Modelling the linkages between dividend policy and future earnings

Abstract

The motivation of this study is to investigate whether the strength of payout ratios able to explain expected earnings. More definitely, do higher dividend payout ratios direct to higher return? The hypothesis is that higher dividend payout is a signal of optimism that leads to higher likelihood of subsiding agency cost and thus resulting to higher growth in expected earnings. In other words lower payout ratio leads to inefficient empire building or even funding in less than ideal projects whereas higher payout ratio leads to more carefully chosen projects leading to higher subsequent growth in earnings. This study aims to explore the relation of dividend policies with expected earnings in 5 major Asian countries - Australia, Singapore, China, Japan and South Korea. The motivation is the inevitably dissimilar environmental characteristic of these Asian countries. Other than that, most of the empirical studies on this subject are conducted in either developed US or EU capital markets. The 5 countries are different in their legal setup, taxation policies and financial structures. All these factors have visible impact on their payout policies. The fixed effect model of regression on 10 year data from 2003 through 2012 reveals some mixed results. We found that the common law followers (Australia and Singapore) have higher mean values for payout ratios whereas the civil law followers (China, South Korea, and Japan) have lower mean value for payout ratios. For all the countries, we found that the large firms tend to have lower future earnings growth. More importantly, we found significant positive relation between dividend payout ratios and future earnings growth in Australia, Singapore, Japan and South Korea. The pervasive positive relationship means that high dividend payout ratios lead to strong growth in subsequent earnings. We found strong positive evidence in favor of free cash flow theory to explain this relationship in Japan. However, China's findings as a negative relationship of dividend payout with future earnings growth is opposing to the inclusive inference.