5

FACTORS AFFECTING DIVIDEND DECISION

Dividend is a widely researched arena but still its fathom has to be explored as numerous

questions remains unanswered. The question of Why do corporations pay dividends?

has puzzled researchers for many years. Despite the extensive research devoted to solve

the dividend puzzle, a complete understanding of the factors that influence dividend

policy and the manner in which these factors interact is yet to be established. Allen et al.

(2000)1 stated that:

Although a number of theories have been put forward in the literature

to explain their pervasive presence, dividends remain one of the

thorniest puzzles in corporate finance.

The dividend decision is taken after due considerations to number of factors like legal as

well as financial. This is so because one set of dividend policy cannot be evolved that can

be applied to all firms rather the dividend decision vary from firm to firm in light of the

firm specific considerations. Lintner (1956)2 suggested that dividend depends in part on

the firm's current earnings and in part on the dividend for the previous year. He found

that major changes in earnings with existing dividend rates were the most important

determinants of the firm's dividend policy. Ramcharran (2001)3 observed that:

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 dividend policy in the equity emerging markets from a corporate

finance perspective has not been empirically examined to

dateContinuing financial reforms in emerging markets, together with

the validity of more published data, will encourage further research on

other determinants of dividend policy, including the impact of agency

costs, information, and taxes as well as the capital structure of firms.

This suggested that much more research needed to be undertaken on dividend policy in

developing economies.

5.1 FACTORS AFFECTING DIVIDEND DECISION

Dividend decision, one of the important aspects of companys financial policy, is not an

independent decision. Rather, it is a decision that is taken after considering the various

related aspects and factors. There are various factors influencing a firm's dividend policy.

For example, some studies suggest that dividend policy plays an important role in

determining firm capital structure and agency costs. Many studies have provided

arguments that link agency costs with the other financial activities of a firm. Easterbrook

(1984)4 argued that firms pay out dividends in order to reduce agency costs. Dividend

payout keeps firms in the capital market, where monitoring of managers is available at

lower cost. If a firm has free cash flows, it is better to share them with shareholders in the

form of dividend in order to reduce the possibility of these funds being wasted on

unprofitable (negative net present value) projects (Jensen, 1986)5.

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Crutchley and Hansen (1989)6 examined the relationship between ownership, dividend

policy, and leverage and concluded that managers make financial policy tradeoffs to

control agency costs in an efficient manner. More recently, researchers have attempted to

establish the link between firm dividend policy and investment decisions. Smith and

Watts (1992)7 investigated the relations among executive compensation, corporate

financing, and dividend policies and concluded that a firm's dividend policy is affected

by its other corporate policy choices. Also, Jensen, Solberg and Zorn (1992)8 linked the

interaction between financial policies and insider ownership to informational

asymmetries between insiders and external investors. Despite this rich literature, most

prior work recognizes differences in determinants of financial decisions between different

firms.

5.1.1 Basic Factors Affecting Dividend Decision

Theoretically, over the past number of years, it has been believed by the academicians

that the dividend decision is influenced by number of factors. Some of the factors that

affect the dividend decision of a firm are listed as follows:

1. Legal Provisions: Indian Companies Act, 1956 has given the guidelines regarding

legal provisions as to dividends. Such guidelines are required to be followed by

the companies whenever the dividend policy is to be formulated. As per the

guidelines, a company is required to transfer a certain percentage of profits to

reserves in case the dividend to be paid is more than 10 percent. Further, a

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 company is also required to pay dividend only in cash but only with the exception

of bonus shares.

2. Magnitude of Earnings: Another important aspect of dividend policy is the

extent of companys earnings. It serves as the introductory point for framing the

dividend policy. This is so because a company can pay dividends either from the

current years profit or the past years profit. So, if the profits of a company

increase, it will directly influence the dividend declaration as the latter may also

increase. Thus, the dividend is directly linked with the availability of the earnings

with the company.

3. Desire of Shareholders: The decision to declare the dividends is taken by Board

of Directors but they are also required to consider the desire of the shareholders,

which depend on the latters economic condition. The shareholders, who are

economically weak, prefer regular dividend policy while the rich shareholders

may prefer capital gains as compared to dividends. However, it is very difficult

for the board to reconcile the conflicting interests of different shareholders yet the

dividend policy has to be framed keeping in view the interest of all the interested

parties.

4. Nature of Industry: The nature of industry in which a company is operating,

influences the dividend decision. Like the industries with stable demand

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 throughout the year are in a position to have stable earnings, thus, should have the

stable dividend policy and vice-versa.

5. Age of the Company: A companys age also determine the quantum of profits to

be declared as dividends. A new company should restrict itself to lower dividend

payment due to saving funds for the expansion and growth as compared to the

already existing companies who can pay more dividends. Grullon et al. (2002)9

suggested that as firms mature, they experience a contraction in their growth

which results in a decline in their capital expenditures. Consequently, these firms

have more free cash flow to pay as dividends. Similarly, Brav et al. (2005)10

suggested that more mature firms are more likely to pay dividends. In contrast,

younger firms need to build up reserves to finance the future growth

opportunities, thus, making them to retain the earnings.

6. Taxation Policy: The tax policy of a country also influences the dividend policy

of a company. The rate of tax directly influences the amount of profits available

to the company for declaring dividends.

7. Control Factor: Yet another factor determining dividend policy is the threat to

loose control. If a company declares high rate of dividend, then there is the

possibility that a company may face liquidity crunch for which it has to issue new

shares, resulting in dilution of control. Keeping this threat in view, a company

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 may go for lower level of dividend payments and more ploughing back of profits

in order to avoid any such threat.

8. Liquidity Position: A companys liquidity position also determines the level of

dividend. If a company does not have sufficient cash resources to make dividend

payment, then it may go for issue of bonus shares.

9. Future Requirements: A company while faming dividend policy should also

consider its future plans. If it foresees some profitable investment opportunities in

near future then it may go for lower dividend and vice-versa.

10. Agency Costs: The separation of ownership and control results in agency

problems. Agency costs can be reduced by distributing dividends (Rozeff, 198211,

Easterbrook, 198412, Jensen et al., 199213). In this stratum, dividends are paid out

to stockholders in order to prevent managers from building unnecessary empires

to be used in their own interest. In addition, dividends reduce the size of internally

generated funds available to managers, forcing them to go to the capital market to

obtain external funds (Easterbrook, 198414). As explained in Rozeff (1982)15,

firms with a larger percentage of outside equity holdings are subject to higher

agency costs. The more widely spread is the ownership structure, the more acute

the free rider problem and the greater the need for outside monitoring. Hence,

these firms should pay more dividends to control the impact of widespread

ownership.

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 11. Business Risk: Business risk is a potential factor that may affect dividend policy.

High levels of business risk make the relationship between current and expected

future profitability less certain. Consequently, it is expected that firms with higher

levels of business risk will have lower dividend payments. Many researchers

argued that the uncertainty of a firms earnings may lead it to pay lower dividends

because volatile earnings materially increase the risk of default. In addition, field

studies using survey data (e.g., Lintner, 195616) reported compelling evidence that

risk can affect dividend policy. In these surveys, managers explicitly cited risk as

a factor that influences their dividend choice.

5.1.2 Financial Factors Affecting Dividend Decision

The above mentioned factors are not limited and many more can be there that affect the

determination of dividend. Keeping in view the above-mentioned factors and the review

of literature, some variable has been identified within the arena of the theoretical factors.

Those variables include both the dependent and independent variables. However, their

interpretation depends upon their measurement. The present study covers the following

set of variables:

1. DPS to Face Value: This ratio evaluates the relationship between dividend per

share and face value of the share. It is calculated as:

Dividend Yield ratio= Dividend per share/Face value per share

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2. DPS to Market Value (Yield ratio): This ratio evaluates the relationship between

dividend per share and market value of the share. It is calculated as:

Dividend Yield ratio= Dividend per share/Market value per share

3. Dividend Payout Ratio: It indicates the extent to which the earnings per share

have been retained by a company. It enables the company to plough back the

profits which will result in more profits in future and hence, more dividends. It is

calculated as:

Dividend Pay-Out Ratio= Dividend per equity share/Earnings per

share

The higher the ratio, lower is the dividend payment and vice-versa.

4. Current Ratio: It is a measure of firms liquidity and is basically used for

measuring the short-term financial position or liquidity of the firm. It indicates the

ability of the firm to meet its current liabilities. It is calculated as:

Current Ratio= Current assets/Current liabilities

A high ratio indicates that firms liquidity position is good and it has the ability to

honor its obligations while a low ratio implies that firms liquidity position is not

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 so good so as to honor all its obligations. However, a ratio of 2:1 is considered

satisfactory. The expected relation between current ratio and dividend payment is

positive.

5. Net Profit Ratio: This ratio establishes the relation between net profits and sales

and indicates the managements efficiency. It is calculated as:

Net Profit ratio= (Net Profit/Net sales)*100

As dividends are declared from the net profits of a firm, so higher the net profit

ratio, higher will be the expected dividend payment.

6. Net Profit to Net worth: This ratio indicates the relation between net profits earned

by a company and the net worth which is represented by shareholders capital. It

is composed of equity share capital, preference share capital, free reserves and

surpluses, if any. It is also referred to as return on investment and is calculated as:

Return on shareholders investment= Net Profit/Net Worth

This ratio is an indication of companys ability to earn profits. If the earning

capacity of the company is more, more dividend payment can be expected and

vice-versa.

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7. Debt Equity Ratio: This ratio measures the claims of outsiders and owners

against the firms assets. It indicates the relation between outsider funds and

shareholders funds. It is calculated as:

Debt-equity ratio= Outsiders funds/Shareholders funds

This ratio tells the solvency position of the firm. Higher the ratio, better will be

the solvency as well as the ability of firm to pay dividends. The vice-versa will

hold true in case of low ratio.

8. Lagged Profits: The dividend is not only influenced by the past years dividend but

also by the past years profits. This is so because a company can follow the stable

dividend policy if it has sufficient current years profit or the past years profit.

9. Behavior of Share Prices: The prevailing share prices also influence the

dividend payment by a company. If the share prices of a company are

unfavorable, then it may increase the dividend in order to boost up the share

prices. It can be calculated as:

Behavior of share prices= Higher share price - Lower share price

Higher share price + Lower share price

10. Growth in Earnings: If the earnings of a company increase, then the chances of

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 increase in dividend payment are also there. Growth is must for the survival of a

company. This ratio can be calculated as:

Growth in Earnings= EPSt- EPSt-1 / EPSt-1

Where, EPSt= Current earnings per share

EPSt-1= Previous earnings per share

12. Growth in Working Capital: This ratio indicates increase in the working capital

of a company.

Growth in Working Capital= WCt- WCt-1 / WCt-1

Where, WCt= Current working capital

WCt-1= Previous working capital

Higher ratio indicates the increase in the capacity of a company to pay dividends

but this is interrelated with other factors also. Like, if a company has increase the

working capital to match the increased level of operations, then this ratio will not

be useful in studying the impact on the dividend payments.

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14. Lagged Dividends: A company may consider the past years dividend as a

benchmark. If a company prefers stability of dividend payments, it may consider

the past years dividend rate and can act accordingly.

15. Tobins Q: This variable represents the investment opportunities for a company.

It is measured as

(MV of equity-BV of equity +Total Assets)/Total Assets

16. Investment Opportunity Set (Market to Book Value): It represents the

availability of investment opportunities to the company and generally is believed

to have negative relationship with dividend payout.

17. Free Cash Flow: This variable is used to measure the availability of cash with the

company. It is calculated as

(Cash flow from Operations-Cash flow from investment activities)/Total assets

18. Cash Holdings: It is another financial variable to analyse the liquidity position of

the firm. It is calculated as

(Cash + Short-term investment)/Total assets

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19. Uncertainty in Earnings: It refers to the variation in the earnings from one year

to another. Some companies might witness irregular earnings and thus, may not

have stable dividend policy. Uncertainty in earnings can be measured as

= (x2/N)

A small value of standard deviation means high degree of uniformity in the

earnings and vice-versa.

20. Solvency Ratio: This ratio is a small variant of equity ratio. It indicates the

relationship between total liabilities to outsiders to total assets of a firm. It can be

calculated as:

Solvency ratio= Total Liabilities to Outsiders/Total Assets

21. Return on Net worth: This ratio is also termed as return on investment. This ratio

indicates the relationship between net profits (after interest and tax) and the

shareholders funds. It can be calculated as

Net profit (after interest and taxes)/Shareholders funds

22. Return on Capital Employed: This ratio establishes the relationship between

profits and capital employed. It can be calculated as

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 (Adjusted Net Profits/Gross Capital Employed)*100

or

(Adjusted Net Profits/Net Capital employed)*100

5.2 DATA ANALYSIS AND INTERPRETATIONS

In the present chapter, the Principal Component Analysis approach has been used in order

to obtain a set of variables pertaining to dividends. The major emphasis was in deriving

the exclusive cluster of the aforesaid group of variables for each of the four industrial

groups: Engineering, FMCG, Information Technology and Textiles; and for the combined

group of all the four industries separately for the years 2007and 2008.

For the same purpose, the following financial variables have been used: DPS to Face

Value, DPS to Market Value, Payout Ratio, Lagged Dividend, Lagged Profits, Current

Ratio, Solvency Ratio, Debt-Equity Ratio, Free Cash Flow, Cash Holdings, Share Price

Behavior, Growth in EPS, Growth in Working Capital, Return on Capital Employed,

Return on Net worth, Age of the Company, Net Profit to Net worth, Net Profit ratio,

Market to Book value, Tobins Q and Uncertainty in EPS. The analysis has been made

carried out with the help of Factor Analysis. The following steps were followed in order

to extract the factors.

The principal component analysis using VARIMAX rotation of twenty one variables

pertaining to Engineering, FMCG, IT and Textiles industrial sector has led to the

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extraction of numerous factors. After a meaningful set of variables have been obtained,

the next task is to group the variables under particular factor and label them in order to

assign some meaning to the factor loadings. Variables with higher loadings are

considered more important and have greater influence on the label selected to represent

the factor. For this purpose, the sampling adequacy tests have been conducted to know

that whether the sample is adequate or not. KMO recommends accepting value greater

than .5 as barely acceptable (value below this leads either to collect more data or to

rethink which variable should be included or excluded). And Bartlett recommends the

accepting value less than .05. Bartletts test finds that the correlations, when taken

collectively are significant at .0001 level whereas measure of sampling adequacy looks at

the patterns between the variables.

Derivation of the factors is based on the perusal of correlation matrix results in retaining

only those components that fulfill the same criteria. The decision to choose the factor

loadings has been based on the criteria of sample size (factor loading between .3-.4 if the

sample ranges between 150 and 350). Since the sample size for the current study is 172,

so only the loadings above .30 have been considered for the study. For obtaining the

rotated factor matrix, Orthogonal rotation method viz. VARIMAX rotation has been used

which shows factor loadings for each variable onto each factor. In this matrix, only the

main factors have been displayed which are reliable & whose value is more than .3 and

the rest have been eliminated. After identifying the significant factor loadings, next step

is to study the communalities of the variables, representing the amount of variance

accounted for by the factor solution for each variable. It is generally assumed that

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variable with communalities> .50 should be retained for the study. In the present analysis,

no variable could be found having communality <.50. Hence, finally, the structure of the

factors for the variables has been well-defined and the significant factors have been

selected and grouped together for labeling.

5.2.1) FACTOR ANALYSIS RESULTS FOR INDIVIDUAL INDUSTRIAL

SECTORS FOR THE YEAR 2007

A) Engineering Industry

For the Engineering industrial sector, the overall MSA value falls in the acceptable range

(above .50) with a value of .656 for KMO and .000 for Bartletts test (less than .5), these

measures indicate that the set of variables are appropriate for factor analysis.

Table 5.1: KMO and Bartlett's Test for Engineering Industry

Kaiser-Meyer-Olkin Measure of Sampling Adequacy .656
Approx. Chi-Square 1069.090
Bartlett's Test of Sphericity df 210
Sig. .000

Factor analysis has yielded eight factors for Engineering Industry which represented

82.815% of the variance, of 21 variables deemed sufficient in terms of total variance

explained (solution should account for >60% variance). Table 5.2 summarises the

orthogonal solution resulting from VARIMAX rotation of the original twenty one

measures for Engineering industrial sector for the year 2007.

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 Table 5.2: Factor Analysis for Factors Affecting Dividend in Engineering Industry

for the Year 2007

Factors Factor Eigen Value Percentage of Variance Cumulative

Loadings Explained Variance
Profitability and
5.150 21.110 21.110
Investment Set
Net Profit Ratio .864
Return on Net worth .961
Return on Capital .871
Employed
Market to Book Value .650
Free Cash flow .549
Net Profit to Net worth .956
Ratio
Dividend Rate 3.781 17.862 38.972
Dividend Per Share .952
Dividend Per Share to .876
Market Value
Dividend Per Share to .930
Face value
Dividend Payout .948
Financial Soundness 2.307 12.460 51.431
Current Ratio .828
Debt Equity Ratio .725
Cash Holding .713
Solvency Ratio .858
Liquidity 1.524 7.555 58.986
Growth in Working .785
Capital
Companys Age 1.306 6.678 65.664
Age .892
Earnings and Share
1.215 6.275 71.939
Price Behavior
Share Price Behavior .694
Profit After Tax .569
Growth in EPS .512
Investment Opportunity 1.098 5.521 77.460
Tobins Q .893
Risk and Uncertainty 1.009 5.355 82.815
EPS Uncertainty .814

The factor 1 variables: Net Profit Ratio, Return on Net worth, Return on Capital

Employed, Market to Book Value, Free Cash Flow and Net profit to Net worth

ratio are interpreted under the construct Profitability and Investment Set. Factor 2 was

named as Dividend Rate and includes the variables Dividend per Share, Dividend

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Per share to Market Value, Dividend per share to Face Value and Dividend Payout.

Factor 3 was named as Financial Soundness and includes variables Current Ratio,

Debt Equity, Cash Holding and Solvency Ratio. Factor 4 was named as Liquidity

and includes variables Growth in Working Capital. Factor 5 was named as Companys

Age and includes variables Age. Factor 6 was named as Earnings and Share Price

Behavior and includes variables Share Price Behavior, Profit after Tax and Growth

in Earnings per Share. Factor 7 was named as Investment Opportunity and includes

variables Tobins Q. Factor 8 was named as Risk and Uncertainty and includes

variables Earnings per Share Uncertainty.

B) FMCG Industry

For the FMCG industrial sector, the overall MSA value falls in the acceptable range

(above .50) with a value of .504 for KMO and .000 for Bartletts test (less than .5), these

measures indicate that the set of variables are appropriate for factor analysis.

Table 5.3: KMO and Bartlett's Test for FMCG Industry

Kaiser-Meyer-Olkin Measure of Sampling Adequacy .504
Approx. Chi-Square 517.791
Bartlett's Test of Sphericity df 210
Sig. .000

Factor analysis has yielded seven factors for FMCG sector which represented 75.5% of

the variance, of 21 variables deemed sufficient in terms of total variance explained

(solution should account for >60% variance). Table 5.4 summarises the orthogonal

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solution resulting from VARIMAX rotation of the original twenty one measures for

FMCG industrial sector for the year 2007.

Table 5.4: Factor Analysis for Factors Affecting Dividend in FMCG Industry for

the Year 2007

Factors Factor Eigen Value Percentage of Variance Cumulative

Loadings Explained Variance
Profitability and
5.336 22.481 22.481
Investment Set
Net Profit Ratio .538
Return on Net worth .944
Return on Capital .955
Employed
Market to Book Value .797
Free Cash flow .688
Net Profit to Net worth .939
Ratio
Dividend Rate 2.732 11.211 33.691
Dividend Per Share .551
Dividend Per Share to .536
Market Value
Dividend Per Share to Face .911
value
Dividend Payout .544
Financial Soundness 2.182 11.182 44.874
EPS Uncertainty .855
Age .611
Debt-Equity Ratio .735
Profit After tax .710
Growth in Working Capital .527
Solvency Ratio .718
Investment Opportunity 1.690 8.291 53.164
Tobins Q .905
Liquidity 1.548 8.089 61.253
Current Ratio .542
Cash Holdings .836
Growth Rate 1.267 7.375 68.628
Growth in EPS .822
Share Price Movement 1.099 6.872 75.500
Share Price Behavior .525

The factor 1 variables: Net Profit Ratio, Return on Net worth, Return on Capital

Employed, Market to Book Value, Free Cash Flow and Net profit to Net worth

Ratio are interpreted under the construct Profitability and Investment Set. Factor 2

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was named as Dividend Rate and includes the variables Dividend per Share,

Dividend Per share to Market Value, Dividend per share to Face Value and

Dividend Payout. Factor 3 was named as Financial Soundness and includes variables

EPS Uncertainty, Age, Debt Equity, Profit after Tax, Growth in Working

Capital and Solvency Ratio. Factor 4 was named as Investment Opportunity and

includes variable Tobins Q. Factor 5 was named as Liquidity and includes variables

Current Ratio and Cash Holdings. Factor 6 was named as Growth Rate and

includes variables Growth in EPS. Factor 7 was named as Share Price Movement and

includes variables Share Price Behavior.

C) IT Industry

For the IT industrial sector, the overall MSA value falls in the acceptable range (above

.50) with a value of .554 for KMO and .000 for Bartletts test (less than .5), these

measures indicate that the set of variables are appropriate for factor analysis.

Table 5.5: KMO and Bartlett's Test for IT Industry

Kaiser-Meyer-Olkin Measure of Sampling Adequacy .554
Approx. Chi-Square 632.765
Bartlett's Test of Sphericity df 210
Sig. .000

Factor analysis has yielded seven factors for IT sector which represented 80.392% of the

variance, of 21 variables deemed sufficient in terms of total variance explained (solution

should account for >60% variance). Table 5.6 summarises the orthogonal solution

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resulting from VARIMAX rotation of the original twenty one measures for IT industrial

sector for the year 2007.

Table 5.6: Factor Analysis for Factors Affecting Dividend in IT Industry for the

Year 2007

Factors Factor Eigen Value Percentage of Cumulative

Loadings Variance Explained Variance
Profitability Position 5.475 22.637 22.637
Net Profit Ratio .940
Return on Net worth .629
Return on Capital Employed .670
Free Cash Flow .846
Net Profit to Net worth Ratio .650
Growth in Working Capital .778
Dividend Rate 3.274 11.999 34.636
Dividend Per Share .494
Dividend Per Share to Market .419
Value
Dividend Per Share to Face .852
value
Dividend Payout .418
Financial Soundness 2.365 11.179 45.815
Current Ratio .836
Cash Holding .746
Debt Equity .873
Solvency Ratio .593
Companys Age 1.984 10.036 55.851
Age .764
Investment Opportunity 1.571 9.853 65.704
Market Value to Book Value .846
Tobins Q .891
Share Prices and
1.169 7.415 73.119
Uncertainty
EPS Uncertainty .505
Share Price Behavior .720
Earnings and Growth Rate 1.044 7.273 80.392
Profit After Tax .864
Growth in EPS .898

The factor 1 variables: Net Profit Ratio, Return on Net worth, Return on Capital

Employed, Market to Book Value, Free Cash Flow , Net profit to Net worth ratio

and Growth in Working Capital are interpreted under the construct Profitability

Position. Factor 2 was named as Dividend Rate and includes the variables Dividend

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per Share, Dividend Per share to Market Value, Dividend per share to Face Value

and Dividend Payout. Factor 3 was named as Financial Soundness and includes

variables Current Ratio, Cash Holding, Debt Equity and Solvency Ratio. Factor

4 was named as Companys Age and includes variables Age. Factor 5 was named as

Investment Opportunity and includes variables Market Value to Book Value and

Tobins Q. Factor 6 was named as Share Prices and Uncertainty and includes

variables EPS Uncertainty and Share Price Behavior. Factor 7 was named as

Earnings and Growth Rate and includes variables Profit after Tax and Growth in

Earnings per Share.

D) Textile Industry

For the Textiles industrial sector, the overall MSA value falls in the acceptable range

(above .50) with a value of .546 for KMO and .000 for Bartletts test (less than .5), these

measures indicate that the set of variables are appropriate for factor analysis.

Table 5.7: KMO and Bartlett's Test for Textiles Industry

Kaiser-Meyer-Olkin Measure of Sampling Adequacy .546
Approx. Chi-Square 655.154
Bartlett's Test of Sphericity df 210
Sig. .000

Factor analysis has yielded seven factors for Textiles sector which represented 86.306%

of the variance, of 21 variables deemed sufficient in terms of total variance explained

(solution should account for >60% variance). Table 5.8 summarises the orthogonal

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solution resulting from VARIMAX rotation of the original twenty one measures for

Textiles industrial sector for the year 2007.

Table 5.8: Factor Analysis for Factors Affecting Dividend in Textiles Industry for

the Year 2007

Factors Factor Eigen Value Percentage of Cumulative

Loadings Variance Explained Variance
Profitability Position 5.109 23.449 23.449
Return on Net worth .928
Return on Capital Employed .851
Net Profit to Net worth Ratio .905
Profit After Tax .880
Growth in EPS .666
Financial Soundness 4.103 16.11 39.559
Growth in Working Capital .820
Net Profit Ratio .947
Cash Holdings .826
Solvency ratio .958
Investment and Risk 3.096 13.427 52.986
EPS Uncertainty .886
Tobins Q .762
Market Value to Book value .943
Dividend Rate 2.220 11.953 64.938
Dividend Per Share .890
DPS to Market Value .811
DPS to Face Value .713
Dividend Payout .780
Capital Structure and Share
1.317 8.000 72.938
Price Behavior
Debt Equity .743
Share Price Behavior .754
Companys Age 1.262 7.114 80.052
Age .798
Liquidity Position 1.110 6.254 86.306
Current Ratio .732
Free Cash Flow .581

The factor 1 variables Return on Net worth, Return on Capital Employed, Net Profit

to Net worth, Market to Book Value, Profit after Tax and Growth in Earnings per

Share are interpreted under the construct Profitability Position. Factor 2 was named as

Financial Soundness and includes the variables Growth in Working Capital, Net

190
profit Ratio, Cash Holdings and Solvency Ratio. Factor 3 was named as Investment

and Risk and includes variables EPS Uncertainty, Tobins Q and Market Value to

Book Value. Factor 4 was named as Dividend Rate and includes variables Dividend

per Share, Dividend to Market Value, Dividend to Face Value and Dividend

Payout. Factor 5 was named as Capital Structure and Share Price Behavior and

includes variables Debt Equity Ratio and Share Price Behavior. Factor 6 was named

as Companys Age and includes variables Age. Factor 7 was named as Liquidity

Position and includes the variables Current Ratio and Free Cash Flow.

5.2.2) FACTOR ANALYSIS RESULTS FOR GROUPED DATA FOR THE YEAR

2007

The sampling adequacy tests have been conducted to know that whether the sample is

adequate or not. For the grouped data, the overall MSA value falls in the acceptable range

(above .50) with a value of .648 for KMO and .000 for Bartletts test (less than .5), these

measures indicate that the set of variables are appropriate for factor analysis.

Table 5.9: KMO and Bartlett's Test for Grouped Data

Kaiser-Meyer-Olkin Measure of Sampling Adequacy .648
Approx. Chi-Square 1982.956
Bartlett's Test of Sphericity df 210
Sig. .000

Factor Analysis has resulted in retaining seven factors for the grouped data which

retained represented 68.771% of the variance, of 21 variables deemed sufficient in terms

of total variance explained (solution should account for >60% variance). Table 5.10

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summarises the orthogonal solution resulting from VARIMAX rotation of the original

twenty one measures for the grouped data for the year 2007.

Table 5.10: Factor Analysis for Factors Affecting Dividend for Grouped Data for

the Year 2007

Factors Factor Eigen Value Percentage of Cumulative

Loadings Variance Explained Variance
Profitability and Investment Set 4.037 17.519 17.519
Return on Net worth .956
Return on Capital Employed .887
Market Value to Book Value .644
Net Profit to Net worth Ratio .946
Profit After Tax .356
Dividend Rate 3.018 13.740 31.259
Dividend Per Share .902
Dividend per Share to Market
.735
Value
Dividend per Share to Face Value .735
Dividend Payout .916
Financial Soundness 2.403 9.365 40.624
Net Profit Ratio .917
Current Ratio .730
Cash Holdings .622
Free Cash Flow .553
Solvency Ratio .926
Share Price Movement 1.465 8.229 48.853
Share Price Behavior .728
Capital Structure and Investment
1.343 6.790 55.642
Opportunity
Debt-Equity Ratio .569
Tobins Q .709
Growth Rate 1.126 6.616 62.259
Growth in EPS .829
Growth in Working Capital .414
Companys Age and Uncertainty 1.049 6.512 68.771
EPS Uncertainty .614
Age .769

The factor 1 variables Return on Net worth, Return on Capital Employed, Market to

Book Value, Net Profit to Net worth and Profit after Tax are interpreted under the

construct Profitability and Investment Set. Factor 2 was named as Dividend Rate and

includes variables Dividend per Share, Dividend to Market Value, Dividend to Face

192
Value and Dividend Payout. Factor 3 was named as Financial Soundness and

includes the variables Net profit Ratio, Current Ratio, Cash Holdings, Free Cash

Flow and Solvency Ratio. Factor 4 was named as Share Price Movement and

includes variables Share Price Behavior. Factor 5 was named as Capital Structure

and Investment Opportunity and includes variables Debt-Equity Ratio and Tobins

Q. Factor 6 was named as Growth Rate and includes the variables Growth Rate in

EPS and Growth Rate in Working Capital. Factor 7 was named as Companys Age

and Uncertainty and includes the variables EPS Uncertainty and Age.

5.2.3) FACTOR ANALYSIS RESULTS FOR INDIVIDUAL INDUSTRIAL

SECTORS FOR THE YEAR 2008

A) Engineering Industry

For the Engineering industrial sector, the overall MSA value falls in the acceptable range

(above .50) with a value of .671 for KMO and .000 for Bartletts test (less than .5), these

measures indicate that the set of variables are appropriate for factor analysis.

Table 5.11: KMO and Bartlett's Test for Engineering Industry

Kaiser-Meyer-Olkin Measure of Sampling Adequacy .671
Approx. Chi-Square 770.271
Bartlett's Test of Sphericity df 210
Sig. .000

Factor analysis has yielded six factors for Engineering sector which represented 68.679%

of the variance, of 21 variables deemed sufficient in terms of total variance explained

(solution should account for >60% variance). Table 5.12 summarises the orthogonal

193
solution resulting from VARIMAX rotation of the original twenty one measures for the

Engineering sector for the year 2008.

Table 5.12: Factor Analysis for Factors Affecting Dividend in Engineering Industry

for the Year 2008

Factors Factor Eigen Value Percentage of Variance Cumulative

Loadings Explained Variance
Profitability Position 5.209 18.222 18.222
Net Profit Ratio .876
Return on Net worth .873
Return on Capital .785
Employed
Free Cash flow .649
Net Profit to Net worth .907
Ratio
Financial Soundness 3.163 14.316 32.538
Current Ratio .885
Debt Equity Ratio .613
Cash Holding .854
Growth in Working .582
Capital
Solvency Ratio .910
Dividend Rate 1.982 11.825 44.363
Dividend Per Share .818
Dividend Per Share to .768
Market Value
Dividend Per Share to .734
Face value
Dividend Payout .462
Companys Age and
1.696 10.312 54.675
Profitability
Age .623
Profit After Tax .488
Investment Opportunity 1.259 8.427 63.102
Market Value to Book .776
Value
Tobins Q
Earnings and Share
1.114 5.578 68.679
Price Behavior
Share Price Behavior .489
Growth in EPS .467

The factor 1 variables: Net Profit Ratio, Return on Net worth, Return on Capital

Employed, Free Cash Flow and Net profit to Net worth ratio are interpreted under

194
the construct Profitability Position. Factor 2 was named as Financial Soundness and

includes variables Current Ratio, Debt Equity, Cash Holding, Growth in Working

Capital and Solvency Ratio. Factor 3 was named as Dividend Rate and includes the

variables Dividend per Share, Dividend Per share to Market Value, Dividend per

share to Face Value and Dividend Payout. Factor 4 was named as Companys Age

and Profitability and includes variables Age and Profit after Tax. Factor 5 was

named as Investment Opportunity and includes variable Market Value to Book Value

and Tobins Q. Factor 6 was named as Earnings and Share Price Behavior and

includes variables Share Price Behavior, and Growth in Earnings per Share.

B) FMCG Industry

For the FMCG industrial sector, the overall MSA value falls in the acceptable range

(above .50) with a value of .556 for KMO and .000 for Bartletts test (less than .5), these

measures indicate that the set of variables are appropriate for factor analysis.

Table 5.13: KMO and Bartlett's Test for FMCG Industry

Kaiser-Meyer-Olkin Measure of Sampling Adequacy .556
Approx. Chi-Square 514.505
Bartlett's Test of Sphericity df 210
Sig. .000

Factor analysis has yielded eight factors for FMCG sector which represented 80.717% of

the variance, of 21 variables deemed sufficient in terms of total variance explained

(solution should account for >60% variance). Table 5.14 summarises the orthogonal

195
solution resulting from VARIMAX rotation of the original twenty one measures for the

FMCG sector for the year 2008.

Table 5.14: Factor Analysis for Factors Affecting Dividend in FMCG Industry for

the Year 2008

Factors Factor Eigen Value Percentage of Cumulative

Loadings Variance Explained Variance
Profitability and Investment
4.723 20.505 20.505
Opportunity
Net Profit Ratio .612
Return on Net worth .947
Return on Capital Employed .950
Market to Book Value .763
Net Profit to Net worth Ratio .951
Capital Structure and Risk 2.830 10.531 31.036
Debt-Equity Ratio .839
Solvency Ratio .771
Liquidity 2.319 10.069 41.105
Current Ratio .710
Cash Holding .758
Growth in Working Capital .850
Dividend Rate 2.027 9.757 50.862
Dividend Per Share .594
Dividend Per Share to Market .698
Value
Dividend Per Share to Face .911
value
Dividend Payout .907
Earnings and Uncertainty 1.539 9.205 60.067
EPS Uncertainty .830
Profit After tax .789
Companys Age and Risk 1.355 8.439 68.506
Age .513
Tobins Q .908
Financial Soundness 1.109 6.262 74.768
Free Cash Flow .448
Growth in EPS .862
Share Price Movement 1.048 5.949 80.717
Share Price Behavior .552

The factor 1 variables: Net Profit Ratio, Return on Net worth, Return on Capital

Employed, Market to Book Value and Net profit to Net worth Ratio are interpreted

under the construct Profitability and Investment Opportunity. Factor 2 was named as

196
Capital Structure and Risk and includes the variables Debt-Equity Ratio, Solvency

Ratio, Dividend per share to Face Value and Dividend Payout. Factor 3 was named

as Liquidity and includes variables Current Ratio, Cash Holdings and Growth in

Working Capital. Factor 4 was named as Dividend Rate and includes the variables

Dividend per Share, Dividend Per share to Market Value, Dividend per share to

Face Value and Dividend Payout. Factor 5 was named as Earnings and Uncertainty

and includes variables EPS Uncertainty and Profit after Tax. Factor 6 was named as

Companys Age and Risk and includes variables Age and Tobins Q. Factor 7 was

named as Financial Soundness and includes variables Free Cash Flow and Growth

in EPS. Factor 8 was named as Share Price Movement and includes variables Share

Price Behavior.

C) IT Industry

For the IT industrial sector, the overall MSA value falls in the acceptable range (above

.50) with a value of .616 for KMO and .000 for Bartletts test (less than .5), these

measures indicate that the set of variables are appropriate for factor analysis.

Table 5.15: KMO and Bartlett's Test for IT Industry

Kaiser-Meyer-Olkin Measure of Sampling Adequacy .616
Approx. Chi-Square 535.094
Bartlett's Test of Sphericity df 210
Sig. .000

Factor analysis has yielded seven factors for IT sector which represented 75.881% of the

variance in IT sector, of 21 variables deemed sufficient in terms of total variance

197
explained (solution should account for >60% variance). Table 5.16 summarises the

orthogonal solution resulting from VARIMAX rotation of the original twenty one

measures for the IT sector for the year 2008.

Table 5.16: Factor Analysis for Factors Affecting Dividend in IT Industry for the
Year 2008

Factors Factor Eigen Value Percentage of Cumulative

Loadings Variance Explained Variance
Profitability Position 5.249 19.166 19.166
Net Profit Ratio .954
Return on Net worth .912
Return on Capital Employed .729
Free Cash Flow .581
Net Profit to Net worth Ratio .901
Dividend Rate 2.945 11.166 30.332
Dividend Per Share .735
Dividend Per Share to Market .897
Value
Dividend Per Share to Face value .821
Dividend Payout .637
Liquidity 2.135 10.485 40.817
Cash Holding .921
Financial Soundness 1.857 10.456 51.273
Current Ratio .879
Growth in Working Capital .559
Solvency Ratio .518
Leverage and Risk 1.354 9.760 61.033
EPS Uncertainty .921
Debt Equity .572
Earnings and Investment
1.264 8.010 69.043
Opportunity
Tobins Q .730
Market Value to Book Value .610
Growth in EPS .799
Share Prices and Profits 1.131 6.839 75.881
Share Price Behavior .685
Profit After Tax .778

The factor 1 variables: Net Profit Ratio, Return on Net worth, Return on Capital

Employed, Free Cash Flow and Net profit to Net worth Ratio are interpreted under

the construct Profitability Position. Factor 2 was named as Dividend Rate and

includes the variables Dividend per Share, Dividend Per share to Market Value,

198
Dividend per share to Face Value and Dividend Payout. Factor 3 was named as

Liquidity and includes variable Cash Holding. Factor 4 was named as Financial

Soundness and includes variables Current Ratio, Growth in Working Capital and

Solvency Ratio. Factor 5 was named as Leverage and Uncertainty and includes

variables Debt-Equity Ratio and EPS Uncertainty. Factor 6 was named as Earnings

and Investment Opportunity and includes variables Tobins Q, Market Value to Book

Value and Growth in Earnings per Share. Factor 7 was named as Share Prices and

Profits and includes variables Share Price Behavior and Profit after Tax.

D) Textile Industry

For the Textile industrial sector, the overall MSA value falls in the acceptable range

(above .50) with a value of .512 for KMO and .000 for Bartletts test (less than .5), these

measures indicate that the set of variables are appropriate for factor analysis.

Table 5.17: KMO and Bartlett's Test for Textile Industry

Kaiser-Meyer-Olkin Measure of Sampling Adequacy .512
Approx. Chi-Square 499.187
Bartlett's Test of Sphericity df 210
Sig. .000

Factor analysis has yielded seven factors for Textile sector which represented 68

84.604% of the variance, of 21 variables deemed sufficient in terms of total variance

explained (solution should account for >60% variance). Table 5.18 summarises the

orthogonal solution resulting from VARIMAX rotation of the original twenty one

measures for the Textile sector for the year 2008.

199
 Table 5.18: Factor Analysis for Factors Affecting Dividend in Textiles Industry for

the Year 2008

Factors Factor Eigen Value Percentage of Cumulative

Loadings Variance Explained Variance
Companys Age and Profitability
6.305 26.809 26.809
Position
Net Profit Ratio .956
Return on Net worth .932
Return on Capital Employed .756
Age .810
Net Profit to Net worth Ratio .923
Profit After Tax .911
Financial Soundness 3.289 13.759 40.568
Current Ratio .807
Debt-Equity Ratio .622
Solvency Ratio .882
Dividend Rate 2.346 13.525 54.094
Dividend Per Share .926
DPS to Market Value .590
DPS to Face Value .919
Dividend Payout .593
Liquidity Growth 2.052 8.176 62.269
Growth in Working Capital .854
Earnings and Uncertainty 1.664 8.007 70.276
EPS Uncertainty .809
Growth in EPS .627
Liquidity Position 1.067 7.563 77.838
Cash Holding .645
Free Cash Flow .830
Investment Opportunity and Share
1.044 6.766 84.604
Price Movement
Share Price Behavior .908
Market Value to Book Value .651
Tobins Q .535

The factor 1 variables Net Profit Ratio, Return on Net worth, Return on Capital

Employed, Age, Net Profit to Net worth and Profit after Tax are interpreted under

the construct Companys Age and Profitability Position. Factor 2 was named as

Financial Soundness and includes the variables Current ratio, Debt-Equity Ratio,

and Solvency Ratio. Factor 3 was named as Dividend Rate and includes variables

Dividend per Share, Dividend to Market Value, Dividend to Face Value and

200
Dividend Payout. Factor 4 was named as Liquidity Growth and includes variable

Growth in Working Capital. Factor 5 was named as Earnings and Uncertainty and

includes variables EPS Uncertainty and Growth in EPS. Factor 6 was named as

Liquidity Position and includes the variables Cash Position and Free Cash Flow.

Factor 7 was named as Investment Opportunity and Share Price Movement and

includes the variables Share Price Behavior, Market Value to Book Value and

Tobins Q.

5.2.4) FACTOR ANALYSIS RESULTS FOR GROUPED DATA FOR THE YEAR

2008

The principal component analysis using VARIMAX rotation of twenty one variables

pertaining to the grouped data for the four industrial sectors viz. Engineering, FMCG, IT

and Textiles, has led to the extraction of numerous factors. The tests of sampling

adequacy have been conducted to know that whether the sample is adequate or not. For

the grouped data, the overall MSA value falls in the acceptable range (above .50) with a

value of .703 for KMO and .000 for Bartletts test (less than .5), these measures indicate

that the set of variables are appropriate for factor analysis.

Table 5.19: KMO and Bartlett's Test for Grouped Data

Kaiser-Meyer-Olkin Measure of Sampling Adequacy .703
Approx. Chi-Square 1458.408
Bartlett's Test of Sphericity df 210
Sig. .000

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Factor Analysis has resulted in retaining seven factors for the grouped data which

represented 64.072% of the variance, of 21 variables deemed sufficient in terms of total

variance explained (solution should account for >60% variance). Table 5.20 summarises

the orthogonal solution resulting from VARIMAX rotation of the original twenty one

measures for the grouped data for the year 2008.

Table 5.20: Factor Analysis for Factors Affecting Dividend for Grouped Data for

the Year 2008

Factors Factor Eigen Value Percentage of Cumulative

Loadings Variance Explained Variance
Profitability Position 4.487 18.251 18.251
Net Profit Ratio .656
Return on Net worth .899
Return on Capital Employed .823
Net Profit to Net worth Ratio .909
Financial Soundness 2.465 11.515 29.765
Current Ratio .850
Debt-Equity Ratio .487
Cash Holding .791
Solvency Ratio .808
Dividend Rate and EPS 1.855 9.948 39.713
EPS Uncertainty .689
Dividend Per Share .694
Dividend per Share to Market
.790
Value
Dividend per Share to Face Value .546
Dividend Payout .623
Investment Opportunity 1.428 6.758 46.471
Market Value to Book Value .557
Tobins Q .724
Liquidity 1.147 6.555 53.025
Free Cash Flow .558
Growth in Working Capital .321
Share Price Movement 1.057 5.645 58.670
Share Price Behavior .750
Growth in EPS .795
Companys Age and Profitability 1.017 5.401 64.072
Age .511
Profit After Tax .733

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The factor 1 variables Return on Net worth, Return on Capital Employed, Net Profit

to Net worth and Profit after Tax are interpreted under the construct Profitability

Position. Factor 2 was named as Financial Soundness and includes the variables Net

profit Ratio, Current Ratio, Debt-Equity Ratio, Cash Holdings and Solvency

Ratio. Factor 3 was named as Dividend Rate and EPS and includes variables EPS

Uncertainty, Dividend per Share, Dividend to Market Value, Dividend to Face

Value and Dividend Payout. Factor 5 was named as Investment Opportunity and

includes variables Market Value to Book Value and Tobins Q. Factor 5 was named

as Liquidity and includes the variables Free Cash Flow and Growth Rate in

Working Capital. Factor 6 was named as Share Price Movement and includes

variables Share Price Behavior. Factor 7 was named as Companys Age and

Profitability and includes the variables Age and Profit after Tax.

5.3 MAIN FINDINGS

The results of the study presented above show that the determinants of dividend

identified in the literature apply equally to Indian industries under study. More

importantly, the results are an important first step in consolidating our understanding of

the factors affecting dividend decision of industries in India in general. The

Profitability factor is related to the extent of profits that accrue to the industry in order

to take a decision on declaration of dividend. Further, it also influences the opportunities

for future investments. The Dividend Rate factor is related to the dividend declared by

the companies. The determinants in this group include the dividend per share, dividend

payout, and relationship of dividend with market value and face value of shares. The

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Financial Soundness factor is related with the creditworthiness of the industries which

is influenced by solvency position and cash position. Further Liquidity factors are also

one of the major factors affecting dividend in terms of free cash holdings and current

ratio. An important factor Share Price Movement also influences the dividend decision

in terms of the relationship of dividend with behavior of the share prices. Further,

Investment Opportunity factor also has emerged as an important factor presenting the

trade-off between the dividend declaration and the future investment opportunities set.

The key implication of these findings is that the Indian industries decision of dividend is

influenced by these factors.

REFERENCES

1 Allen, F., Bernardo, A. and Welch, I., 2000, A Theory Of Dividends Based On Tax
Clienteles, Journal of Finance, Vol. 55, pp. 2499-2536
2 Lintner, J., 1956, Distribution of Income of Corporation among Dividends Retained
Earning and Taxes, American Economic Review, Vol. 46, pp. 97-133
3 Ramcharran, H., 2001, An Empirical Model of Dividend Policy in Emerging
Equity Markets, Emerging Markets Quarterly, Vol. 5, pp. 39-49
4 Easterbrook, F.H., 1984, Two Agency-Cost Explanations of Dividends, American
Economic Review, Vol. 74, Issue-4, pp. 650-659
5 Jensen, M., 1986, Agency Costs of Free Cash Flow, Corporate Finance, and
Takeovers, American Economic Review, Vol. 76, pp. 323-329
6 Crutchley, C. E. and Hansen, R., 1989, A Test of Agency Theory of Managerial
Ownership, Corporate Leverage, and Corporate Dividends, Financial Management,
Vol. 18, No. 4
7 Smith, C. W., and Watts, R., "The Investment Opportunity Set and Corporate
Financing, Dividend, and Compensation," Journal of Financial Economics, Vol. 32,

204
 pp. 263-292
8 Jensen, G., Donald, R., Solberg, P., and Zorn, T. S., 1992, Simultaneous
Determination of Insider Ownership, Debt and Dividend Policies, Journal of
Financial and Quantitative Analysis, Vol. 27, Issue-2, pp. 247-263
9 Grullon, G., Michaely, R. and Bhaskaran S., 2002, Are Dividend Changes a Sign of
Firm Maturity? Journal of Business, Vol. 75, Issue-3, pp. 387-424
10 Brav, A., Graham, J., Harvey, C. and R. Michaely, 2005, Payout Policy in the 21st
Century, Journal of Financial Economics, Vol. 77, pp. 483-527
11 Rozeff, M.S., 1982, Growth, Beta And Agency Costs As Determinants Of
Dividend Payout Ratios, Journal of Financial Research, Vol. 5, Issue-3, pp. 249-
259
12 Easterbrook, F.H., 1984, op.cit.
13 Jensen, G., Donald R., Solberg, P., and Zorn, T. S., 1992, op.cit.
14 Easterbrook, F.H., 1984, op.cit.
15 Rozeff, M.S., 1982, op.cit.
16 Lintner, J., 1956, op.cit.

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