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Factors Determining the Dividend Policy of a Company.


Dividends are returns to shareholders for their investment in firms and the dividend policy is a set of guidelines that a firm uses to decide how much cash to give to its shareholders in the form of dividends. Dividend policy of a company remains one of the key areas of research in finance. Lintner (1956) was the pioneer in studying the behavioural pattern of management in deciding dividend policy and his study revealed that management is usually conservative in nature; and dividend policy is largely based on the earnings of current year, as also the dividend pay-out of the previous year, and does not deviate largely from this. Miller and Scholes (1982) argue that in the real world, dividend decision is inspired more by high taxes on dividends than on other alternatives such as capital gains. Ali, Khan and Ramirez (1993) observe that dividend policy has a signalling effect in the market in that a change in the pay-out policy provides information about future earnings and reflects the true share price of the firm. Also the agency theory suggests that there has always been a conflict between the insiders and outsiders on the determination of dividend policy and the managers decide the dividend policy to meet their own selfish interests.

Theories Related to Dividend Policy

Dividend-Irrelevance Theory

Miller and Modigliani's (1961) dividend-irrelevance theory implies that investors should be indifferent between receiving cash dividends at present or enjoying future payoffs from capital gains, as long as the firm accepts projects with positive NPV. However, dividends and capital gains do not fully compensate the risk of the investors such as risks related to business cycles, managerial capability, or availability of funds for unexpected expenses. Also capital gains cannot take place of dividends to meet cash needs. The assumptions considered in the theory such as no taxes, no transaction costs, rational behaviour of investors are very idealistic and therefore, this theory may not work in real situations.

Signalling Effect Theory

Several studies observe stickiness in dividend policy. For example, Lintner (1956) finds that firms have long-run target pay-out rates, and that managers seek to smooth out dividends. Dividend is considered as a signal for the market regarding the earnings and the future prospects of the firm. Signalling theory advocates that firms may increase cash dividends in attempts to signal to investors that expected future cash flows have increased. Similarly, a decrease in cash dividends serves as evidence to investors that expected future cash flows have decreased.

Agency Theory

Agency theory says that there is always a conflict between the insiders (top management) and the outsiders (shareholders and lenders). The insiders tend to maximize their benefit while deciding the dividend policy and overlook the interest of outsiders. It has been suggested by researchers in the past that firms pay dividends to reduce their agency costs.

Pecking Order Theory

Myers (1984) argues that the traditional pecking order framework, in which a firm prefers internal to external financing and debt to equity if it issues securities, can also explain a firm's capital structure choice. Because of asymmetric information, external financing is much more costly than internal free cash flows for investment. Although pecking order theory was originally introduced to explain the capital structure puzzle, it can be easily applied to the dividend puzzle, because dividends could have been internal free cash flows if they had not been issued. With the coming up of other alternatives such as share buybacks, stock dividend instead of cash dividends, it has become even more difficult to identify the factors in which the dividend policy of a firm can depend on. Options such as stock buyback provides a tax advantage and are considered an alternative to dividend payment.

This paper has attempted to determine the factors affecting the dividend policy in the Indian context. The data from Bombay Stock Exchange (BSE) has been used to get a fair idea of the market. Top 500 BSE companies have been considered for the purpose of the study.

The research study seeks to answer the following questions:

* What are the factors that impact dividend policy?

* How does the dividend payment relate to the ownership structure of the firm?

* Among these factors identified, which are the key factors?

The research study attempts to narrow down some factors that can possibly determine the dividend policy of firms in India and attempts to measure the significance of each in determining the same.

The remaining paper is organised as follows: Section II describes the literature review while Section III describes the data collection and methodology adopted for the purpose of the study. Section IV presents the empirical findings and section V describes the concluding observations.

II Literature Review

The proponents to the significance of dividend policy of an organisation and its contribution to shareholders wealth maximisation were Miller and Modigliani (1961). Several studies observe stickiness in dividend policy. The pioneer to this study has been Lintner (1956) who found that firms have long-run target pay-out rates, and that managers seek to smooth out dividends. Baker and Powell (2000) examined factors influencing dividend decision of US firms in 1997. Their findings indicated that the track record of dividend payments and the level of present earnings and potential earnings are key in deciding the dividend pay-outs. Pourheydari (2009) analyzed factors impacting dividend policy of Iranian firms. Using survey method, he identified cash flows, stability of profitability, viable investment opportunities and industry-specific factors as the key determinants of the dividend decision. A study on the patterns of dividend policy for nonfinancial Jordanian firms was done by Najjar (2009). He observed that the factors influencing the dividend decision were very similar across the developed and emerging economies.

Gupta and Banga (2010) identified five factors impacting the dividend policy of a firm. The major finding of their study was that a company with higher internal ownership structure tends to give less divided and institutional investors tend to demand higher dividend pay-out ratio. Leverage and dividend policy have an inverse relationship while profitability and liquidity have a positive relation with the dividend policy; also growth-firms tend to distribute higher dividends. Stanley Block (2007) argues on the declining importance of cash dividends with the coming up of new alternatives, primarily due to stock repurchase options. Baker and Powell (2000) adopted a primary survey method to analyse the dividend determinants. The evidence from their study shows that the stability of earnings and the level of current and expected future earnings are considered most significant determinants of dividend policy. Baker and Kapoor (2014) suggested that the most important factors influencing dividend policy involve earnings stability, the level of current and expected earnings; and the pattern of past dividends. Evidence supported multiple theories for paying cash dividends with the strongest agreement involving signalling, firm life cycle, and catering theories with the least support for agency theory. Dhar and Chhaochharia (2008) found a positive average abnormal return on dividend announcement which was very significant. Uddin and Chaudhary (2003) in their study regarding investigation of dividend announcement impact on stock price of Dhaka market found that there were no abnormal return in response to dividend announcement.

Recent studies include those of Setiawan and Phua (2013) which examined the impact of corporate governance (CG), size, profitability and growth factors on the dividend policy of Indonesian firms. Their research findings showed that Indonesian firms tend to compensate their poor corporate governance practices through higher dividend payments. Among the determinants of dividend policy, growth and firm profitability show positive association while size of firm does not. Yousaf et al. (2014) examined the dividend policy for firms in the oil and gas sector of Pakistan using panel dataset of firms. Their research findings revealed that assets, and profit before tax are positively correlated to dividend policy while liabilities are negatively correlated to the dividend policy. Hakeem and Bambale (2016) examined the relationship between the firm's financial performance and dividend payout among listed manufacturing firms in Nigeria for the period 2007-2014. They emphasized that liquidity is a good mediator between firm performance and dividend payout and firm performance has a significant impact on the dividend pay-out ratios for firms in Nigeria. Kuzucu (2015) examined the corporate dividend payout behaviors of non-financial firms from Istanbul Stock Exchange using survey method. The findings reveal that sustainable change in earnings, stability and level of future earnings, and the desire to distribute a proportion of earnings to shareholders are the common determinants of dividend policy.

Demirguneg (2015) studied the determinants of target dividend payout ratio (TDPR) of BIST--listed firms of Turkey operating in the non-metallic products (cement) manufacturing industry in the period 2002-2012. Empirical findings indicate that in the long-run, factors related to profitability, growth and corporate taxation significantly affect TDPR negatively; while factors related to risk and market expectations have statistically significant and positive effects on TDPR.

Other studies on emerging market economies include by Khalid and Rehman (2015) which advocated that ownership structure plays a significant role in determining the dividend pay-outs and firms with large outside shareholdings have a tendency to pay higher dividends. Ozo, et al. (2015) also conclude that similar factors impact firms in developed and emerging countries. Their study was based on primary data through the semi-structured interview of management. Najjar (2009) examined the determinants of dividend policy for non-financial Jordanian firms. His findings were that the same factors affect both developed and developing countries and that the Lintner model holds true for firms in Jordan also.

III Research Design and Methodology

The research study is based on secondary data. Financial data of companies listed in BSE 500 index were considered for the research. BSE 500 was chosen to give a clear picture of the market as a whole covering all the major sectors. The author has analysed the dividend policy of the companies in the last 3 consecutive years and thus the time period chosen for the study is from FY2013-2016. The data is taken from Capitaline Plus database. Data was filtered to include only those companies which paid cash dividends and for which data was available for all the financial parameters. As complete data was not available in the data base for all the companies, some of the companies had to be omitted leaving the data set comprising of 355 companies. Dividend pay-out ratio was considered a measure of the company paying dividend. No stock dividends and share buybacks were considered for this study.

Based on prior works and on our learnings in finance, 16 factors that impact the dividend decision of a firm were identified in the first stage of analysis. These factors are stated in table-1 in the first column.

The study re-examines the factors deciding the dividend policy of the firm by a multivariate procedure. The Multivariate platform examines multiple variables to see how they relate to each other. 16 factors from literature were considered. In the first step, a factor analysis on the data to extract prominent factors from these sixteen variables was performed. In the second step multiple regression was done on the factors extracted. The objective is to identify the key factors that impact the dividend decision.

IV Empirical Findings

Descriptive Statistics

The size of promoter's holdings range from 0 per cent to 90 per cent. The average holdings of promoters is around 54 per cent which is true in the Indian context where most firms are family-driven. The same is also true for institutional holdings which ranges from 0 per cent to 89 per cent, the average being around 26 per cent. Also a lot of variation in EPS from Rs. 0.020 to Rs. 245.250 is observed. It can be seen from the table below that the sample contains a mix of both mature companies of age around 90 years and young companies of 5 years of age. It can be seen that the market capitalisation also reflects on a fair sample pf companies. Therefore, this sample can be said as a nearly true representation of the market. It is observed that the minimum value for the cash flow from operations is negative while maximum shows positive surplus of large quantum. Thus our sample covers companies over a wide spectrum in their liquidity position. Thus, almost all the factors considered for our study reflects a fair view in its wide range and are a representative sample.

Principal Component Analysis

Principal component analysis (PCA) is a data reduction technique. Some of factors that summarise the available information as a linear relationship of factors are chosen. There are two indicators used for the checking of the interest of the implementation of the PCA on a dataset: the Bartlett's sphericity test and the Kaiser-Meyer-Olkin (KMO) index.

Bartlett Test: This test checks if there is a certain redundancy between the variables that can be summarized with a fewer number of factors. If the variables are perfectly correlated, only one factor is sufficient. If they are orthogonal, one needs as many factors as variables.

KMO index: KMO Test is a measure of how suited the data is for factor analysis. The test measures sampling adequacy for each variable in the model and for the complete model. This statistic is a measure of the proportion of variance among variables that might be common variance. The lower the proportion, the more suited the data is to Factor Analysis.

Bartlett test and KMO test were conducted on all the above variables and data was found suitable for factor analysis.

Test Interpretation:

[H.sub.0]: There is no correlation significantly different from 0 between the set of variables.

[H.sub.a]: At least one of the correlations between the variables is significantly different from 0.

The Chi-square (observed value) is 2046.494 while the chi-square (critical value) is 182.865, with p-value < 0.0001. As the computed p-value is lower than the significance level alpha=0.05, one should reject the null hypothesis H0, and accept the alternative hypothesis Ha. Our p -value is much lower than the significance value and hence a correlation exists between the variables and the data is suitable for factor analysis. Our value for the KMO test is 0.597 > 0.5 which indicates data is acceptable for conducting factor analysis.

Factor Analysis

After analysing the data, factor analysis was done to reduce the number of factors in the data. The factors are reduced based upon the correlation existing among them. By factor analysis, 16 variables were reduced to 7 variables and the factor scores were recorded. After conducting the factor analysis, multiple regression was done on the factor scores as independent variables and the dividend pay-out ratio of 2016 as the dependent variable.

The table II represents the correlation between variables and factors. The variable that are considered most significant in generating the factor score are represented in the above table. The significance rate of 5 percent is considered for the purpose of our analysis. The values in the table gives us the correlation between the factors and the variables. The names of the factors are decided on the basis of the type of the variables they contain.

The factor names and variables are chosen as follows:
Findings on Factor Analysis

                           Factor 1      Factor-2       Factor-3
                          Financial      Ownership     Liquidity,
                         Performance                  leverage and
                           and size                     Dividends

Current Ratio                                             0.525
CFO                          0.640
Market Cap                   0.906
D/E                                                       0.587
RRE (retention to            0.364
equity ratio)
Tax/PAT (%)
Total of Promoter (%)                      0.841
Institution (%)                            -0.793
PAT                          0.941
Div. Yield                                                0.565
Pay-out 2015
Pay-out 2014
Pay-out 2013
Size                         0.793

                           Factor-4      Factor-5     Factor-6
                          Return to        Growth        Tax
                         Shareholders                 behaviour

Current Ratio
Market Cap
RRE (retention to           -0.548
equity ratio)
Tax/PAT (%)                                             -0.620
Total of Promoter (%)
Institution (%)
RONW                                       -0.640
EPS                         -0.627
Div. Yield
Pay-out 2015                               -0.326
Pay-out 2014                                            -0.583
Pay-out 2013                 0.475
Age                                                     -0.465


Current Ratio
Market Cap
RRE (retention to
equity ratio)
Tax/PAT (%)
Total of Promoter (%)
Institution (%)
ROI                         -0.819
Div. Yield
Pay-out 2015
Pay-out 2014
Pay-out 2013

The first factor is financial performance and size; the major contributors of this factor are cash from operations CFO (.640), market capitalisation (.906), retention to equity ratio (.364), profit after tax PAT (.941) and the size of the company (.793). All the factors are positively loaded for this factor. More cash flow from operations indicates more liquidity and the ability of the company to pay more dividends. Large market capitalisation, and high PAT indicate high market values and profitability increasing the dividend pay-out ratio of the company. A large firm will have greater access to capital markets and is thus in a better position to pay more dividends and thus there is a positive relation with dividend outflows.

* The second factor is the ownership structure that consists of promotors shareholdings (.841) which is positively loaded and institutional shareholdings (-.793). The impact of ownership structure on the dividend policy varies across countries. Prior research works have propagated that dividends serve as a mechanism for reducing agency costs by offering a rational for distributing free cash to owners. The dividend pay-out tends to bring a decline in the stock value, thus, a conflict of interest for the insiders. Thus, promoters holding being higher leads to high pay-out. While agency theory is based on a positive relationship between institutional holdings and dividend policy, there is another perspective that large institutional holdings are by themselves a signal of good governance and stable performance of the company and thus, the signalling effect of dividend distribution is reduced to that extent. Institutional ownership and dividend distribution can be two ways of signalling and can be thus considered as alternated. (Kulathunga and Azeez, 2016). Thus, relationship of institutional holding and dividend can be positive (agency theory) or inverse (signalling theory).

* The third factor is a mix of liquidity position, leverage and dividends. The major variables contributing to it are current ratio (.525), the debt to equity ratio (.587) and dividend yield (.565). All the factors are positively related in this factor. The signalling theory confirms a positive relationship between financial leverage and dividend pay-outs. A sound liquidity facilitates outflows on account of dividends.

* The fourth factor is Return to shareholders' as it contains a ratio of retention to equity (-.548). This ratio indicates what percentage of equity is held with the company as retained earnings. The second factor is EPS (-.627) which is also related to shareholders funds. In addition to the above factors dividend pay-out (.475) of 2013 is also related to this factor, which indicates the relation of past trends in the dividend policy of a company.

* The fifth factor considered is growth. The return on net worth (-.640) or ROE is considered as a major factor indicating the growth prospects of the firm. Profitable investment opportunities will warrant high retention ratios and low pay-outs as shareholders wealth maximisation comes with growth prospects. Thus, high growth firms, will have less dividend payments. In addition to the above factors dividend pay-out (-.326) of 2015 is also related to this factor, which indicates the relation of past trends in the dividend policy of a company. Both the variables are negatively loaded in this factor.


After factor analysis, we run regression on these factors to identify the key predictors of dividend policy for Indian listed companies. It is observed that ownership structure, liquidity, leverage and dividends, returns to shareholders, growth, tax aspects and investment policy are all statistically significant and explain the dividend decision taken for firms in India.

The effect of different factors on dividend policy has been summarised in Table III.

Cash from operations has a direct relation with the dividend pay-out. Similarly, the market cap, PAT and price also have a positive impact on the dividend. REE is negatively related to dividend. Since all factors considered above have a positive sign while generating the factor score and the combined impact of all factors is considered to be positively related to dividend pay-out ratio, hence the expected sign of the factor is positive. However, the observed sign is negative. But since the p value of this factor is very high it had become statistically insignificant and difficult to make a conclusion.

The second factor is ownership with the promotor holdings of positive correlation and institutional holdings of negative correlation. As promotor holding have a negative impact and institutional holding have positive impact which is opposite to the factor loading sign, the expected sign of this factor becomes negative. But the observed sign that is the beta value for this factor is positive. This means that this factor is not in sync with the previous studies and does not give the expected result.

The loadings of all the variables, namely are current ratio, debt to equity and dividend yield are positive in the third factor liquidity, leverage and dividends. Current ratio and divided yield are expected to have a positive impact and debt to equity ratio is expected to have a negative or a neutral impact on the dividend policy and hence the overall impact of this factor is expected to be positive. Also the observed impact of this factor is positive. This observation is in sync with the previous theories regarding the dividend policy.

RRE, EPS and pay-out ratio 2015 in the fourth factor returns to shareholders have negative, negative and positive correlations respectively. RRE and pay-out ratio are correlated to the factor and dividend pay-out ratio in the same way. Considering the majority impact of variables, the expected sign of this factor comes out to be positive. Also the observed sign of this factor is positive. Hence it is in conformity with the previous studies.

The fifth factor growth is with the maximum weighted variable as RONW i.e. return on net worth and dividend pay-out ratio of previous year. These factors has a positive impact on the dividend pay-out ratio. But since this factor is negatively considered to calculate the factor scores the expected sign of this factor becomes negative. The observed sign of this factor is also negative which agrees to the fact that RONW is positively related to dividend pay-out ratio.

The sixth factor is tax behaviour Tax/PAT, pay-out and age all as negative loadings. According to the existing literature these factors are considered to be positively related to dividend policies and hence the expected sign of this factor become negative. The observed sign of this factor is also negative which is relating to the previous studies.

The seventh factor is return on investments, higher the investment opportunities, lesser will be the cash available for dividends. Hence a negative relation exists between the two. Also the factor correlation for investments is also negative and hence a positive sign is expected for this factor. But a negative sign is observed. According to this observation, ROI and dividend pay-out ratio are positively correlated.

Concluding Observations

The present study has been undertaken with the objective of identifying the significant factors that determine the dividend policy for companies in India. At the outset, sixteen variables that effect the dividend policy were identified, which were taken based on prior works on the topic and based on our conceptual knowledge on the theoretical framework relating to dividends. On running factor analysis, these variables were reduced into 7 factors which had a significant bearing in deciding the dividend policy of the firm when considering dividend pay-out ratio as the main determinant of dividend policy. On comparing the signs of these factors with earlier literature on the subject it is seen that financial performance and size, ownership structure and investment policy are not found to be consistent with the existing literature, while other factors as liquidity, leverage and dividends, shareholders' returns, growth and tax behaviour were found to be consistent with the previous studies. Regression analysis indicate that stability of earnings, profitability, liquidity and ownership all have a bearing on the dividend policy. Though the factors that emerged as significant are mostly the traditional factors, this study gives us an insight into the dividend decision of BSE 500 companies which represent the bulk of market capitalisation.

The research adds to the existing literature by examining the determinants of dividend policy for BSE companies and thus show the trends observed for this finance decision for companies in an emerging market, like India.


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Descriptive Statistics for the Variables

Variable                     Observations     Minimum       Maximum

Current Ratio                     355          0.000        12.330
CFO                               355        -27280.800    44082.000
Market Cap                        355         859.550     427790.000
D/E                               355          -0.110       12.230
RRE                               355          0.376        351.843
Tax/PAT (%)                       355         -37.792       319.338
Total share of romoter (%)        355          0.000         0.901
Institution (%)                   355          0.007         0.894
PAT                               355          0.590       27417.000
ROI                               355          0.000       19861.000
RONW                              355         -14.040       110.170
EPS                               355          0.020        245.250
Div. Yield                        355          0.000        10.750
Pay-out 2015                      355         -88.730      11059.500
Pay-out 2014                      355        -77066.700    2806.400
Pay-out 2013                      355         -106.760      539.920
Size (Rs. lacs)                   355          30.760     458052.000
Age (in years)                    355          5.000        90.000

Variable                        Mean     Std. deviation

Current Ratio                  1.632          1.422
CFO                           979.688       5102.986
Market Cap                   24258.415      50986.934
D/E                            0.784          1.699
RRE                            46.692        47.813
Tax/PAT (%)                    35.650        28.526
Total share of romoter (%)     0.540          0.188
Institution (%)                0.269          0.160
PAT                           1154.593      2938.067
ROI                           111.224       1181.011
RONW                           17.872        14.488
EPS                            27.883        36.134
Div. Yield                     1.226          1.312
Pay-out 2015                   65.023        587.270
Pay-out 2014                  -178.537      4095.366
Pay-out 2013                   31.413        42.465
Size (Rs. lacs)              18236.926      47132.854
Age (in years)                 41.355        25.485

Summary for Factors Impacting Dividend Policy

       Factor          Variables            Sign

     Financial         CFO                  Positive
  Performance and      Market Cap           Positive
        Size           RRE                  Positive
                       PAT                  Positive
                       Size                 Positive
     Ownership         Total of Promoter    Positive
     structure         Institution          Negative
Liquidity, leverage    Current Ratio        Positive
   and Dividends       D/E                  Positive
                       Div. Yield           Positive
     Return to         RRE                  Negative
   Shareholders'       EPS                  Negative
                       Pay-out 2015         Positive
       Growth          RONW                 Negative
                       Pay-out 2015         Negative
   Tax behaviour       Tax/PAT (%)          Negative
                       Pay-out 2014         Negative
                       Age                  Negative
    Investments        ROI                  Negative

       Factor          Overall Expected Sign    Observed Sign

     Financial         Positive                 Negative
  Performance and

     Ownership         Negative                 Positive
Liquidity, leverage    Positive                 Positive
   and Dividends

     Return to         Positive                 Positive

       Growth          Negative                 Negative

   Tax behaviour       Negative                 Negative

    Investments        Positive                 Negative

Vandana Gupta

Associate Professor, FORE School of Management, New Delhi.
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