Leverage (D/E):
Debt to equity ratio can be used for calculating the financial leverage of the companies which shows that how much the financing has been done from Debt (External) and how much from the Equity (Internal). Debt to Equity ratio can be calculated by dividing the total debt over the total equity in the particular financial year. Return on Investment (ROI): AS Return on Investment is the measure of profitability in our case, which is calculated by dividing the net profits after taxes by the total assets of the firms. Since these firms have more opportunities of investing their earnings then retaining.
Size (SZ) of the firms /Sales: The size reflects the order of magnitude in real terms. In order to construct the variable we will take the Log of Sales of the firms. This actually describes the firm’s actual size. Growth in Assets (G): The yearly growth rate is to be calculated as the change in total assets in a financial year from the previous year. This describes that how much the firm’s growth has been recorded from the previous year. Research Problem Does the dividend pay out is affected by growth, size, debt to equity, current ratio and return on investment etc.
In this research we will try to identify what are the factors influencing dividend pay out decisions. Our findings will be based on “Oil and Gas Sector”. Limitations Concerned people whom we contact for data gathering were reluctant to co-operate with us. Limited availability of data. Limited time. Budget constraints. Objective of the Study • To study the factors those affect the dividend payment of Oil & Gas companies. • To identify the prominent variables influencing the dividend policies of the selected companies of Oil and Gas sector. • To study which variables are influencing Oil & Gas companies dividend Payout pattern?
Theoretical Framework Dependent Variable: • Dividend Payout (DPO) Independent Variables: • Growth of Assets (G) • Size of the company / Sales (SZ) • Financial Leverage (D/E) • Liquidity (CR) • Return on Investment (ROI) CHAPTER 2 LITERATURE REVIEW We have focused on the factors affecting dividend policies to get a comprehensive view of the dividend policies as exercised in different countries of the world we need to go thorough review of many previous researches relevant dividend policies literature to help us understand the significance of dividend policies, and hence add our contribution in this research.
Based on the earlier work done by different researchers, The issue of dividend policy is far more pervasive, this study tries to address the factors of dividend payout for firms. Specifically, it is concerned with addressing what factors determine the dividend payout rate. Hence, for the purpose of this firm’s dividend policy is proxy by its dividend payout rate, which is defined as the ratio of dividends per share and earnings per share. Although the dividend policy of publicly listed companies has been a subject of considerable economic research, the dividend decision is still one of the main challenges for modern finance.
We still have to understand why companies all over the world pay a substantial part of their earnings as dividends, despite the Miller and Modigliani (1961) argument that market valuation should not depend on the (form of) payout. The economic forces underlying the phenomenon of dividend smoothing, documented for the first time by Lintner (1956), are also not clear yet. The Lintner model is considered the “best description of the dividend-setting process available” (Benartzi, Michaely, and Thaler (1997)), but it still lacks a comprehensive theoretical justification.
Moreover, surprisingly little is known about the reasons and the timing of dividend changes and especially, dividend increases. Miller and Modigliani  view dividend payment as irrelevant. According to them, the investor is indifferent between dividend payment and capital gains. Black  poses the question again, “Why do corporations pay dividends? ” In addition, he poses a second question, “Why do investors pay attention to dividends? ” Although, the answers to these questions may appear obvious, he concludes that they are not.
The harder we try to explain the phenomenon, the more it seems like a puzzle, with pieces that just do not fit together. After over two decades since Black’s paper, the dividend puzzle persists. Fisher Black’s Conclude that “dividends” is a puzzle. This conclusion is a motivation to study the subject in more detail, specially the factors that would be helpful in determining the dividend policy for Pakistani Oil & Gas Companies as a country of emerging economy.
A study on emerging countries including Pakistan is done by Aivazian, Booth and Clearly (2003). They find that profitability and Investment opportunities play an important role in determination of dividends. Similarly Hu and Liu, (2005) conclude that there is a positive relationship between the current earnings of a company and the cash dividend they pay, and a significant negative relationship between the debt to total assets and dividends.
Also, an Industry analysis by Dhanani (2005) provides clear evidence that those companies in the financial and utility sectors support the dividend signaling hypothesis more than their counterparts in other industrial, consumer and service industries. Japanese keiretsu firms are also found to cut dividends more often and respond to poor performance by cutting dividends more quickly than either U. S or independent firms according to Dewentner and Warther (1998). Higher revenue is another factor which negatively influences the dividends (Ramcharran 2001).
However DeAngelo and Skinner (1996) find no evidence of positive future earnings for firms increasing dividends where as Cash in excess of peer firms in their industry also have significant effect on dividend-increasing or repurchase firms Lie (2000). Some researchers have also focused on emerging markets like Glen, Karmokolias, Miller, and Shah, (1997); who examine dividend behavior in emerging equity markets and found that firms often have a target dividend payout ratio like their developed country counterparts.
In a comparative study on the dividend policy of Australian and Japanese firms Ho (2003) shows that Australian firms’ dividend policies are positively affected by size but their counterparts in Japan have them positively affected by the liquidity, while risk has a negative effect. The dominant favorable tax effect of dividends in Australia, and the positive size effect suggest that transactions cost is a key determinant of distributing payments to shareholders in Australia but not in Japan, possibly because of its relatively small sized firms.
Another study about Egyptian firms shows that for non-actively traded firms, the accounting book value is important determinant for dividend policy. But, for actively traded firms, gearing ratio and the market to book value are more important determinants of dividend policy (Omran and Pointon, 2004). Whereas Holder, Langrehr and Hexter (1998) provide another important factor “corporate focus”; but it is negatively related to dividend payout ratios. Another study found on banks’ dividend policy is provided by Dickens, Casey, and Newman (2000).
They show that there is a negative relationship between dividend yields and investment opportunities, signaling, ownership, and risk and a positive relationship with size and dividend history (also see Omet, 2004). Barclay, Smith, Ross (1995) find investment opportunities and leverage where as Baker, Theodore, and Gary (2001) find that the pattern of past dividends, stability of earnings, and level of current and expected future earnings are the most important determinants of dividend decision; (also see Brav, Graham, Harvey, Michaely, 2005).
Whereas, Fama and French (2001) state that the decline in the incidence of dividend payers is in part due to an increasing tilt of publicly traded firms toward the characteristics, small size, low earnings, and high growth, of firms that typically have never paid dividends, There are also other interesting articles like that of Alli, Khan, Ramirez (1993) who find that Firms experiencing high issue cost, high growth level, and high risk, and experiencing a high level of capital expenditure pay low dividends.
Grullon, Michaely and Swaminathan (2002) state that firms increasing dividends experience also a significant decline in their return on assets, which indicates a decline in systematic risk. Anand (2004) results reveal that most of the firms that have target dividend payout ratio and dividend changes follow shift in the long term sustainable earnings. This brief review of literature shows that factors influencing the corporate dividend policy, according to them, may substantially vary from country to country because of inconsistency or variation in legal, tax and accounting policy between countries.
In view of these facts, the present study aims at identifying the factors/variables influencing dividend policy of Oil & Gas Sector in Pakistan. CHAPTER 3 DATA AND METHODOLOGY For the purpose of identifying the factors affecting the dividend policy Oil & Gas sector in Pakistan a sample of 03 companies during the time frame 2003–2006 has been taken. We acquire the data from the financial statements of the companies so our research is secondary based. We also use Dividend payout ratio defined as the dividend declared for a company divided by the net income of that company, as our dependent variable.
For the purpose of examining the affect of liquidity we will use current ratio which is calculated by dividing current assets by current liabilities we hypothesize that Liquidity of a firm has negative relationship with dividend payout. Debt ratio can be used as independent variable because when a firm has relatively high financial leverage, its dependence on external finance is increased, thus, has low dividend payout ratios. Higher revenue firms should have lower probability of bankruptcy, therefore, should be more likely to pay higher dividends; Barclay, Smith, and Watts, (1995).
We also think that size of firms, measured by log of sales, has an important contribution in explaining dividend policy since Larger firms have better access to market and therefore able to pay higher dividends. Investments in fixed assets for expansion purpose leave little out of profits to be paid to shareholders as dividends. Therefore, we hypothesize these ratios to have a negative relationship with dividend policy. For example, Ramcharran (2001) also finds support that retentions (i. e. lower dividends) are associated with greater growth.
The measure of profitability in our case is return on investments, which is calculated by dividing the net profits after taxes for the firm by the total assets and hypothesize it to be positively related to dividend payout ratio. Previous year’s dividend may also be another independent variable to examine the effect of previous year’s dividend payout ratio on current year’s dividend payout ratio. Looking at dividends pattern in general we find that firms have a tendency to follow the pattern of past dividends.
Time Frame Data gathered within the three months from available sources. Sample size For conducting the research work we focused on the Oil & Gas sector of Pakistan. Companies that we consider for our research were three: OGDCL SNGPL POL We utilize the data of three years from 2003/2004 to 2005/2006 that was easily available for our research. Data Collection Secondary data o Companies Financial Statements o Internet o Books CHAPTER 4 RESULT AND ANALYSIS |Table 4. Dividend Payout Ratio during 2003 – 2006 (in %) | | | | | | |Companies |2003/04 |2004/05 |2005/06 | | | | | | |OGDCL |77% |98% |84% | | | | | | |SNGPL |54. 2% |54. 74% |40. 23% | | | | | | |POL |65. 84% |43. 66% |40. 22% | From the Table 4. 1: Researches have found the dividend payout ratio of the firms during our study period (2003-2006). The inconsistent trends in dividend payout have been noticed which brings us to the conclusion that companies have instability in dividend payments.
It indicates that when firms have more investment opportunities, they pay fewer dividends. Line graph on the right side shows the dividend paid by these companies in different financial years and also their comparison of paying dividend is given on the left side in the bar graph. It is found that OGDCL has more Dividend Pay Out as compare to the other two firms in the same sector |Table 4. 2 Dividend Per Share during 2003 – 2006 (in Rs. ) | | | | | |Companies |2003/04 |2004/05 |2005/06 | | | | | | |OGDCL |Rs. 4 |Rs. 7. 50 |Rs. 9 | | | | | | |SNGPL |Rs. 2. 50 |Rs. 3 |Rs. 3 | | | | | | |POL |Rs. 12. 50 |Rs. 2. 50 |Rs. 18. 75 | From the Table 4. 2: Researchers got the dividend per share of companies in Oil & Gas sector over the period of study (2003 – 2006). The result shows that the highest dividend per share was paid by Pakistan Oil Fields during the year 2005/06, (18. 75 Rs. Per share). Line graph on the right side indicates the separate dividend per share paid by the companies in that period while the bar graph on the left shows the comparison of the dividend per share between the firms that we consider for our research. |Table 4. Liquidity (CR) during 2003 – 2006 (in times) | | | | | | |Companies |2003/04 |2004/05 |2005/06 | | | | | | |OGDCL |12. 17 |4. 96 |6. 67 | | | | | | |SNGPL |1. 32 |1. 2 |1. 3 | | | | | | |POL |2. 62 |4. 22 |2. 13 | From Table 4. 3: Result describes the Liquidity of the three firms using current ratio. It shows that liquidity of the firms has negative relation with Dividend Payout. Line graph on the right side indicates the current ratio of the companies in the financial years and the bar graph on the left side gives the comparison between the companies’ current ratios. |Table 4. Financial Leverage (D/E) During 2003 – | |2006 (in %) | | | | | | |Companies |2003/04 |2004/05 |2005/06 | | | | | | |OGDCL |26% |38% |28% | | | | | | |SNGPL |54% |49% |40% | | | | | | |POL |0% |0% |16% | From Table 4. : Researchers analyze the Financial Leverage of the firms by using debt to equity ratio. In the Oil and Gas sector of Pakistan over the study period (2003-2006),we notice that Financial Leverage has negative relation with the Dividend Payout of these firms. As the dependence on external finance has increased these results in the low dividend payout ratio as in the case of OGDCL and POL in year 2005/2006. Line graph on the right shows different values of debt to equity ratio of the companies in different years as mentioned above. The bar graph on the left gives the comparison of debt to equity ratio of the companies in the financial years. |Table 4. Market value / Share (as at | |June,30) | | | | | | |Companies |2003/04 |2004/05 |2005/06 | | | | | | |OGDCL |64. 5 |105. 3 |136. 75 | | | | | | |SNGPL |64. 7 |61. |100 | | | | | | |POL |208. 5 |281. 4 |334. 8 | From the Table 4. 5: Market Value per share of Oil and Gas companies Pakistan over the study period (2003-2006) has been found. These values have been obtained from the Karachi Stock Exchange (KSE). It has been examined during that particular period market value of POL share is higher than the other two firms in the same sector. Line graph on the right shows the Market value per share of the companies separately while the bar graph on the left gives the comparison of the Market Value per share of the companies. |Table 4. Dividend Yield Ratio during 2003 – | |2006 (in %) | | | | | | |Companies |2003/04 |2004/05 |2005/06 | | | | | | |OGDCL |6% |7% |7% | | | | | | |SNGPL |3. 86% |4. 9% |3% | | | | | | |POL |5. 76% |5. 10% |6. 09% | From Table 4. 6: Dividend yield ratio of the firms of Oil and Gas sector in Pakistan during the study period (2003-2006) has been obtained. It has been noticed that dividend yield of OGDCL is relatively high than the other two firms of the same sector during that period. During the research it is found that dividend yield ratio has a positive relation with the dividend payout. Line graph on the right indicates the values of the companies separately and the bar chart on the left shows the comparison among the three companies. |Table 4. 7 Return on Investment during 2003 – |2006 (in %) | | | | | | |Companies |2003/04 |2004/05 |2005/06 | | | | | | |OGDCL |23% |29% |38% | | | | | | |SNGPL |4. 28% |4. 05% |4. 20% | | | | | | |POL |19. 3% |23. 75% |26. 35% | From Table 4. 7: Return on Investment of the three Oil and Gas firms that were considered for our research in the study period (2003-2006). While calculating the ROI of these firms it has been observed that they have more opportunities of investing their earnings then retaining. Hence the table suggests that OGDCL has more return on investment as compare to the other two firms in the industry. Line graph on the right side gives the values of ROI of three companies separately in the respective financial years while the bar graph on left side gives the comparison of the ROI of three companies. |Table 4. Growth of the Firms (Assets) During 2003 – 2006 (in %) | | | | | | |Companies |2003/04 |2004/05 |2005/06 | | | | | | |OGDCL |13% |19% |6% | | | | | | |SNGPL |25% |14% |19% | | | | | | |POL |18% |25% |47% | From Table 4. 8: Researchers found the result of the firms growth regarding assets in the study period 2003 – 2006, the yearly growth describes that how much the firm’s growth has been recorded from the previous year.
Calculations indicate that POL has more growth in 2005-2006 as compare to the other two firms in the same sector. Investments in fixed assets for expansion purpose leave little out of profits to be paid to shareholders as dividends. Therefore, it has a negative relationship with dividend policy because lower dividends are associated with greater growth. Line graph on the right side indicates the firm’s growth in their respective financial years while the bar graph on the left shows the comparison of growth between the companies in that period. | | |Table 4. Log of Sales (Size) during 2003 – | |2006 | | | | | | |Companies |2003/04 |2004/05 |2005/06 | | | | | | |OGDCL |10. 71 |10. 87 |11 | | | | | | |SNGPL |10. 1 |10. 92 |11. 03 | | | | | | |POL |9. 84 |9. 95 |10. 19 | From Table 4. 9: The Log of Sales that has been calculated for the companies in the particular study period. This actually describes the firm’s size regarding sales of the firms during that period. It has an important contribution in explaining dividend policy since these companies are larger and they have better access to market and therefore able to pay higher dividends as compare to market.
The Line graph on the right side indicates the companies’ size (sales) while the bar graph on the left side shows the comparison among the firms size (sales) in the financial years. CHAPTER 5 CONCLUSION AND RECOMMENDATIONS The objective of this study is to find out the Factors that are affecting the dividend payout of Oil and Gas sector of Pakistan. It has been concluded that there is inconsistency in the dividend paying pattern of Pakistani firms. As no firm or organization follows the international standards in paying their dividends to the share holders. For paying the dividends to the share holders it all depends upon the decision of The Board of Directors in their annual meeting.
We also find that the Oil and Gas sector firms have greater investment opportunities, so they conserve cash to fund those opportunities and, therefore, paid fewer dividends and secure their future growth by investment. But we have also seen that the oil & gas companies distribution have higher dividend payouts and dividend per share relative to other large number of firms that paid less or even no dividends. We concluded that profitability is positively related to dividend payout for the firms because firms earning more profits are more likely to pay higher dividends compared to less profitable firms or loss making firms. More research is needed for an extended period of time and including for other number of firms in Pakistan.
Further studies are also needed to examine the market reaction to dividend announcements, and other possible factors of dividend payouts such as market to book ratio for capturing the investment opportunities, flotation costs, macroeconomic factors and other firm level factors. Well, there is much work left for further research. s Recommendations • Security and Exchange Commission of Pakistan (SECP) should ensure the firms to strictly follow the rules and regulations for announcing the dividends to the share holders. • Investors prefer stable dependable dividends as they invest for profit not for gaining loss. • Ks would be higher and the stock price lower if the firms followed the models in a strict sense rather than attempting to stabilize its dividends over time therefore firms should estimate the firm’s earnings and investment opportunities on average over the next five years or more. Firms may use their forecasted information to find the residual dividend model payout ratio and dividend during the planning period based on the projected data. • Thus firms should use the dividend models for help to set their long run target payout ratios but not as a guide to payout in any one year. References: Annual reports of Oil and Gas Development Corporation (20004, 2005, 2006) Annual reports of Pakistan Oilfields Limited (20004, 2005, 2006) Annual reports of Sui Northern Gas Pipelines (20004, 2005, 2006) Brigham Financial Management 10th Edition. Shammyla Naeem and Muhammad Nasr Dividend Policy of Pakitani Firms: Trends and determinants August 2007. Varouj Aivazian a, Laurence Booth a,*, Sean Cleary b
Dividend policy and the organization of capital markets 20 April 2002. Nishat, M. (1999), “The Impact of Institutional Development on Stock Prices in Pakistan,” Doctoral Dissertation, Auckland Business School, University of Auckland Allen, Dave E and Rachim, Veronica S. ” Dividend policy and stock price volatility: Australian evidence. ” Applied Financial Economics, 1996, 6, 175-188. Internet: www. sbp. com. pk www. kse. com. pk www. ssrn. com www. fbi. com. pk [pic][pic][pic] ———————– Growth(g)of (Assets) Dividend Pay out (DPO) Dependent Variable Liquidity (CR) Financial Leverage (D/E) Size of Company (Sales) Return on Investment (ROI) Independent Variables