Economic reforms, determinants and stability of dividends in a dynamic setting
| Date | 11 January 2013 |
| Published date | 11 January 2013 |
| DOI | https://doi.org/10.1108/15587891311300990 |
| Pages | 5-30 |
| Author | Manoj Subhash Kamat,Manasvi M. Kamat |
| Subject Matter | Strategy |
Economic reforms, determinants and
stability of dividends in a dynamic setting
Manoj Subhash Kamat and Manasvi M. Kamat
Abstract
Purpose – This study aims to find whether the Indian private corporate sector follow stable cash
dividend policies, whether dividends smoothen earnings, estimate the implicit target dividend ratio, and
examine the determinants along with speed of adjustment of dividends towards a long run target ratio.
Design/methodology/approach – The study uses the instrumental variable (IV) approach for dynamic
panel data for 1971-2010 periods controlling for economic reforms. The GMM-in-levels model,
GMM-in-first-differences and GMM-in-systems are alternatively estimated to include other lag
structures.
Findings – In the post-reform period lower dividends are consistent with rapid growth in the economic
environment and the tendency to smoothen dividends has considerably decreased over time. The
estimated model suggests dividends substitute for less opportunity for internal growth and increased
general likening to relatively retain their earnings and finance their growth, unlike the past.
Research limitations/implications – Limitation to capture substitution, ownership and self selection
effects stems up from data as the Annual Studies RBI does not include such variables, does not capture
qualitative data and disallows identification of the firm.
Practical implications – The paper documents long run trends and inter-temporal dividend patterns
controlling economic reforms for a relatively larger number of public limited firms nearing four decades
for an emerging economy.
Originality/value – This is a first attempt to take a holistic view of dividend using rich set of unexplored
dynamic panel data on Indian firms controlling for reforms using contemporary econometric models and
analyzes issues relating determinants, smoothening and stability of the corporate dividend structure.
Keywords Economic reforms, Dividends, Stability, Determinants, Dynamic panel data,
Partial adjustment model, GMM, India
Paper type Research paper
1. Introduction
Among the foremost papers on dividend policy Lintner (1956) embodies dominant patterns
of decision-making with respect to dividends. Since Lintner neither considers the factors like
size, debt, investment, managerial aspects, etc., nor regulatory constraints in determining
dividends, has led other researchers to explore and investigate other plausible variables
which might possibly be significant. The issue of dividend stability and determinants has
been researched across countries except for very limited and recent studies in the emerging
market context. This piece of research is planned in context of an emerging market, India
and aims to set the stage for enquiry into relevance of dividend policy by emphasizing its
importance to the firm. As such this is a first attempt to take a holistic view of dividend using
rich set of unexplored panel data on Indian firms controlling for economic reforms and
analyzes issue relating determinants and stability of the corporate dividend structures in
India. It would be intriguing to find whether dividends smooth earnings in India and to
estimate the implicit target dividend ratio along with speed of adjustment of dividends
towards a long run target dividend ratio. The test for applicability of dividend stability
DOI 10.1108/15587891311300990 VOL. 7 NO. 1 2013, pp. 5-30, QEmerald Group Publishing Limited, ISSN 1558-7894
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Manoj Subhash Kamat is
based at the Department of
Commerce, Vidya Vikas
Mandals Shree Damodar
College of Commerce and
Economics, Goa, India.
Manasvi M. Kamat is based
at the Department of
Economics, Vidya Vikas
Mandals Shree Damodar
College of Commerce and
Economics, Goa, India
The authors acknowledge the
financial support from National
Stock Exchange (NSE) Mumbai
under the NSE Research
Initiative to carry out the project
from which the present study
largely draws upon. The
authors are grateful to
Professor L.M. Bhole and
Professor Arif Khurshed,
Manchester Business School,
UK for their guidance and
mentoring role in finalizing this
manuscript. Thanks are also
due to Professor Amitabh
Gupta, Faculty of Management
Studies at Delhi University,
Professor Sony Thomas and
Professor Sthanu Nair, both
from Indian Institute of
Management Kozhikode and all
participants present at the
International Conference on
‘‘Financial Sector Reforms and
the Indian Economy’’ organized
by the Indian Institute of
Management Kozhikode in
association with the British
Northern Universities Forum
(BNUIF), for their valuable
comments and suggestions.
Usual disclaimer applies.
hypothesis adds to the relatively limited literature on aspects of dividend decision by
examining the dynamics of relationship between dividends and a host of explanatory
variables in the emerging market. The factors as to how reform process affects dividend
decisions and whether these factors have changed over time are also explored.
This study is novel in many respects and unearths a host of financial factors that determine
the dividend policy decisions in India. Earlier tax policy, depreciation policy, retention policy,
size of the firm, debt levels and investment opportunities etc. were theoretically assumed to
be major determinants of the corporate dividends. In the light of lower effective corporation
tax rate than nominal rate and higher effective depreciation rate than its nominal or general
rate, the meager dividend performance in India cannot be attributed to the taxation and
depreciation systems. Detailed empirical evidence from a developing countries’ viewpoint is
important because the institutional frameworks can differ significantly from those in the
developed countries and, given that the Indian capital market is emerging and the economy
is targeted to be one of the largest in world, our results could fill an important gap in this
aspect of empirical literature.
Dividend policies have implications on financing and investment behavior of firms. Payment
of dividends reduces free cash flows (FCF) and alternatively the scope for investments in
newer and efficient projects. Deciding what percentage of earnings to dividend as
dividends is a basic choice confronting managers because this decision determines not
only how much funds flow to investors, but also what funds are retained for reinvestments.
Thus the decisions taken by managers relating dividends are interwoven with that of
investments, leverage, cost of borrowings and so on. Conflicting opinions exists regarding
whether a dividend is decided first and retained earnings are residual, or retained earnings
is an active variable and dividends the result thereof. This attempt highlights the importance
of dividends by enquiring its specific role and significance amongst other investment and
financing decisions. According to stable dividend hypothesis a firm’s value is influenced by
the regularity of its dividend. Firms with stable dividend policies enjoy better valuation in the
capital markets than those with a variable dividend policy and it therefore follows that the
investors of firms following stable dividend policy will enjoy better opportunity for wealth
creation. Stable dividend policy results in more predictable cash flows in the hands of the
shareholders and this reduces uncertainty, whereas variable dividend policy makes the
cash flow in the hands of shareholder more variable and hence increases their risk and
subsequently, the required rate of return. Managers may than have to satisfy the
shareholder’s preference for increases in rate of return; else the value of the firm will be
subsequently affected. In this context, the questions addressed are whether corporate
investments and financing patterns lead to dividends or it is the other way round and
whether economic reforms have impacted stability of corporate dividend payments in the
market.
Unlike earlier studies we take a holistic view of dividend using dynamic panel data (DPD)
pertaining to Indian companies for the years 1971 through 2010. Second, earlier studies on
dividend policy for this market did not control for unobserved firm-specific effects which
might be correlated with other explanatory variables causing ordinary least squares (OLS)
and within-groups estimators to be biased and inconsistent. Generalized method of
moments (GMM) following Arellanno and Bond (1991), Arellanno and Bover (1995) and
Blundell and Bond (1998) is used to control the above-mentioned biases using the rich data
compiled by Reserve Bank of India (RBI) on company finances, This data source is
extensive but scantly used by researchers and has been conducting studies on financial
performance of private corporate sector for over nearing four decades. The usage of such a
consistent, reliable and wider data canvas can improve reliability of tested models.
It is hypothesized that dividend policy of the firms is chosen and is not randomly distributed
among companies. Literature on dividend policies reviewed herein reinforces the fact that
number of studies on dividends in emerging market context is scanty. Dividend policy
theories are exhaustively propounded, critically evaluated and empirically tested in the West
and mostly in the context of developed markets. Use of reliable databases, wide and deep
sample frame and use of contemporary econometric techniques characterize research on
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