Factors Determining the Dividend Policy of a Company

Abstract

Dividends are returns to shareholders for their investment in firms and the dividend policy is a set of guidelines that a firm uses to decide how much cash to give to its shareholders in the form of dividends. Dividend policy of a company remains one of the key areas of research in finance. Lintner (1956) was the pioneer in studying the behavioural pattern of management in deciding dividend policy and his study revealed that management is usually conservative in nature; and dividend policy is largely based on the earnings of current year, as also the dividend pay-out of the previous year, and does not deviate largely from this. Miller and Scholes (1982) argue that in the real world, dividend decision is inspired more by high taxes on dividends than on other alternatives such as capital gains. Ali, Khan and Ramirez (1993) observe that dividend policy has a signalling effect in the market in that a change in the pay-out policy provides information about future earnings and reflects the true share price of the firm. Also the agency theory suggests that there has always been a conflict between the insiders and outsiders on the determination of dividend policy and the managers decide the dividend policy to meet their own selfish interests. The objective of this paper is to analyse the factors which determine the dividend policy for companies in India. The author has identified a set of 16 factors which may impact the dividend decision. These factors are identified based on prior works in the area and on theoretical framework on dividend policy. The dataset is from the BSE 500 companies, which represent a fair share of the market. The methodology applied is principal component analysis; with Bartlett Test and KMO test done to check the suitability of data for factor analysis. Factor analysis reduces the sixteen variable to seven and these factors are then regressed to the dividend pay-out ratio to identify the key determinants of dividend policy. The major findings of the study are that the ownership structure (both promoters and institutional holdings), liquidity, debt/equity, dividend yield, shareholders' returns, investment policy, taxation aspect, and growth prospects are all significant predictors of the dividend policy for Indian firms.