Article

Determinants of Dividend Policy Paradigm

20(1) 36–55
of Indian Companies: © 2016 IMT
SAGE Publications
A Panel Data Analysis sagepub.in/home.nav
DOI: 10.1177/0971890716637698
http://par.sagepub.com

Nishant B. Labhane1
Jitendra Mahakud2

Abstract
This article analyzes the trends and the determinants of the dividend policy of Indian companies that
were continuously paying dividend during the whole period study that is from 1994–1995 to 2012–
2013. We have used the static panel data models to carry out this analysis. From the trend analysis we
find that larger, more profitable, more mature and highly liquid firms have higher dividend payout ratio,
whereas the firms with high investment opportunity, financial leverage and business risk have lower
dividend payout ratio. The findings from the panel data analysis suggest that investment opportunity,
financial leverage, size of the company, business risk, firm life cycle, profitability, tax and liquidity are the
major determinants of the dividend policy for Indian companies. These results were robust across the
period also. The findings are consistent with the pecking order, transaction cost, signalling and firm
life cycle theories of the dividend policy.

Keywords
Dividends, dividend policy, dividend payout ratio, dividend yield, dividend policy theory

Introduction
The studies on the dividend policy have attempted to answer two questions: (a) Does the dividend policy
affect the value of the firm? and (b) What are the factors that determine the dividend policy? Among the
early studies on this issue, Linter (1956) argues that firms target their desired payout ratio, and it is
determined by the current earnings and past dividends of the companies. Considering certain unrealistic
assumptions like (a) there is no tax, (b) there is no agency cost, (c) there is no asymmetric information,
(d) there is no transaction costs and so on. Miller and Modigliani (1961) are of the opinion that the

1
Senior Research Scholar, Department of Humanities and Social Sciences, IIT Kharagpur, West Bengal, India.
2
Associate Professor of Economics and Finance, Department of Humanities and Social Sciences, IIT Kharagpur, West Bengal,
India.

Corresponding author:
Jitendra Mahakud, Associate Professor of Economics and Finance, Department of Humanities and Social Sciences, IIT Kharagpur
721302, West Bengal, India.
E-mail: [email protected]
Labhane and Mahakud 37

dividend policy is irrelevant in measuring the value of the firm or shareholder’s wealth in a perfect
market. Over the years relaxing all these unrealistic assumptions taken by Miller and Modigliani, a large
amount of research has been carried out on firms’ dividend policy. This research has led to number of
competing theories such as tax clientele theory, signalling theory, agency theory, firm life cycle theory
and so on to explain the dividend payout ratio of the companies.
The tax clientele theory states that investors in low tax bracket prefer the high dividend paying stock,
and investors in high tax bracket prefer low dividend paying stocks (Litzenberger & Ramaswamy, 1979).
The other argument related to tax is that if the dividend tax is more than the capital gain tax then
investors do not prefer dividends (Elton & Gruber, 1970). The advocators of signalling theory argue that
the payment of dividend convey private information about current and future earnings and it can be used
to minimise the information asymmetry between the insider and outsider, therefore, the dividend policy
does affect the value of the firm (Aharony & Swary, 1980; Bhattacharya, 1979). The agency cost theory
views that dividend payments would reduce the extra discretionary power of the managers and thus
reduce the agency problem arising between the shareholders and managers (Jensen & Meckling, 1976;
Easterbrook, 1984: Rozeff, 1982).Therefore, a positive relationship can be expected between dividend
payout ratio and the value of the firm. The life cycle theory of dividends argues that more mature firms
have higher accumulated profits, retained earnings and less growth opportunities as compared to young
firms; so, more mature firms are likely to pay higher dividends than younger firms (DeAngelo, DeAngelo,
& Stulz, 2006). Baker and Wurgler (2004) provide behavioural explanation for dividend payment
decision known as ‘Catering theory of dividends’, which suggests that managers cater rationally to
investor demand for dividends by paying dividends when investors prefer dividend-paying firms and by
not paying dividends when investors prefer non dividend-paying companies.
However, there has been no consensus on any particular theoretical explanations of the dividend
policy after several decades of research. In this context, Black (1976) has said, ‘The harder we look at
the dividend picture, the more it seems like a puzzle, with pieces that just don’t fit together.’ Therefore,
the research on the dividend policy has been increasing by manifolds to explain the conflicting issues
like: Why companies pay dividends? Moreover, what are the factors that determine the payment policy
of the companies? The empirical studies on the determinants of dividend policy are basically based on
the various theoretical explanations given in the different competing theories. However, the results
widely vary across the countries and the time periods. Therefore, time to time the empirical examination
of factors affecting the dividend policy has been warranted. Other argument is that most of the studies
have tried to explain the determinants of the dividend policy in the context of specific theories of payout
policy, but there is a lack of studies in an integrated theoretical framework where all the theoretical
relationship between the a priori factors affecting the dividend payout ratio and payout proxies have been
discussed in a comprehensive manner. The studies carried out during the period 1960–1990 have mainly
focused on the tax-clientele, agency cost and the free cash flow hypothesis, and asymmetric information
and signalling theory of dividends. However, the firm life-cycle theory of dividends is quite new and the
empirical evidence on this theory is limited.
With reference to India most of the studies have tried to determine the factors affecting the probability
of payments of dividends considering the agency theory, tax clientele theory and signalling theory. But
the studies have not considered other factors that are derived from other theories of the dividend policy
and also not given focus on the factors which affect the dividend payout ratio of continuously dividend
paying companies across the years. It is also observed that during the period of liberalization, the average
payout ratio of the companies has increased for the companies, which are continuously paying dividends.
Most of the previous studies have examined the impact of dividend distribution tax rates on the dividend
policy during the period 1960–1990. However, the dividend distribution tax rates have changed in recent
38 Paradigm 20(1)

years as per the decision taken by the government in Union Budget and the analysis of the impact of such
changed dividend distribution tax rates on the dividend policy in the post-liberalization period is not
examined in Indian context. Particularly, this study has also certain relevance in the context of India as
the new economic policy since 1991 has led to the listing of many new firms in the stock exchanges.
These new firm are in the initial stage having more investment opportunity and less profit. The
liberalization policy has also changed the shareholding pattern of the firms due to the availability of
many alternative sources of finance in the capital market.
Keeping all these things in the mind, the broad objective of this study is to analyze the trends and the
determinants of the dividend policy of National Stock Exchange (NSE)-listed Indian companies during
the period of liberalization, that is from 1994–1995 to 2012–2013. This article uses a firm level panel
dataset of 240 NSE-listed companies that are continuously paying dividends for the entire period of
study and fixed effect model estimation has been used to determine the factors affecting the dividend
payout ratio.
The rest of the article is organized as follows. Next section reviews the empirical literature on factors
affecting the dividend policy. The third section highlights the methodology used in this study. The fourth
section discusses the measures and a priori determinants of dividend policy. The fifth section describes
the data and period of study. The section before the last section analyzes the trends in the dividend payout
ratio. The last section discusses the empirical results and gives the conclusion.

Review of Literature
Among the early studies on the determinants of the dividend payout ratio, Lintner (1956) finds earnings
as the major determinant of dividend payment decision and every company has a target payout ratio and
it always adjusts its payout ratio to reach that target. Brittain (1966) suggests that cash flow has a positive
and the variables like depreciation allowance, interest payment and change in sales have a negative impact
on dividend payout ratio. Higgins (1972) finds a significant inverse relationship between the financial
leverage and the dividend payout ratio statistically. Higgins (1981) further explores that the rapidly growing
companies have high working capital requirements that may exceed the incremental cash flow from the
net sales and these companies may go for the procurement of external finance from capital market, and
thus, have lower dividend payout ratio. Firm size is positively and a growth opportunity for the firm is
negatively associated with the dividend yield and regulation has no impact on dividend payout ratio
(Smith & Watts, 1992). Gaver and Gaver (1993) examine the dividend policy of 237 growth and 237
non-growth firms to find the relation between the investment opportunity set and financing, dividend and
compensation policies. They find that the growth firms have lower financial leverage and lower dividend
yield than the non-growth firms. Also, the growth companies pay high cash compensation to their
executive and have high frequency of stock option plan than the non-growth firms.
Yoon and Starks (1995) find that dividend announcement do not reveal new information about the
managers’ investment policies, and following the dividend change dividend increases (decreases) are
correlated with consequent increases (decreases) in capital expenditures over the three years. Further,
the dividend change announcements are related to revisions in analysts’ forecasts of current earnings.
Benartzi, Michaely and Thaler (1997) find that although there is a strong past and concurrent association
between dividend changes and earnings, this study did not find any evidence in support of the view that
dividends changes have information content about future earnings changes. Fama and French (2001)
have studied the dividend policy of NYSE, AMEX and NASDAQ firms using the Center for Research
in Securities Prices (CRSP) and Compustat during the period from 1926 to 1999, and found that size,
Labhane and Mahakud 39

profitability and investment opportunity as the three fundamental factors that affect the dividend payment
decision. They also concluded that the dividend-paying companies are larger, more profitable and have
high investment opportunity than the non-dividend paying companies.
DeAngelo, DeAngelo and Skinner (2004) observe that the aggregate real dividends increased over the
period of study with fewer US firms paying more dividends than before. They argue that the simultaneous
increase in aggregate dividends and a decrease in the number of dividend-paying firms led to the
concentration in the supply of dividends. Using data from CRSP Grullon et al. (2005) find that dividend
changes contain no information about future earnings changes once they control for the non-linear
pattern in earnings behavior. Furthermore, they find that dividend changes are negatively associated with
future changes in profitability (return on assets). Amidu and Abor (2006) examine the factor affecting the
dividend payout ratio of firms enlisted on Ghana Stock Exchange during the period 1998–2002. The
results suggest that the more profitable firms and high liquid firms tend to pay high dividends and the
firms experiencing high earnings volatility that is risk, high growth and investment opportunity and high
institutional shareholding pattern tend to pay low or no dividend.
Analysing the dividend policies in six developed financial markets that is United States, Canada,
United Kingdom, Germany, France, and Japan for the period 1989–2002, Denis and Osobov (2008) find
that the propensity to pay dividends is higher among larger, more profitable firms and more mature firms
for which the retained earnings constitute larger proportion of total equity. However, the relationship of
dividends and growth opportunities is less robust. The results found by Al-Ajmi and Hussain (2011)
reveal that more profitable firms, firms larger in size, firms that paid dividends last year and more mature
firms with few investment opportunities pay high amount of dividends, and agency costs are not the key
factors affecting the dividend payment decision in the case of Saudi-listed companies. Mollah (2011)
found that financial leverage and firm’s size as the two major factors affecting the dividend payout policy
of companies in Bangladesh. Using the Generalized Method of Moments technique Patra, Poshakwale
and Ow-Yong (2012) find that the firm size, profitability and liquidity affect the dividend payment
decision positively, whereas the investment opportunities, financial leverage and business risk have
inverse relationship with the dividend payment decision for the companies listed on Athen Stock
Exchange (ASE). The empirical results are broadly consistent with the signalling, pecking order and
agency cost theories associated with the corporate dividend policy.
In the context of India, Kevin (1992) finds profitability and earnings as key determinants of the
dividend policy and Indian firms strive to achieve stable dividend payment for the period September
1983–September 1984. Mahapatra and Sahu (1993) have found that cash flows, current earnings and
past dividend as the primary factors affecting the dividends policy but the findings are not consistent
with the Lintner (1956) model. Bhat and Pandey (1994) finds that the current year’s profits, expected
future profits, past dividends and change in an equity for a firm have the impact on the dividend payment
decision. Narasimhan and Asha (1997) studied the impact of dividend distribution tax on the dividend
policy of firms and found that investors demand more dividends when government imposes a uniform
tax rate of 10 per cent on dividends against a 20 per cent tax on the capital gains during the union budget
of 1997–1998. Mohanty (1999) examines the dividend and bonus policies of 200 companies for the
period of 15 years and find that most of the companies do not maintain constant payout ratio and maintain
(or at least do not reduce) dividend rates after the bonus issue. He also observed that the returns of bonus-
issuing companies have been higher than non-bonus issuing companies during the sub-period 1982–
1991, while the result has been opposite during the sub-period 1992–1996.
Mahakud (2005) finds a direct relationship of past year’s dividend, profits, sales and size of the firm
with that of dividends. The debt to equity ratio and the institutional ownership has negative impact on
the dividend payment decisions. Kumar (2006) has investigated the relationship between corporate
40 Paradigm 20(1)

governance and dividend policy for Indian companies for the period 1994–2000 and found that investment
opportunity, earnings, corporate and directors’ ownership have significant positive impact and debt-to-
equity ratio and institutional ownership have significant negative impact on payout ratio. He found no
evidence in support of any relationship between dividend policy and foreign ownership.
Cash flow, beta of the firm and profit are the major determinants of payout ratio of Indian IT companies
(Kanwal & Kapoor, 2008a, 2008b). Saravanakumar (2011) has examined the factor affecting the dividend
policy of top 50 firms in terms of size enlisted on NSE for the period 2004–2005 and 2008–2009 and
finds that the dividend rates increases when there is growth in sales, net profits, improvement in liquidity
position and reserves. On the other hand, the dividend rates decrease when there is a decline in net
profits, sales and liquidity position is weak and reserves are scarce. Analyzing the behaviour of corporate
dividend payout ratio of the Indian manufacturing companies during the period of post-liberalization that
is from 1998–1999 to 2007–2008 Sur and Majumdar (2012) have found that higher liquid firms have
lower dividend payout ratio that is inconsistent with the theoretical argument and current earnings after
tax, post earnings after tax, cash flow and pattern of past dividends fail to have any substantial impact on
the dividend payout ratio of the firms under study.
Considering all the available literature on dividend policy we find that market-to-book ratio, debt-to-
capital ratio, free cash flow, asset tangibility, business risk, firm maturity, size, profitability, taxes and
liquidity factors are the major determinants of dividend policy and the role of these factors varies across
the time period, countries and industries.

Methodology
The previous studies have used the probabilistic models like logit/probit model in their study to answer
the question that in a given year why some firms are paying dividends and others are not. However, the
basic objective of our study is to identify the factors which determine the dividend payout ratio for
those companies, which are continuously paying dividends across the whole period. In other words,
we try to examine the factors which determine the level of payment of the dividends. Therefore, as the
dependent variable in our study is not binary in nature we have not used the logit/probit model for the
estimation of dividend payout ratio determination equation. Some of the previous studies which
focussed on this issue have used cross-sectional analysis. As pointed by Hsiao (1986) panel data
analysis has certain advantage because it incorporates the role of unobservable firm-specific and time-
specific factors with other quantifiable factors on determination of dependent variable. Considering
this advantage of panel data analysis over the cross-sectional analysis we have used the panel data
models for our study.
In the panel data model, the unobserved effects can be accommodated using one of the two
techniques. First, the unobservable effects can be included in the error term. The variance–covariance
matrix of the resulting non-spherical errors must be transformed to obtain consistent estimates of
standard errors. In this case, the ‘random effect’ estimator is appropriate (Hsiao, 1986). However, a
problem arises with the random effect estimator if the unobservable effects, which have been included
in the error term, are correlated with some or all of the repressors. As an alternative to the random effect
estimator, a dummy variable can be included for each firm. This estimation approach is known as ‘fixed
effect approach’. If we use the dummy variable for the firms only, then that model is called ‘one-way
fixed effect model’ and if we take dummy variables for both firm and time, then the model is called
‘two-way fixed effect model’.
Labhane and Mahakud 41

Assuming a linear relationship between dividend payout policy and its determinants the panel data
models can be specified as follows:

Yit = a + bXit + eit (Pooled Model) (1)

Yit = ai + bXit + eit (One way Fixed Effects Model) (2)

Yit = a + bXit + (eit + mi) (One way Random Effects Model) (3)

Yit = ai + gt + bXit + eit (Two-way Fixed Effects Model) (4)

Yit = a + bXit + (eit + mi + gt) (Two-way Random Effects Model) (5)

where Yit is dividend policy proxies, Xit is determinants of dividend policy, b is coefficients, ai is the
unobserved individual effect, gt is the time effect, mi is the individual-specific error term, and eit is the
combined time series and cross-section error term.
The statistical test like the F-test, restricted F-test, Breusch–Pagan’s Lagrange Multiplier (LM) test
and Hausman test have been used to find out a suitable model for estimating the dividend policy
determination equation. The Lagrange Multiplier (LM) test (Breusch and Pagan, 1980) has been carried
out to find the robustness of static panel data model over the classical pooled effect model. We have
carried out the Hausman test to identify a suitable panel data models that is fixed effect model or random
effect models. The F-test reports the fitness of the model and the restricted F-test suggests if there is any
individual effect in the data or not.

Measures and Determinants of Dividend Policy

Measures of Dividend Policy

Following the literature, we have used two measures of dividend policy such as dividend yield and
dividend payout ratio. The dividend yield is defined as the annual dividend paid per share divided by the
market price per share (DYLD) and dividend payout ratio is measured as the ratio of total annual dividend
paid to the profit after tax (DPR).

Determinants of Dividend Payout Ratio

Investment Opportunity (INVT: Companies having high investment opportunities require more money
to finance their future investments, so that they pay fewer dividends and make more investments to
maximize their expected return (Myers & Majluf, 1984). Therefore, an inverse relationship can be
expected between investment opportunity of the company and dividend policy. We have used market-to-
book ratio as a proxy for the investment opportunity, which is calculated as the market value of equity
divided by the book value of equity.
Leverage Ratio (LEV): The transaction cost theory states that the firms having higher proportion of
debt finance in total capital will have higher level of commitment to pay the fixed interest charges and
42 Paradigm 20(1)

this will reduce the dividend payment to common equity shareholders (Al-Malkawi, 2008; Fama, 1974;
Higgins, 1972). Therefore, companies having high financial leverage pay fewer dividends. We have used
long-term debt to capital ratio as a proxy for the leverage ratio and hypothesised an inverse relationship
between the leverage ratio and dividend payout ratio.
Free Cash Flow (FCF): According to agency cost theory the agency problem arises between the
principal owner (shareholders) and agent (manager) when the manager takes the action for their self-
interest without considering the benefits shareholders. The excess amount of free cash flow available to
the manager increases the agency cost as they are free to use that financial reserves for their self-interest.
In this regard, the payment of dividend to the shareholders reduces the free cash flow available to
managers and also the agency problem between them (Easterbrook, 1984; Jensen & Meckling, 1976;
Rozeff, 1982). Therefore, a positive relationship can be expected between the free cash flow available
for the company and the dividend payout ratio. The free cash flow is measured as the ratio of the net
operating cash flow to the total assets.
Tangibility of asset (TANG): The agency problem may also arise between the bondholders and
shareholders. The higher proportion of tangible or collateralizable assets ensures higher level of
protection for the bondholders thereby reducing the agency problem arising due to the conflicts between
the bondholders and shareholders. The tangibility of asset has been measured as the net fixed assets
divided by total assets, and a positive relationship has been hypothesised between tangibility and the
dividend payout ratio.
Business risk (BR): The signalling theory suggests information asymmetry always exists between
the insider (managers) and outsiders (shareholders) as the inside managers have private information
about the firm’s current condition and future prospects which are not known to the outsiders. The
managers can convey this private information to the shareholders in the form of dividend (Bhattacharya,
1979). Thus, dividend acts as a signalling device and managers can receive incentives for communicating
the private information to the outsiders. Business risk is used as a proxy for the uncertainty in the firm’s
current and future earnings, and it is measured as the standard deviation of first difference of operating
income divided by total assets and we hypothesize a negative relationship between the business risk and
dividend payout ratio.
Life Cycle (LC): The life cycle theory proposed by Mueller (1972) states that each firm has a well-
defined life cycle, and the payment of dividends varies across the different cycle of the firm. The mature
firms have fewer investment opportunities, more accumulated profits and retained earnings which cause
them to pay more dividends and in contrast to this, younger firms have new growth opportunities and
need to build reserves of profit to finance its growth opportunities that result in less dividend payment.
The present study uses the ratio of retained earnings to total equity as a proxy for a firm’s maturity and
it is expected a positive association of life cycle variable with dividend payout ratio.
Firm Size (SIZE): The larger firms have higher proportion of institutional shareholdings, and,
therefore, they have easy access to capital market, which lead them to pay higher amount of dividend.
Another argument is that the larger the size of the firm more it would be difficult to monitor the firm,
which increases the agency problem between the managers and the shareholders. Therefore, larger firms
need to pay more dividends in order to reduce the agency problem. Considering these arguments, we
hypothesise a positive relationship between size of the firm, which is measured as the natural log of the
market capitalisation of the company and the dividend payout ratio.
Profitability (PROF): Lintner (1956) found that the critical factor affecting the dividend decision of
a firm is the net earnings. In another study, Fama and French (2001) found that the larger and more
profitable firms pay more dividends as compared to smaller and fewer profitable firms as the dividends
are paid from the profit after tax. Therefore, we expect a positive relation between the profitability,
Labhane and Mahakud 43

which has been proxied by return on assets and dividend payout ratio. The return on assets is measured
as the ratio between earnings before interest and taxes and the total assets.
Dividend Distribution Tax (DDT): According to tax preference theory, investor want the firms to
retain the profit instead of distributing it in the form of dividend because the dividends are taxed higher
as compared to the long-term capital gains. Therefore, companies should keep its payout ratio as low as
possible to maximize their value. In a country like India the higher dividend distribution tax rate increases
the burden of tax payments for a firm and reduces the after-tax profit thereby reducing the profit available
for dividend payments (Damodaran, 2000; Kamat & Kamat, 2013; Panda & Lall, 1993). In the line of
this argument, we expect a negative relationship between dividend distribution tax rate that is measured
as the ratio of dividend distribution tax payments to the profit after tax and dividend payout ratio.
Liquidity (LIQ): It may happen that a firm can have enough profits to declare the dividends but
not sufficient cash in hand to pay the dividends. The payment of dividend means outflow of cash for
a company. Thus, it is expected that the dividend decision of the firm is affected by the liquidity
position of firm. Higher liquid company can pay higher dividend due to the excess amount of cash.
The current ratio is used to measure the liquidity position of a company, and it is defined as the ratio
of current assets to current liabilities and we expect a positive relation between the current ratio and
dividend payout ratio.
Table 1 summarizes the the determinants of payout ratio and their expected relationship with dividend
payments.
Following the theories mentioned above, the model has been specified as follows:

Yit = a + b1INVTit + b2 LEVit + b3 FCFit + b4TANGit + b5BRit + b6LCit

+ b7SIZEit + b8PROFit + b9DDTit + b10LIQit + eit (6)

Table 1. Determinants of Dividend Policy

Expected
Relation with
Variable Measure Dividends
Investment Opportunity (INVT) calculated as the market value of equity divided by the book –
value of equity
Leverage Ratio (LEV) calculated as the total debt divided total capital employed –
Free Cash Flow (FCF) measured as the net operating cash flow scaled by total assets +
Tangibility of asset (TANG) measured as the net fixed assets divided by total assets +
Business risk (BR) measured as the standard deviation of first difference of –
operating income divided by total assets
Life Cycle (LC) measured as the ratio of retained earnings to total equity +
Firm Size (SIZE) measured as the natural log of market capitalization +
Profitability (ROA) defined as the earnings before interest and taxes divided by +
the total assets
Dividend Distribution Tax (DDT) dividend distribution tax divided by net profit after tax –
Liquidity (LIQ) defined as the ratio of current assets to current liabilities +
Source: Authors’ own compilations.
44 Paradigm 20(1)

where Yit = DPR for firm i in period t or DYLD for firm i in period t, INVT is investment opportunity
variable measured as market-to-book ratio for firm i in period t, LEVit is the leverage ratio measured as
debt-to-capital ratio for firm i in period t, FCTit is free cash flow measured as the net operating cash flow
scaled by total assets, TANGit = is asset tangibility measured as the ratio of net fixed assets to total assets
for firm i in period t, BRit is the standard deviation of first difference of operating income divided by total
assets for firm i in period t, LCit is the life cycle variable measured as ratio between retained earnings to
total equity for firm i in period t, SIZEit is size variable measured as natural log of market capitalization
for firm i in period t, PROFit is profitability variable measured as return on assets that is earnings before
interest and taxes divided by the total assets for firm i in period t, DDTit is dividend distribution tax
divided by net profit after tax for firm i in period t, LIQit is liquidity measured as current ratio that is
current assets divided by current liabilities for firm i in period t, a is a constant, bs are the slope
coefficients, eit is the error term for firm i in period t.

Data and Period of Study

The data is collected from Prowess database maintained by Center for Monitoring of the Indian Economy
(CMIE), which is a leading business and economic database and research company in India. The sample
companies are selected from the companies listed on NSE. The reason to choose NSE is that all the
companies listed on NSE follow the financial reporting norms set by Securities and Exchange Board of
India (SEBI) and next the NSE was established after post-liberalization, privatization and globalization
period in the country. Also, the introduction of economic policies starting in 1991 changed the Indian
financial system from the public sector-dominated structure to free market system, which in turn changed
the financing pattern of corporate sector moving them from state-owned banks towards market-based
equity capital markets as the alternative sources of finance (Agarwal, 2002).
The period of our empirical study is from March 1995 to March 2013 (i.e., from fiscal year 1994–
1995 to fiscal year 2012–13). From now on, the fiscal year 1994–1995 will be called as 1995 and
accordingly the fiscal year 2012–2013 as 2013. There are two main reasons to select the above period as
a period of study. First, the time is concerned with the post-liberalization period and second, this is the
period during which most of the financial information is available in the database. Currently, 1730
companies are enlisted on NSE, out of which 179 companies are financial services, 28 companies are
from utilities sector and 35 companies are public sector enterprises. We are excluding financial services
companies, utilities sector companies and public sector enterprises companies from our sample. Financial
services companies and utilities sector companies are excluded from the sample because of the accounting
practices and the regulation norms followed by these companies are different from other companies,
which may significantly affect the dividend payment decisions. Public sector enterprises companies are
excluded from the sample as their dividend payment decisions are hugely affected by the government’s
financing constraint and the social obligations. Out of remaining 1488 companies we got maximum
information for 781 companies for the given explanatory variables for the given period of study, that is,
1995–2013. So, our final sample consists of 781 companies, out of which 240 companies are paying
dividend continuously for the entire period of study from 1995 to 2013. Thus, we are using a sample of
240 companies in our empirical study to find the determinants of dividend policy. Also, the entire period
of study 1995–2013 is divided into two sub-periods that is 1995–2003 and 2004–2013, which represents
the post-liberalization period and the period of second-generation reform respectively, and these two
sub-periods are examined separately. Thus, we examine the dividend policy of 781 sample firms during
the entire period of study 1995–2013 as well as for two sub-periods 1995–2003 and 2004–2013.
Labhane and Mahakud 45

Table 2. Trends in Dividend Payout Ratio During the Period 1994–95–2012–13.

Investment Firm Maturity

Profitability Opportunities Financial (Retained
Size (Market (Return on (Market to Book Leverage (Debt- Earnings Divided
Capitalization) Assets) Ratio) to-Capital Ratio) by Total Equity)
Small Large Small Large High Low High Low More Less
< 521.20 ≥ 521.20
Year ` Crores ` Crores < 12 % ≥ 12 % < 1.89 ≥ 1.89 ≥ 38% < 38% ≥ 0.11 < 0.11
1995 0.13 0.19 0.17 0.17 0.14 0.18 0.15 0.19 0.21 0.15
1996 0.12 0.18 0.17 0.15 0.14 0.17 0.14 0.18 0.21 0.14
1997 0.13 0.18 0.17 0.15 0.16 0.17 0.15 0.18 0.18 0.15
1998 0.13 0.18 0.15 0.18 0.15 0.20 0.15 0.20 0.18 0.16
1999 0.13 0.18 0.15 0.19 0.14 0.19 0.14 0.20 0.17 0.16
2000 0.14 0.18 0.14 0.20 0.14 0.20 0.13 0.22 0.20 0.15
2001 0.14 0.19 0.15 0.19 0.15 0.20 0.13 0.23 0.20 0.16
2002 0.14 0.20 0.14 0.24 0.14 0.26 0.14 0.24 0.16 0.22
2003 0.13 0.21 0.14 0.25 0.13 0.21 0.13 0.27 0.21 0.19
2004 0.15 0.23 0.13 0.29 0.15 0.24 0.18 0.27 0.35 0.15
2005 0.16 0.19 0.17 0.19 0.12 0.19 0.22 0.18 0.33 0.16
2006 0.15 0.21 0.14 0.23 0.13 0.21 0.12 0.23 0.30 0.19
2007 0.13 0.17 0.13 0.17 0.09 0.17 0.12 0.19 0.24 0.16
2008 0.11 0.17 0.10 0.17 0.11 0.20 0.11 0.18 0.35 0.14
2009 0.12 0.15 0.10 0.19 0.08 0.17 0.11 0.20 0.14 0.16
2010 0.10 0.18 0.10 0.22 0.08 0.20 0.09 0.21 0.30 0.14
2011 0.11 0.18 0.11 0.22 0.08 0.30 0.16 0.18 0.31 0.13
2012 0.10 0.18 0.11 0.24 0.10 0.25 0.12 0.20 0.13 0.23
2013 0.11 0.19 0.11 0.26 0.09 0.26 0.09 0.21 0.18 0.20
Source: CMIE Prowess database.

Trends in Dividend Payout Ratio

Table 2 shows the trends in the dividend payout ratio of continuously dividend paying firms across
various firms specific characteristics for the period that is 1994–1995–2012-2013. The dividend
paying firms are sub-divided into small and large, high and low, more and less on the basis of size,
profitability, investment opportunity, financial leverage and maturity considering the threshold value.
The average of annual median value is considered as threshold for the division. The companies having
the market capitalisation, return on assets, market-to-book ratio, debt-to-capital ratio and retained
earnings to total equity ratio greater than the threshold value are considered as large size firms, more
profitable, firms with high investment opportunity, highly levered and more matured firms respectively
and vice versa. From the Table 2, we found that the dividend payout ratio of larger size, more profitable,
low investment opportunity, low leveraged and more mature firms has been much higher as compared
46 Paradigm 20(1)

to the small size, less profitable, high investment opportunity, high leveraged and younger firms
during the whole period of study that is 1994–1995 to 2012–2013. This finding has been consistent
with the theoretical arguments.

Empirical Results
Table 3 presents descriptive statistics for all variables used in the study. The table reports the mean,
median, standard deviation, skewness, kurtosis, minimum and maximum for each of the dependent and
independent variables.
The investment opportunity and size variables that is market-to-book ratio and market capitalization,
respectively, are highly volatile among all the variables. The mean value for dependent variable dividend
payout ratio is 0.16, suggesting that the sample firms have an average dividend payout ratio of 16 percent.
However, there is a variation 0.10 in the dividend payout ratio across the sample firms with a minimum
of 0.01 and maximum of 0.61 dividend payout ratio. Dividend yield has a mean value of 0.031729, and
the median value of 0.021990 and the variation in the dividend yield value is of 0.028690 with minimum
and maximum of 0.000030 and 0.149483, respectively. The skewness and kurtosis are with the acceptable

Table 3. Summary Statistics

Variable Mean Median Std Dev Skewness Kurtosis Min Max

DPR 0.16 0.14 0.10 1.37 2.38 0.01 0.61
DYLD 0.032 0.022 0.029 1.59 2.28 0.000030 0.15
INVT 2.91 1.77 3.33 2.61 8.24 0.23 22.91
LEV 0.35 0.38 0.22 –0.10 –1.07 0.00 1.05
FCF 0.10 0.10 0.09 0.20 2.93 –0.53 0.72
TANG 0.33 0.32 0.16 0.37 –0.24 0.00 0.95
BR 0.26 0.21 0.17 2.00 5.42 0.06 1.33
LC 0.12 0.11 0.08 0.63 0.51 –0.09 0.39
SIZE 5.92 5.78 2.11 0.35 –0.27 0.85 12.95
PROF 0.09 0.08 0.06 1.17 1.41 –0.02 0.35
DDT 0.21 0.21 0.12 –0.03 –0.93 0.00 0.51
LIQ 1.33 1.22 0.65 1.81 4.86 0.26 4.98
Source: CMIE Prowess database.
Notes: This table presents descriptive statistics for all variables employed in the study. DPR is a firm’s dividend payout ratio
defined as the ratio of annual dividend paid per share to earnings per share, DYLD is a firm’s dividend yield defined as
the ratio of annual dividend paid per share to market price per share, INVT is a firm’s market to book ratio, LEV is
a firm’s financial leverage defined as total debt divided by total capital employed, FCF is free cash flow defined as net
operating cash flow scaled by total assets, TANG is the tangibility of assets measured as the ratio of net fixed assets
to total assets, BR is a firm’s business risk defined as the standard deviation of first difference of operating income
divided by total assets, LC is a life cycle variable for a firm defined as the ratio of retained earnings to total equity, SIZE
is natural log of market capitalization, PROFis a firm’s return on assets measured as earnings before interest and tax
divided by total assets, DDT is dividend distribution tax divided by net profit after tax for a firm, LIQ is current ratio
that is measured as current assets divided by current liabilities.
Labhane and Mahakud 47

Table 4. Correlation Matrix and Variance Inflation Factor of Independent Variables

Variable INVT LEV FCF TANG BR LC SIZE PROF DDT LIQ

INVT 1.000
LEV –0.242** 1.000
FCF 0.213** –0.218** 1.000
TANG –0.217** 0.393** 0.219** 1.000
BR 0.010 –0.289** 0.096** –0.088** 1.000
LC 0.317** –0.102** 0.227** –0.069** 0.037* 1.000
SIZE 0.534** –0.242** 0.122** –0.215** –0.148** 0.194** 1.000
PROF 0.431** –0.542** 0.364** –0.193** 0.178** 0.655** 0.320** 1.000
DDT 0.160** –0.349** 0.067** –0.293** 0.060** 0.059** 0.107** 0.142** 1.000
LIQ –0.075** –0.216** –0.023 –0.127** 0.053** 0.048** –0.078** 0.180** –0.035* 1.000
VIF 1.644 2.266 1.348 1.470 1.173 2.114 1.551 3.354 1.222 1.129
Source: Authors’ own calculation.
Notes: This table reports the correlation matrix for the independent variables used in this study. For variable explanation see
notes in Table. 2. ** indicates significance at 1% level and * indicates significance at 5% level.

range for all the dependent and independent variables that is skewness between ±3 and kurtosis between
±10, suggesting that the data is normalized (Kline, 2005).
Table 4 represents the correlation between the independent variables and variance inflation factor (VIF).
Although correlation coefficients between some of the independent variables of Table 4 are significant, the
values of the correlation coefficients and VIF indicate the absence of multicollinearity problem.
The results estimated from the fixed effect models for the whole period that is 1995 to 2013 as well
as for the two sub-periods that is 1995 to 2003 and 2004 to 2013 are presented in Tables 5 and 6 for both
dividend policy proxies. The restricted F-test results provided in Tables 5 and 6 suggest that both firm
and time effects are present in the data. LM-test statistics presented in both the tables indicate that either
one-way fixed effect model that is fixed effect firm, two-way fixed effect model that is fixed effect firm
and time models or random effect model are to be preferred to classical linear regression model. The
Hausman specification test results presented in the tables suggest that fixed effect models are suitable
over random effect models.
During the whole period, that is, 1995–2013 for both the dependent variables, the variables like
investment opportunity, leverage, tangibility, business risk, life cycle variable, size of the company,
profitability, dividend distribution tax and liquidity have been statistically significant and the relationship
between these variables with dividend policy proxies are consistent with the hypothesis. The significant
negative impact of investment opportunity on dividend policy supports the pecking order hypothesis.
The findings are consistent with the results of previous research (see Amidu & Abor, 2006). The
regression coefficient of financial leverage has been negative and significant, which indicates that high
levered firms pay lower amount of dividends compared to low levered firms due to the burden of fixed
interest payments. These results are consistent with the findings of Higgins (1972) and Al-Malkawi
(2008). Free cash flow has no significant impact on determination of dividend payout ratio, which is
inconsistent with the results found by Jensen and Meckling (1976), Rozeff (1982), Easterbrook (1984)
and Mollah (2011). However, it has been positive and significant for the determination of dividend yield.
Tangibility has been statistically significant, but the relationship between the tangibility and dividend
Table 5. Determinants of Dividend Payout Ratio (Fixed Effects Regression Results)

Dependent Variable: Dividend Payout Ratio

1995–2013 1995–2003 2004–2013
Variable FIF FIFT FIF FIFT FIF FIFT
INVT –0.002*** –0.002*** –0.001 –0.001 –0.003*** –0.001**
(–6.23) (–4.876) (–0.43) (–.378) (–6.02) (–2.960)
LEV –0.108*** –0.108*** –0.116*** –0.120*** –0.092*** –0.086***
(–11.98) (–11.890) (–8.42) (–8.500) (–6.44) (–6.120)
FCF –0.001 –0.009 –0.041** –0.029* 0.033** 0.046**
(–0.14) (–.647) (–2.42) (–1.74) (2.60) (2.283)
TANG –0.029** –0.030** –0.056*** –0.047* –0.002 –0.019
(–2.57) (–2.639) (–3.33) (-2.746) (–0.16) (–1.052)
BR –0.018** –0.019** .011916 0.0051369 –0.025** –0.033**
(–2.32) (–2.426) (1.13) (.477) (–1.99) (–2.642)
LC 0.491*** 0.495*** 0.396*** 0.407*** 0.430*** 0.438***
(23.31) (23.317) (14.28) (14.299) (13.94) (14.335)
SIZE 0.001* 0.001* 0.004** 0.002*** 0.004* 0.010**
(1.73) (1.777) (2.33) (2.909) (1.78) (3.223)
PROF 0.259*** 0.245*** 0.089** 0.099** 0.183*** 0.109**
(7.70) (7.242) (2.04) (2.241) (3.62) (2.140)
DDT –0.067*** –0.069*** –0.088*** –0.088*** –0.026 –0.025**
(–5.99) (–6.251) (–5.88) (–5.838) (–1.50) (–1.482)
LIQ 0.007*** 0.006** 0.008*** 0.007* 0.006** 0.006***
(3.57) (3.317) (2.77) (2.641) (2.07) (2.203)
No. of Observation 4560 4560 2160 2160 2400 2400
2
Adjusted R 0.3712 .59058 0.2660 .63508 0.3788 .67782
F-Test F(10,4310) = F(10, 4310) = F(10,1910) = F(10,1910) = F(10,2150) = F(10,2150) =
06.35 (0.000) 9.87 (0.000) 50.55(0.000) 57.21 (0.000) 36.99 (0.000) 39.79 (0.000)
Restricted F(239, 4310) = F(268, 4391) = F(239, 1910) = F(258, 1901) = F(239, 2150) = F(259, 2140) =
F-Test 9.16 (0.000) 25.54 (0.000) 8.07 (0.000) 15.56 (0.000) 7.55 (0.000) 20.49 (0.000)
2 2 2 2 2 2
LM Test c (1) = 2726.68 c (2) = 2782.29 c (1) = 1328.28 c (2) = 1331.59 c (1) = 1187.56 c (2) = 1218.78
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
2 2 2 2 2 2
Hausman Test c (10) = 340.38 c (10) = 145.15 c (10) = 143.44 c (10) = 91.27 c (10) = 703.45 c (10) = 137.6
(0.0000) (0.0000) (0.0000) (0.0000) (0.0000) (0.0000)
Source: Authors’ own calculation.
Notes: The figures in parentheses are the t-statistics. FIF is fixed effects firm, and FEFT is fixed effects firm time. *** indicates significance at 1 per cent level, ** indicates
significance at 5 per cent level and * indicates significance at 10 per cent level.
Table 6. Determinants of Dividend Yield (Fixed Effects Regression Results)

Dependent Variable: Dividend Yield

1995–2013 1995–2003 2004–2013
Variable FIF FIFT FIF FIFT FIF FIFT
INVT –0.001*** –0.001** –0.001 –0.001 –0.001*** –0.001
(–3.44) (–2.003) (–0.61) (–1.574) (–6.32) (–1.497)
LEV –0.018*** –0.012*** –0.037*** –0.023*** –0.006** –0.004**
(–6.93) (–4.948) (–7.22) (–4.625) (-2.39) (–2.036)
FCF 0.017*** 0.011* 0.023*** 0.005*** –0.006 –0.001
(4.35) (2.650) (3.80) (2.935) (–1.55) (–.160)
TANG –0.016*** –0.015*** 0.006 0.008 –0.011*** –0.001**
(–5.11) (–4.829) (1.00) (1.451) (–3.26) (–2.059)
BR –0.017*** –0.011*** –0.035*** –0.024*** –0.006*** –0.004**
(–7.42) (–5.251) (–9.00) (–6.270) (–2.72) (–2.105)
LC 0.052*** 0.041*** 0.048*** 0.018* –0.007 –0.015***
(8.49) (7.194) (4.58) (1.788) (–1.33) (–2.910)
SIZE 0.012*** 0.014*** 0.021*** 0.021*** 0.009*** 0.011***
(45.46) (30.961) (27.33) (24.903) (21.81) (19.989)
PROF 0.091*** 0.101*** 0.063*** 0.077*** 0.076*** 0.085***
(9.34) (10.904) (3.81) (4.928) (8.07) (9.891)
DDT –0.008** –0.011** –0.001 –0.003 0.009*** 0.006**
(–2.48) (–3.300) (–0.21) (–.665) (2.97) (2.362)
LIQ 0.002*** 0.001** –0.001 –0.001 0.002*** 0.001***
(3.46) (2.146) (–1.32) (–.330) (3.92) (3.070)
No. of Observation 4560 4560 2160 2160 2400 2400
2
R 0.3219 .61624 0.3104 .67789 0.2045 .63442
F-Test F(10,4310) = F(10,4310) = F(10,1910) = F(10,1910) = F(10,2150) = F(10,2150) =
295.32 (0.000) 301.49 (0.000) 104.10 (0.000) 111.79 (0.000) 76.99 (0.000) 81.74 (0.000)
Restricted F(239, 4310) = F(268, 4291) = F(239, 1910) = F(258, 1901) = F(239, 2150) = F(259, 2140) =
F-Test 9.39 28.32 7.55 18.61 6.79 17.07
(0.0000) (0.0000) (0.0000) (0.0000) (0.0000) (0.0000)
LM Test c2 (1) = 2136.33 c2 (2) = 2279.91 c2 (1) = 899.68 c2 (2) = 2045.55 c2 (1) = 950.37 c2 (2) = 1178.28
(0.000) (0.000) (0.000) (0.000) (0.000) (0.000)
2 2 2 2 2 2
Hausman Test c (10) = 486.54 c (10) = 277.14 c (10) = 210.33 c (10) = 214.39 c (10) = 126.58 c (10) = 162.54
(0.0000) (0.0000) (0.0000) (0.0000) (0.0000) (0.0000)
Source: Authors’ own calculation.
Notes: The figures in parentheses are the t-statistics. FIF is fixed effects firm, and FEFT is fixed effects firm time. *** indicates significance at 1 per cent level, ** indicates
significance at 5 per cent level and * indicates significance at 10 per cent level.
52 Paradigm 20(1)

policy is not consistent with the hypothesis. This finding has been consistent with the argument given by
Aivazian, Booth, and Cleary (2003). They argue that the firms with more fixed assets operating in an
emerging market are sometimes financially constraint due to the unavailability of the short-term finances
to fullfil the working capital requirements.
The regression results show a negative and significant relationship between the business risk and
dividend policy, which suggest that highly risky firms pay higher amount of dividends to the shareholders
and vice versa. The reason might be that the firms experiencing high volatility in earnings have high
uncertainty about the future, which comply them not to pay more dividend. Ceteris paribus the firms
having stability in earnings are approximately able to anticipate their future and could be able to signal
to the investor in the form of dividends. Thus, firms with lower business risk pay more dividend and the
firms with high business risk pay fewer dividends to the shareholders. These findings are consistent with
the findings of Yoon and Starks (1995) and are inconsistent with the findings of Benartzi et al., (1997)
and Grullon et al., (2005). The positive and significant association of life cycle variable with the dividend
policy measures has been consistent with our hypothesis and the results are in line with the findings of
Grullon and Michaely (2002) and DeAngelo et al. (2006).
The significant positive relationship between size of the company and profitability with the dividend
payout ratio accepts our hypothesis and the results are consistent with the findings of DeAngelo et al.,
(2004), Al-Malkawi (2008), Mollah (2011), Hamill and Al-Shattarat (2012) and Patra et al. (2012). The
dividend distribution tax is significant and depicts a negative association with both the dependent
variables. In a country like India, the government charges a high tax rate, that is, around 15 per cent on
a dividend distribution plus additional surcharges. Thus, higher rate of dividend distribution tax increases
the tax payment, reduces the net income of the company that in turn reduces its residual profit available
for paying the dividends. Our results are consistent with the findings of Panda and Lall (1993), Damodaran
(2000) and Kamat and Kamat (2013). In accordance with our hypothesis the regression coefficient of the
firm-specific liquidity is statistically significant and positive, and the results are consistent with the
findings of Patra et al. (2012).
During the first generation reform period, that is, 1995–2003, all the variables except investment
opportunity and business risk have played significant role in the determination of dividend payout ratio,
but for the determination of dividend yield the variables like leverage, free cash flow, business risk, life
cycle, size of the company and profitability have played significant role. During the second generation
of reform period, that is, 2004–2013, the variables like investment opportunity, leverage, business risk,
life cycle, size of the company, profitability and liquidity have been statistically significant for the
determination of dividend payout ratio and the relationship of these variables with the payout ratio are
consistent with our expected hypothesis. For the determination of dividend yield all the variables except
free cash flow and life cycle have played the significant role.

Conclusions and Policy Implications

The present study examines the determinants of dividend payout ratio for Indian companies during the
period 1994–1995 to 2012–2013. A period wise analysis has been carried out to examine the robustness
of results. From the trend analysis, we found that the larger and profitable firms have high dividend
payout ratio whereas firms having high investment opportunities and high financial leverage have low
dividend payout ratio. From the empirical analysis we found that the variables like leverage ratio, life
cycle, size of the company, profitability and liquidity have significant impact on determination of payout
Labhane and Mahakud 53

ratio in the whole as well as for two sub-periods. For the determination of dividend yield variables, such
as leverage, business risk, size of the company and profitability, has played a significant role. The results
are varying across the dividend policy proxies and the time periods.
The empirical results suggest that variables like market-to-book ratio, debt-to-capital ratio, tangibility
of assets, business risk and dividend distribution tax are negatively and the variables like life cycle,
market capitalization, return on assets and liquidity are positively affecting the dividend payout ratio and
dividend yield. This indicates that larger, more profitable, more mature and highly liquid firms have
higher dividend payout ratio whereas the firms with high investment opportunity, financial leverage and
business risk have lower dividend payout ratio. Comparing the results across the periods and as well as
across the different dividend policy proxies we found that only three variables such as leverage ratio, size
of the company and profitability are significantly affecting the dividend payment decisions of the
companies in India. The findings are consistent with the pecking order, transaction cost, signalling and
firm life cycle theory of dividend policy and we find little evidence for the agency problem of free cash
flow theory. This study has implications for both investors and managers. The managers can consider the
major determinants of dividend payout ratio while formulating the appropriate dividend policy for a
firm. Considering the nature of the companies on the basis of payment of dividends the investors can
choose the companies for better investment.

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Authors’ bio-sketch

Nishant B. Labhane is working as a senior UGC fellow in the Department of Humanities and Social
Sciences, IIT Kharagpur. His research area for the doctoral dissertation is related to corporate dividend
policy decisions determination. His research interest includes corporate finance and financial markets.

Jitendra Mahakud is associate professor of economics and finance in the Department of Humanities
and Social Sciences, IIT Kharagpur. His areas of research and teaching include Financial Institutions
and Markets, Corporate Finance, Investment Management, Financial Econometrics, Macroeconomics
and Monetary Economics. He has published more than 35 papers in leading national and international
journals. He has co-authored a book titled “Financial Institutions and Markets: Structure, Growth and
Innovations” published by Tata McGraw-Hill.