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Impact of Dividend Policy on Stock Price Risk:

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Pakistan

Article · March 2011

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Far East Journal of Psychology and Business Vol 4 No 1 July 2011

Impact of Dividend Policy on Stock Price Risk: Empirical Evidence from

Equity Market of Pakistan
Muhammad Asghar
International Islamic University Islamabad
Email: asghar224@hotmail.com

Syed Zulfiqar Ali Shah

Assistant Professor-Finance, Department of Business Administration, Faculty of Management
Sciences, International Islamic University Islamabad
Email: zulfiqar.shah@gmail.com
Kashif Hamid
Institute of Business Management Sciences, University of Agriculture Faisalabad
E.mail: kashifboparoy@hotmail.com
Contact: +923325038092
Muhammad Tahir Suleman
Department of Finance and Statistics
Hanken - Swedish School of Economics and Business Administration
PB. 287(Handelsesplanaden 2),Vaasa, Finland
Email: tahir_suleman@hotmail.com

Abstract

This study is conducted with the objective to find out impact of dividend policy on stock price
risk in Pakistan. The data of the study is taken from the published resources of State Bank of
Pakistan and Karachi Stock Exchange regarding to five important sectors for the period 2005-
2009. Descriptive statistics, correlation and regression models are used to perform the data
analysis. The results of the study reveals that the correlation of price volatility and dividend yield
is quite significant as compare to other variables. Moreover price volatility has negative
correlation to the growth in assets. It is also inferred from the study that all the Variables are
linked to the price Volatility; however, second model justifies the relational impact of some
variables on the price volatility.

Key word: Price volatility, dividend yield, KSE, Earning Volatility.

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1. INTRODUCTION
Presently issues regarding to the dividends decisions that may affect stock prices and return
patters have created the attention of the financial analysts and economists to establish
relationship between these parameters. Gordon (1962) developed a model to describe dividend
price ratio, the model is as under.

(1)

Gordon or dividend price ratio model is used to predict discount rate and growth of dividend.
Gordon narrated that high dividend would be less sensitive to discount rate and may depict lower
price volatility. Fama and French (1992) inferred that dividend and cash flow variables such as
earning, investment and industrial production may serve as indicator of stock returns.
Baskin(1989) had different approach and studied the impact of dividend policy on stock price
instead of stock returns. The variables considered in Baskin study were earning, size of the firm
and level of debt financing, payout ratio and level of growth. Gordon model was quite simple
and subject to limitation. Hence later on comprehensive approach was adopted by Campbell and
Shiller (1989) and other econometrists to describe the dividend price model. Similar study was
conducted in Pakistan by Nishat and Irfan (Unpublished ) in order to determine the impact of
dividend policy on stock price risks in Pakistan. The objectives of the study were to determine
role of dividend policy measures ( dividend yield and payout ratio) on share price changes in
long run and also to ascertain relationship during pre-reform (1981-1990) and reform (1991-
2000) periods. The reforms relating to dividend policy were tax sealing, bonus exemption from
tax, pattern shifting from cash to share dividends and making easy transfer of market profit by
the Government. The data was collected from Karachi stock exchange is important stock
exchange market and is also representative of the region. The variables involved in study were
Dividend yield, Price volatility Earning Volatility, Payout ratio , size were independent variables
and Price volatility is dependent variables .The results of the study indicates that dividend yield
and payout ratio both had impact on share price volatility. The dividend yield in relation to stock
price volatility was more responsive during reform period (1991-2000). The Size of firm has
also affected stock price volatility. It was negative during perform period (1981-1990) but
positive during reform period and overprices the impact was positive and significant. The
earning impact is negative during reform period. The results of their findings were similar to that
Baskin(1989) but different from Allen and Rochin (1996), Irfan and Nishat (2003) observed a
positive correlation between debt and price volatility but its influence is less than that of
dividend yield. Allen and Rachine (1996) sorted the relationship between dividend policy and
stock price risk. They observed that dividend yield was not related to stock price volatility and
earning dynamicity, But there was a negative correlation between size and stock price volatility,
as large companies incurs more liabilities. Size of firm is important variable that affect the
volatility of stock return. The stock price of small firms may be more unstable compare to large
firms, as small firms are less diversified than large firms. Moreover investor of small firms acts
more irrationally to new events. Hence size of firm may affect choice of dividend policy.

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Roll(1983) observed that abnormally large returns of small firms are obtained in last trading day
of December. Fama and French (1992) discovered that book to market equity was important as
high equity values are associated with high future returns. Miller and Roch (1985) model
described that dividends policy information about fund constraints and predict future expected
earnings. The Larger the change in dividend and profit, larger will be change in share price.
Akderiz et al.(2006) employed dividend discount model to test stock price volatility in Turkey
the result of the study testity the dividend discount model is quite valid and markets are efficient
and in certain instances stock price may be volatile to be explained by dividend discount model.
Although Nishat and Irfan (Unpublished) has pioneered investigations pertaining to dividend
policy and stock price volatility in Pakistan, yet this is start and lot is still to be done , hence
study will be conducted to develop dividend discount model to study its impact on stock price
volatility in Stock exchange in Pakistan.

2. Theoretical Consideration and Model Employed

Price volatility was dependent Variables while earning volatility, dividend yield, dividend payout
ratio and growth in assets were independent variables.

2.1 Price Volatility (PV)

Price Volatility may diversify for various firms; small firms may have different price volatility
then larger firms. Keeping this view the varied size firms are included in the study. The dividend
policy may affect price volatility, which in turn are affected by the market conditions, cost
structure and regulatory restrictions. Price volatility is derived by regression analysis as per
Parkinson’s (1980) value estimates by estimating variance of rate of return. Annual range of
stock prices is divided by average high and low stock prices. The variance for year 2005-2009 is
averaged and transformed to standard deviation. The analysts in Pakistan have taken into
consideration this methodology by preferring over the method of estimation that uses opening
and closing prices only.

2.2 Dividend Yield (DY).

Dividend yield is computed by taking the sum of annual cash dividends paid to stock holder’s and then
divided by the sum of average market value of stock in that year. The average of five years is taken into
account for this study.

2.3 Earning Volatility (EV)

Earning volatility is calculated as the ratio of operating earnings to total assets. The deviation from
average is computed and thereafter standard deviation is taken.

2.4 Dividend Payout Price Ratio (DP).

The dividend payout price ratio for the year 2005-2009 is calculated. This ratio is computed as
dividing the total dividends to the total earnings. The ratio is taken in relation to price
considerations.

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2.5 Growth in Assets (GA).

The ratio of change in total assets is taken and measured as averaged for year 2005-2009.
Hypothesis of the Study
On the basis of above discussed relations and variables we developed the following hypothesis,
H1: Earning Volatility has significant positive correlation and has direct effect on Price
Volatility.
H2: Dividend Yield has significant positive correlation and has direct effect on Price
Volatility.
H3: Dividend Payout Price Ratio has significant positive correlation and has direct effect on
Price Volatility.
H4: Growth in Assets has significant positive correlation and has direct effect on Price
Volatility.

3. DATA AND METHODLOGY

Model employed was regression model based on Baskin (1989) documentation; the description is
given in methodology section.
3.1 Methodology
The data was subject to regression model as under.
(2)

The PV is taken as dependent variable; While DY and DP are independent variables. The
limitation to above equation is that price volatility which is affected by other factors so hence
regression equation is modified as under

(3)

The summarized data is presented in tables and inference is drawn accordingly in results and
discussion section.
3.2 Data
Data is taken for Non- Financial Listed firms regarding to five sectors i.e., Chemical, Cement,
Sugar, Engineering and Synthetic & Fiber for the period 2005-2009. The data taken is relevant to
total assets, net profit, share prices, cash dividend and stock dividend from the published
resources of State Bank of Pakistan and Karachi Stock Exchange .

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Far East Journal of Psychology and Business Vol 4 No 1 July 2011

Results and Discussion

The descriptive statistics of variables is presented in table 1.

Table 1
Descriptive Statistics
Variable Mean Std. Dev.
PV 0.702635 0.58038
EV 0.083346 0.036395
DP 0.145866 0.187588
DY 0.307599 0.133601
GA 0.136167 0.196565
Where, PV: Price Volatility, EV: Earning Volatility, DP: Dividend Payout ratio, DY: Dividend Yield and GA:
Growth in Assets

The result of the Table 1 indicates that the mean value of price volatility (PV) is 0.70 with a 0.58
standard deviation, which means that it remained highly volatile during this session. Among the
independent variables the mean of earning volatility remained 0.08 with 0.036 standard
deviation, which indicates very little volatility. The dividend yield has 0.30 mean values and
0.133 standard deviation which indicate less volatility. While mean and standard deviation of
dividend payout remained 0.145 and 0.187 respectively. On the other hand the mean and
standard deviation of growth in assets is 0.136 and 0.196 respectively. Nishat and Irfan
(Unpublished), obtain a standard deviation of 0.15 and similar variation was observed in case of
other variables. This may be attributed to the time period change and gap from our study time
period of 2005-2009 and the study of Nishat and Irfan for the time period 1981-2000
investigation. Secondly Nishat and Irfan took all stock exchange companies list during 1981-
2000 period, while present study relate to five sectors only. The results of Nishat and Irfan
(Unpublished) are similar to Allen and Rachin (1996), while reverse may be true in present as
per reasons outlined in paragraph narrated above. The correlation results are presented in table 2.
Table 2
Correlation Matrix
PV EV DP DY GA
PV 1
EV 0.21 1
DP 0.37 -0.26 1
DY 0.51 0.45 0.43 1
GA -0.57 -0.37 -0.03 -0.29 1
Correlation is significant at the 0.01 level (2- Tailed)

The earnings volatility and the price volatility has 0.21 correlation which is significant at 0.05
level and ensures that H1 is acceptable regarding to the significant positive correlation. In the

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same way DP, DY are also positively correlated to PV and are significant at 0.01 level, hence
accepts the H2 and H3 with respect to positive correlation. The correlation in between GA and
PV is highly negative but significant at 0.01 levels but rejects the part of H4.

The results pertaining to relationship between share prices and dividend policy variable are
presented in table 3.

Table 3
Model 1
Variable Coefficient Beta T- Value Sig
Constant 0.039 0.298 0.132 0.897
DY 1.890 0.983 1.922 0.071
DP 0.561 0.700 0.802 0.43

R Square = .290 Adjusted R Square = .207

F = 3.474 Significance = 0.54
The R2 value is 0.29 which indicates that the independent variables explain 29% variation in the
dependent variable due to their effect. The coefficient of DY is 1.89 with 0.071 significance
value indicates that it has related effect on the price volatility with respect to model 1. Moreover
the coefficient of DP i.e., 0.561 with 0.43 values is insignificant in explaining the effectiveness
in this model. The results of present study are not compatible to the markets of developed
countries of US and Australia. The above variables are fit in the model for developed economies
but it is not true in some parameters regarding to the case in Pakistani equity market. Its only due
to the greater level of price volatility and subject to high fluctuations even in the same day, pre
noon and post noon period. Keeping the limitation of Karachi stock market in view, the data is
subject to extended regression model with inclusion of earning volatility and growth of assets,
in addition to DY and DP variables as presented in table 3.

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Table 4

Relationship between share prices and dividend policy, Earning Volatility and Growth in Assets

Model 2

Variables Coefficient Beta T-Value Sig

Constant 0.480 1.298 0.216
DY 1.307 0.301 1.142 0.217
DP 0.643 0.208 0.854 0.407
EV -0.870 -0.055 -0.214 0.834
GA -1.477 -0.500 -2.545 0.023

R Square = 0.507 Adjusted R Square = 0.376

F = 3.863 Significance = 0.024

The results indicate that the model is significant and have R-Square 50.7% which explains the
the price volatility with the given explained variables in the model 2. The growth of Assets has
negative relationship to the price volatility which is quite significant in the model. There is
interesting comparison between table 3 and 4. The coefficient PV, DY and DP are higher in table
3 in comparison to the table 4. This is logical that in table 3 only three variables are encountered
and table 4 entertains five variables for this study. The results are insignificant in respect to DY,
DP and EV except to GA. Growth of assets has negative effect on the price volatility. The
results of present study are different than Nishat and Irfan (Unpublished) investigation, as they
considered size of firm and long term debt in their investigation as independent variable. This is
logical as value of coefficients, significance in regression model depends on number of variables
involved, more accurate and efficient model will be and its applicability will be broader one as
well. In Nishat and Irfan (Unpublished) study two main variable dividend yield and payout ratio
were significant and explained the large portion of variance involved. Baskin (1989) also
narrated relationship between dividend yield and price volatility but in reverse direction.
However Allen and Rachin (1996) reported that payout ratio was important variable for

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Australian market. In present study price volatility and growth in assets are more related
compared to other variables.
Conclusion:
The results of present study considers the previous studies of Baskin (1989) Allen and Rakhim
(1996) and Nishat and Irfan (Unpublished) concluded that dependency of price volatility on
other variables is site specific but also depends on the structure of market. The stable and
efficient markets are easy to predict but the markets where high share price fluctuations exists
then it is difficult to design a model which can forecast the prices and returns in a more accurate
manner. One thing is very clear from the results of this study that some variables have their
impact on the price volatility. In present study price volatility and dividend yield have strong
positive correlation but price volatility is highly negatively correlated with growth in assets.
Growth in assets has impact on the price volatility for this time period. This is suggested that for
future study the data for the period should take into account more sectors with small and large
firm size to develop a comprehensive model that may predict the visual economic situation, price
volatility in prevalent market in its true prospective.
References

1] Akdeniz , L., Salih, Ok . S. T.2007. Are stock prices too volatile to be justified by the
dividend discount model. Science Direct. Physica A 376: 433-444.
2] Allen, D.E and Rachim, V.S.1996. Diviend Policy and stock price Volatility, Australian
evidence Applied Financial Economics.6:175-188.
3] Baskin, J. 1989. Dividend Policy and Volatility of common Stock, Journal of Portfolio
Management, 15 (3):19-25.
4] Campbell, J.Y and R.J Shiller 1989. The dividend price ratio and expectation of future
dividends and discount factors. Rev. Fin.Stud.1:195-228.
5] Fama and French. 1992, The cross-section of expected stock returns, The Journal of
Finance 47(4):427-465.
6] Gordon, M.J.1962. The investment financing and Valuation of corporation. Homewood.
Illinoise. Irwin
7] Irfan, C.M. and M.Nishat.2003, Key Fundamental factors and long run stock price
changes in an emerging market- A case study of Karachi stock exchange, Paper
presented at PSDE conference, Islamabad.
8] Miller, M. H and K. Rock. 1985. Dividend policy under asymmetric information. Journal
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Pakistan.
10] Roll, R. 1983 The turn of the year effect and return premium of small firms, Journal of
Portfolio Management.10:18-28

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