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EFFECT OF DIVIDEND ANNOUNCEMENT ON SHAREHOLDERS VALUE: EVIDENCE FROM DHAKA STOCK EXCHANGE
Md. Hamid Uddin* Golam Mohammed Chowdhury**
ABSTRACT Academic literature suggests that dividend payments should have no impact on shareholders value in the absence of taxes and market imperfections. Hence, companies should invest excess funds in the positive net present value projects instead of paying out them to the shareholders. Literature also suggests that market valuation of stocks depends on the expected future dividends. If company pays out all of the earnings, funds for future investment will decrease and dividend may not increase in the future. Moreover, when dividend is taxable, paying out more cash would increase the shareholders tax liability. Despite these theoretical arguments for not paying dividends, companies often pay cash dividends to their shareholders possibly to signal information about the future earnings prospects. Our empirical results based on 137 samples of dividend paying companies listed on Dhaka Stock Exchange, showed that investors do not gain value from dividend announcement. Indeed shareholders lost about 20 percent of value over a period of 30 days prior to the dividend announcement through to 30 days after the announcement. The lost value may be partially compensated because of the current dividend yield. Overall, the evidence tends to support the dividend irrelevancy hypothesis. Evidence also indicates that dividend payment does not signal any information to the investors, which needs to be further investigated.

1.0 INTRODUCTION The goal of corporate entities is to maximize the value of shareholders investment in the firm. Managers pursue this goal through their investment and financing decisions. Investment decisions involve with selection of positive net present value projects while financing decisions involve with selection of a capital structure that would minimize the cost of capital of firm. Apart from the investment and financing decisions, managers need to decide on regular basis whether to payout the earning to shareholders, reducing the agency problem (Jensen and Meckling, 1976). However, the question remains whether paying out of earnings would essentially create value for the shareholders or not. A dividend payment provides cash flow to the shareholders but reduces firms recourses for investment; this dilemma is a myth in the finance literature. A great deal of theoretical and empirical research on dividend effects has been done over the last several decades. Theoretically, cash dividend means giving reward to the shareholders that is something they already own in the company; hence this will be offset by the decline in stock value (Porterfield, 1959 and 1965). In an ideal world (without tax and any restrictions) therefore dividend payments would have no impact on the shareholders value (Miller and Modigliani, 1961)[1]. In the real world, however a change in the dividend policy is often followed by change in the market value of stocks. The economic argument for investor preference to dividend income was
* **

Assistant Professor, Institute of Business Administration, University of Dhaka, Dhaka, Bangladesh. Professor, Institute of Business Administration, University of Dhaka, Dhaka, Bangladesh.

Effect of Dividend Announcement on Shareholders Value

offered by Graham-Dodd (1951). Subsequently, Walter (1956) and Gordon (1959 and 1962) forwarded the dividend relevancy idea, which has been formalized into a theory, postulating that current stock price would reflect the present value of all expected dividend payments in the future. Other researchers made efforts to further understand the dividend controversy. Among them, Brennan (1970 and 1973), Litzenberger and Ramaswamy (1979 and 1980) showed that it is not optimal for the investors to receive dividends if their marginal tax rate is greater than zero, and investors after-tax expected rate of return (discount rate) depends on the dividend yield and systematic risk[2]. This leads to an idea that at least dividend might have some tax-induced effect on the share prices. Average investors, subject to their personal tax rates, would prefer to have less cash dividend if it is taxable: size of optimal dividend inversely related to personal income tax rates (Pye, 1972). Hence, stocks prices tend to decline after announcement of dividend increase. Empirical studies however showed mixed evidence, using the data from US, Japan and Singapore markets. A number of studies found that stock price has a significant positive relationship with the dividend payment [Gordon (1959), Ogden (1994), Stevens and Jose (1989), Kato and Loewenstein (1995), Ariff and Finn (1986), and Lee (1995)], while others found a negative relationship [Loughlin (1989) and Easton and Sinclair (1989)]. A negative relationship between dividend announcement stock returns is expected due to tax effect, but researchers tended to relate the positive relationship between the stock returns and dividend announcement with the information effect of dividend. The dividend information hypothesis postulates that cash dividend carries information regarding the future cash flows of firm that is to be reflected in the market price of stock after announcement of dividend, particularly when dividend increases [Bhattacharya (1979) Bar-Yosef and Huffman (1986) and Yoon and Starks (1995)]. The theoretical literature on dividend effects has been well developed. Researchers largely accepted that dividend per-se has no impact on the shareholders value in an ideal economy. However, in a real world, dividend announcement is important to the shareholders because of its tax effect and information content. In this study, we have examined the dividend effect on shareholders value in Dhaka Stock Market with a sample of 137 companies who announced dividend over a period from October 2001 to September 2002. Our results showed that Cumulative Abnormal Return (CAR) of 137 stocks portfolio increased shortly before the announcement of dividends but this value increase did not sustain in the ex-dividend periods. Indeed, the shareholders of dividend paying companies lost significant amount of value over a period of 30 days after the dividend announcement. However, the lost value can be partially compensated by the dividend yield. As CARs are negative in the periods after dividend announcement, evidence suggests dividend announcements do not carry information about the future earnings and cash flows of the companies. Hence, our findings are not consistent with the dividend information hypothesis. The negative CAR in the ex-dividend periods is apparently consistent with the dividend tax-effect hypothesis. This could be possible because dividend income generally needs to be included in the investors personal income for tax purposes. Since the dividend yield partially compensates the value lost in the exdividend periods, investors overall value remains largely unchanged after dividend payments. Hence, evidence seems to be consistent with Miller and Modigliani hypothesis (1961).

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The rest of the paper is organized as follows: in Section 2, we discuss the methodology. Characteristics of samples are described in Section 3. The empirical findings are presented and analyzed in Section 4. Finally, Section 6 concludes the paper.

2.0 RESEARCH METHODOLOGY In order to study the impact of dividend announcement on shareholders value we use two measures: firstly, daily market-adjusted abnormal return (MAAR) and secondly, daily cumulative abnormal return (CAR). MAAR indicates the relative daily percentage price change in the dividend paying stocks compared to the change in average market price. We use DSE all-share price index as the proxy of average market price. MAAR is calculated as follows: Where,
MAARit Rit is the market adjusted abnormal return for security i over time t is the time t return on security i, calculated as (Pit Pit-1)/Pit-1. Where, Pit is the market closing price of stock i on day t. Pit-1 is the market closing price of stock i on day t-1. is the time t return on the DSE all-share price index calculated as (It It-1)/It1. Where, Iit is the market index on day t. It-1 is the market index on day t-1.

Rmt

The market adjusted abnormal return (MAAR) shows the change in individual stocks value due to the dividend announcement. As the percentage change in market index (average market price) is deducted, the remainder gives us the unsystematic portion of the value change, which is specific to that particular stock resulting from its dividend announcement. MAAR is calculated over a period starting to 30 days to +30 days relative to the dividend announcement day (0-day). The second measure used is cumulative abnormal returns (CAR), which measures the investors total return over a period starting from well before the announcement of dividend to well after the dividend announcement day. We use a 61-day window period staring from -30-day to +30-day relative to the dividend announcement day (0-day). CAR is computed as follows:
CARt = MAARt
t =1 t= j

(2)

Where, CARt is cumulative abnormal return, MAARt as defined above, j denotes the day -30 through day +30. Finally, we used parametric test to determine the statistical significance of market adjusted average abnormal return of dividend paying stocks over the window period (-30 day to +30 day relative to dividend announcement). The t-statistics were calculated cross-sectionally by using the standard deviation of abnormal returns of the portfolio of 137 dividend-paying stocks. Moreover, t-test suggested in Brown and Warner (1980, p. 251-252) is also applied to test the statistical significance of the cumulative abnormal returns.

Effect of Dividend Announcement on Shareholders Value

3.0 SAMPLE DESCRIPTIONS The sample includes 137 companies listed on the Dhaka Stock Exchange (DSE) who announced dividends between October 2001 and September 2002. We considered the sample period as the stable year in recent periods, as this period followed immediately after the change of political power in the country when political chaos was generally absent and market run smoothly. A stable market period is essential for collecting samples. Otherwise, the empirical results may be contaminated by the other factors such as market volatility. A breakdown of the sample companies according to industrial sectors is given below in Table 1 and Figure 1. Table 1 shows that the highest average dividend was paid in the Fuel and Power sector, followed by that in the investment sector. The highest dividend was announced in the food sector, and lowest in the Jute and Services sectors. In Jute sector, only one company announced dividend during the sample period. The average dividend was 19.5 percent with standard deviation of 12.9 percent. Overall, the table shows that our sample includes stocks from all sectors, except the paper sector. The number of samples are also fairly equally distributed with 10 to 20 stocks from each sector - except Paper, Jute and Services sectors. This is also noted that out of 137 companies, 34 companies announced dividend in 2001 and 103 in 2003. Sample also displays that 108 companies belong to A-category, 17 belong to Bcategory and 12 belong to Z-category[3]. Therefore, the empirical result based this sample is likely to be reliable.
Table 1: Distribution of Sample Companies Listed on DSE Sector Bank Chemical Engineering Food Fuel and Power Insurance Investment Jute Paper Service Textile Misc. Total Number of Companies 16 14 15 15 3 17 10 1 1 3 22 20 137 Maximum Dividend 50.0% 40.0% 50.0% 60.0% 50.0% 43.0% 50.0% 10.0% 40.0% 50.0% Minimum Dividend 16.5% 5.0% 10.0% 8.0% 5.0% 10% 7.5% 5.0% 5.0% Average Dividend 27.0% 18.3% 19.5% 19.0% 33.0% 20.1% 23.7% 10.0% 10.0% 10.3% 21.1%

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Figure 1: Average dividend in different industrial sectors

35.00% 30.00% Dividend % 25.00% 20.00% 15.00% 10.00% 5.00% 0.00%

Ba Ch nk e En mic a gi ne l er in g Fo od F In uel su r In anc ve e stm en t Ju te Pa pe Se r rv ice Te xt ile M isc .

Induatrial Sectors

4.0 EMPIRICAL FINDINGS AND ANALYSES 4.1 Market Adjusted Abnormal Return Findings reported in Table 2 shows that average market adjusted abnormal return (MAAR) on the day of dividend announcement was only 0.8 percent, which was not statistically significant. This could be due to the fact that the information of dividend payment often leaks out to the market a few days before the announcement made by the company. Hence, the announcement of dividend normally carries no surprise to the market. Therefore, evidence shows that MAARs of day 4 and 3 are about 2 percent and 2.9 percent respectively, which are significant at 5 percent level. This suggests that market reacts earlier than the actual announcement of dividend.
Table 2: MAAR of 137 dividend-paying DSE stocks over a window period of day 30 to day +30 relative to dividend announcement day (0-day) Day relative to dividend announcement -30 -29 -28 -27 -26 -25 -24 -23 -22 -21 -20 -19 -18 -17 -16 Average MAAR -0.049 -0.012 -0.002 0.004 -0.001 0.006 0.005 0.005 0.002 0.01 0.004 0.01 -0.002 0.001 0.009

t statistic
-1.091 -0.664 -1.037 1.275 -0.239 1.625 1.451 2.071 0.738 0.579 -2.031** 0.497 -0.884 0.268 1.526

Effect of Dividend Announcement on Shareholders Value

Day relative to dividend announcement -15 -14 -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Average MAAR 0.016 0.003 0.02 -0.004 0.011 0.008 -0.002 0.015 0.004 -0.005 0.002 0.020 0.029 -0.007 -0.003 0.008 -0.004 -0.007 0.001 -0.014 0.004 -0.011 -0.039 -0.029 -0.008 0.004 -0.036 -0.02 0.001 -0.015 -0.016 -0.019 -0.045 -0.04 -0.0028 0.000 0.001 -0.010 -0.001 -0.005 0.005 0.0012 0.004 -0.0046 -0.003 0.008

t statistic
3.877*** 1.155 0.653 -1.951* 1.953* 1.161 -0.958 0.374 0.867 -1.892* 0.215 2.038** 2.172* -1.064 -0.439 0.554 -0.669 -0.779 0.386 -1.635 0.976 -1.218 -1.748* -1.474 -0.370 0.458 -1.590 -1.086 0.194 -0.956 -0.892 -0.915 -1.569 -1.342 -1.168 0.051 0.122 -0.958 -1.707* -0.534 0.660 0.695 0.634 -2.052** -0.196 1.093

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Note: Asterisks in the last column denotes that the corresponding MAAR is statistically significant. The asterisks ***, **, and * indicate the level of significance (based on the t values) at respectively the 1, 5 and 10 percent level. Prior to dividend announcement, MAAR also found significant on the days 6, -11, -12, and 20. However, the percentage returns on these days are less than that on the day4. On other days, MAAR is insignificant. Therefore, evidence tends to confirm that market reacts a few days before the announcement of dividend is made. During the post-announcement periods (day +1 to +30), all MAARs are insignificant except those on day +7, +23, and +28. Overall, MAAR results suggest that the effect of dividend announcement is not strong in Dhaka Stock Exchange. Shareholders gain only about 4 percent value about three/four days before the announcement of dividend but no significant value gain on the announcement day.

4.2 Cumulative Abnormal Return Results in Table 3 shows that investors do not gain value from dividend announcement. Evidence depicts that CAR had risen from -4.9 percent on day -30 to a level of 10.5 percent on the day of dividend announcement. But the gained value was lost over the next 30 days after dividend announcement, as CAR dropped to 19.52 percent on the day 30. Although results tends to suggest that investors may have overreacted to the dividend announcement, the evidence generally consistent with the dividend irrelevance hypothesis of Miller and Modigliani (1961). This is because investors seemed to gain no value from the dividend announcements. Findings also show that investors lost more value in the ex-dividend period than the value gained in the pre-dividend period. This finding tends to suggest that dividend announcement does not carry information about the future earnings and cash flow of the companies. In Bangladesh, DSE and Security and Exchange Commissions (SEC) generally rate the performance of the listed companies based on their regular dividend payments. Hence, companies may like to retain their good standing by paying regular dividends[4]. In the presence of a kind of indirect pressures from the regulatory authorities, the companies may not be able to effectively signal the future earning prospects through their dividend announcement.
Table 3: CAR of 137 dividend-paying DSE stocks over a window period of day 30 to day +30 relative to dividend announcement day (0-day)
Days relative to dividend announcement -30 -29 -28 -27 -26 -25 -24 -23 -22 -21 -20 -19 -18 -17 -16 -15 -14 CAR -0.049 -0.061 -0.063 -0.059 -0.060 -0.054 -0.049 -0.044 -0.042 -0.032 -0.028 -0.018 -0.02 -0.019 -0.010 0.006 0.009

t-values
-1.091 -1.571 -1.141 -1.271 -1.091 -1.781 -2.052 -1.781 -1.111 -0.890 -0.111 -1.194 -1.123 -1.178 -1.152 3.125 1.962

8 Days relative to dividend announcement -13 -12 -11 -10 -9 -8 -7 -6 -5 -4 -3 -2 -1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

Effect of Dividend Announcement on Shareholders Value CAR t-values 0.029 0.025 0.036 0.044 0.042 0.057 0.061 0.056 0.058 0.078 0.107 0.100 0.097 0.105 0.101 0.094 0.095 0.081 0.085 0.074 0.035 0.006 -0.002 0.002 -0.034 -0.054 -0.053 -0.068 -0.084 -0.103 -0.148 -0.188 -0.1908 -0.1908 -0.1898 -0.1998 -0.2008 -0.2058 -0.2008 -0.1996 -0.1956 -0.2002 -0.2032 -0.1952 1.561 1.333 3.152 2.150 2.111 4.591 4.781 3.589 3.456 7.985 8.978 9.781 5.891 6.888 5.578 4.595 4.258 8.654 4.568 3.245 1.589 0.015 1.065 0.860 -3.656 -7.891 -2.456 -5.892 -5.654 -4.444 -10.652 -5.456 -4.658 -3.222 -4.658 -7.698 -4.587 -7.159 -9.346 -11.986 -12.654 -10.258 -8.348 -8.147

Our results reported above support the dividend irrelevance proposition in the Dhaka Stock Market. It is however important to examine further whether dividend carries any information, e.g., future earnings. We leave it for future research because the

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earning data for the year following the current dividend payment is not yet available[5] Hopefully, future findings on the dividend information hypothesis would validate the current evidence from DSE, which supports the dividend irrelevancy proposition in Bangladesh.

Figure 2: Cumulative abnormal return (CAR) of 137 DSE listed companies over period from day -30 to day +30 relative to dividend anncouncement

Cumulative abnormal return

-7

-3

-27

-23

-19

-15

-11

13

17

21

25

Event days relative to dividend anncouncement

5.0 CONCLUSION In academic literature, it was suggested that dividend payments have no impact on the shareholders value (Miller and Modigliani, 1961) in the absence of taxes and other market imperfections. A dividend payment provides cash flow to the shareholders but it reduces firms recourses for investment. Hence, firms should not pay dividend if they have any positive net present value project in hand. However, Walter (1956) and Gordon (1959 and 1962) showed that valuation of stock depends on the expected future dividends. If company pays out all the earnings to shareholders, funds for future investment will decrease and dividend may not increase in the future. Therefore, theoretical literature suggested that dividends payout should not be desirable provided that companies can better invest their funds. Moreover, cash dividend is not desirable if investors need to pay taxes on their dividend income. Given the valid reasons for not paying dividends, an announcement of dividend payments may carry some information for the market and stock prices may be adjusted accordingly. Based on the 137 DSE listed companies declaring dividends during October 2001 and September 2002, we found that investors do not benefit from dividend announcement. Over the period starting from 30 days prior to dividend announcement to 30 days after the announcement of dividend payment, investors incurred losses upto 19.52 percent of stock value. Although this loss of value is partially compensated by the current dividend yield, investors in Bangladesh seemed to have no net gain due to dividend payments. The evidence from DSE tends to support Miller and Modigliani (1961) hypothesis of dividend irrelevancy. Apart from the academic significance of our findings, the regulatory authorities (DSE and SEC) may wish to review their policy of company evaluation, which emphasizes on dividend payments by the listed companies, in the context of empirical evidence on the dividend effects.

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NOTES 1. It was further showed that the irrelevancy of dividend policy holds even after dropping the assumption of ideal economy. 2. Black and Scholes (1974) argued however that tax effect is not uniform for all investors, because different investors are subject to different tax rates depending on the level of their wealth and income. DSE classify the listed companies into A, B and Z categories. A category companies are good stocks as their operating performance are assessed to be good and pay regular dividends, B-category companies are moderate companies whose operating performance are satisfactory and pay some dividends from time to time, and Z-category companies are those whose operating performance are not good and normally pay no dividend. Payment of dividend is purely a corporate financial decision of a firm. Dividend per se should not have any impact on the shareholders value but companies may like to pay dividend due to tax effect or information effect. Since dividend income was tax free in Bangladesh, tax effect should not be found at DSE. If companies pay dividend that should be for signaling any information to the investors, but when regulatory authorities rate the companies based on their regular dividend payments, investors may become confused about the purpose of dividend announcement by the companies. We have collected the dividend announcement data from October 2001 to September 2002, which have been analyzed in this paper. Currently, we are keeping the track of information on earning announcements by the same companies from October 2002 onward. Hopefully, we will get most of the earning announcements by the end of year 2003, which will be analyzed in next paper on dividend information hypothesis.

3.

4.

5.

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