27th Sept 2011

Dividend Policy: Relevant to value of a firm?

Strategic Financial Decision Making Debate

Submitted by Aditya Datta (MS10A001) Anand Agarwal (MS10A002) Ankush Sharma (MS10A004) Neha Khanna ( MS10A037) Neha Singhvi (Ms10A038) Jania Kesarwani (MS10A070)

[DIVIDEND POLICY: RELEVANT TO VALUE OF A FIRM?] September 21, 2011

Contents
Dividend Policy: Relevant to the value of a firm ..................................................................................... 3 Introduction ........................................................................................................................................ 3 Relation between Dividend paid per Share and Earnings per Share .................................................. 4 Relationship between Dividend paid per share and Share Prices ...................................................... 4 Relationship between Dividend Payout Ratio and Life Cycle of the firm ........................................... 4 Relationship between Dividend paid per share and Value ................................................................. 4 Conclusion ........................................................................................................................................... 5 Dividend Policy: Irrelevant to the value of a firm ................................................................................... 6 Introduction ........................................................................................................................................ 6 Methodology....................................................................................................................................... 6 Analysis ............................................................................................................................................... 6 Impact of dividends on net gain...................................................................................................... 6 Regression analysis ......................................................................................................................... 8 Conclusion ........................................................................................................................................... 9 References ............................................................................................................................................ 10 Appendix ............................................................................................................................................... 10 1. 2. 3. 4. Tables for EPS vs Dividend per share ........................................................................................ 10 Share Price and Announcements .............................................................................................. 13 D/E ratio, Dividend Paid per Share and Value of the firm ........................................................ 15 Net Gains calculation companies after dividend declaration ................................................... 16

DoMS, IIT Madras

[DIVIDEND POLICY: RELEVANT TO VALUE OF A FIRM?] September 21, 2011

Dividend Policy: Relevant to the value of a firm

Introduction
The primary goal of management of any firm is maximising Shareholders Wealth. This implies maximising the value of a firm as measured by the price of the firms common stock. Paying dividends is one such way of achieving this target. Investopedia defines Dividends as A distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders. The dividend is most often quoted in terms of the dollar amount each share receives (dividends per share). It can also be quoted in terms of a percent of the current market price, referred to as dividend yield. Dividend policy has been a favourite discussion topic since Joint Stock companies came into existence. It is not only a favourite but also one of the most complex aspects in finance. As said by Black in his study on dividend in 1976 The harder we look at the dividend picture the more it seems like a puzzle, with pieces that just dont fit together. The dividend policies differ not only across firms but also within firms, which adds to the complexity of predicting the effect of dividends. To overcome this complexity we have identified certain patterns which will help us in analysing the effect of dividend on value of the firm. The below patterns were taken by us: a) Lag factor: Dividends tend to lag behind earnings i.e. increase (decrease) in earnings is followed by increase (decrease) in dividend payout. b) Stick factor: Dividends are called sticky as firms are generally reluctant to change dividends as it is believed it hurts the image of the firm. Firms go as far as paying dividends even when their earnings drop. c) Life Cycle of a firm: Various factors, such as growth rates, cash flows and project investments, affect the dividends. These factors change over the life cycle of a firm. d) Macroeconomic factors: Firms affected by macroeconomic variables tend to keep their dividends on the lower side so as to avoid going for dividend cuts in tough times. This phenomenon is very visible in cyclical industries. e) Value of the firm: A combination of D/E ratio and Dividend paid per share gives an indication of the change being observed in the value of the firm year on year. Looking upon these patterns we will attempt to understand the effect of dividends on the value of a firm. To get a comprehensive overview of the topic we choose three sectors and two firms in each sector. The following sectors along with the firms were chosen:

Sector
IT (Service) Automobile (Manufacturing) Banking

Firm Name
Infosys Ltd. TCS Tata Motors Maruti Suzuki Ltd. Kotak Mahindra Ltd. State Bank of India

Table 1: List of firms

Our research has been based on the five points described above. Using the points above, we have tried to draw a correlation between the dividend policy of a firm and the value of the firm. To do the analysis we collected data regarding the share price, dividend paid, EPS and growth, D/E ratio and value of a firm. We analysed the share prices to see the effect of dividend paid. This was DoMS, IIT Madras 3

[DIVIDEND POLICY: RELEVANT TO VALUE OF A FIRM?] September 21, 2011

done for the month after the dividend was paid. EPS and growth were also plotted with dividend paid to see their effect on the dividend paid. The macroeconomic conditions were also kept in mind while looking at these factors. To analyse the effect of dividend on the value of the firm analysis of various factors was done. Analysis of relationship between a. b. c. d. Dividend paid per share and EPS Dividend paid per share and Share price Dividend Payout Ratio and Life Cycle of Firm Dividend Paid per share and Value of Firm

Relation between Dividend paid per Share and Earnings per Share
Graph between EPS and dividend paid per share for each of the 6 firms was plotted. From the graphs (see appendix 1) we see that: a. There is correlation between the EPS and Dividend paid per share for all the 6 firms i.e. when dividend is paid the EPS changes. b. For manufacturing sector we are able to see a positive correlation while in the service sector no such trend is visible. We can conclude that if a higher dividend has been paid out in year n then there must have been an increase in EPS in year n-1. This argument holds valid for manufacturing sector. An increase in EPS, for the shareholder, indicates an increase in the value of the firm.

Relationship between Dividend paid per share and Share Prices

Graph showing relationship between dividend paid, bonuses and splits (wherever applicable) and share price was analysed. Analysis of the graphs (see appendix 2) leads us to the following conclusions: a. The share prices have moved up after the dividend was paid (we are not looking at it day wise but rather over a period of time) b. Bonuses and splits lead to a sudden drop in the share price due to increase in number of shares and volatility but then it follows the same pattern as the dividend i.e. the adjusted price increases. For most of the firms we were able to observe this change and hence can conclude that paying dividend leads to an increase in the value of the firm (value being measured by the price of the common stock).

Relationship between Dividend Payout Ratio and Life Cycle of the firm
Cyclical firms tend to give lower dividends as their revenue is dependent on the business cycles. Manufacturing is one such sector which sees a low Dividend Payout Ratio. Maruti Suzuki has had a dividend payout ratio of 0.1 or less for the last 5 years. Tata Motors, with the exception of 2011, has had a dividend payout ratio of less than 0.4. Firms follow this policy so that when a lower dividend is paid it does not affect the value of the firm negatively.

Relationship between Dividend paid per share and Value

For this we analysed D/E ratio of a firm and the dividend paid per share. We then correlated it to the value of a firm (value being measured by debt and equity of the firm). (see appendix 3) DoMS, IIT Madras 4

[DIVIDEND POLICY: RELEVANT TO VALUE OF A FIRM?] September 21, 2011

Type D/E (Low/High) DPS(Low/High) Change in Value of the firm (Increase/Decrease)

Type 1 High High Decrease

Type 2 Low Low Increase

Type 3 High Low Increase

Type 4 Low High Decrease

Table 2: Types of firms according to D/E ratio, Dividend paid per share and value of the firm

For the combination of D/E and DPS there were 4 possible combinations. Type 1 and Type 3 have a high D/E (i.e. value of D/E was greater than 0.4). Type 2 and Type 4 were firms with a low D/E. For DPS we took a comparative analysis i.e. we compared firms within a sector. For each sector the definition of high and low changed (as firms differ in their dividend policy). Our argument is that Type 1 and Type 4 firms will have a decrease in the change in value of the firm while Type 2 and Type 3 firms will exhibit an increase in the change of value of firm year on year. The rationale behind this was that if D/E ratio is low, then the cost of equity will decrease when you pay lower dividends. This will lead to a lower cost of investment leading to higher investments and hence will amount to an increase in change in the value of the firm (Type 2). If the D/E ratio is high and a higher dividend is paid, then the effect of dividend on cost of equity is high. This results in an increase in cost of equity which hence cost of capital increases marginally. This will, in turn, make the rate at which firms can invest increase thus leading to firms investing less and hence leading to a decrease in the change in the value of a firm (Type 4). Based on our rationale we identified TCS and Maruti Suzuki Ltd.as Type 2 firms. Infosys is a Type 4 firm and Tata Motors Ltd. is a Type 1 firm. This rationale was found to be prevalent in both manufacturing and service sector. Type 1 Tata Motors Type 2 TCS Maruti Suzuki Type 3 Type 4 Infosys

Firm

Table 3: Categorization of firms according to the 4 Types

Conclusion
From our findings we conclude that dividend has an effect on the value of the firm. The study fails to identify a generalized trend. Trends were observed sector wise and at times firm wise but nothing can be concluded for a firm as a whole. For example, dividend paid changes as EPS and growth change but their direction may not be the same. In manufacturing there is positive correlation while in service we cant say the same. Further we also saw that variations were observed in the dividends paid out in different sectors. While all the three sectors saw an increase in dividend being paid out in the last 3 years the increase seen in IT and banking (service) sectors was greater than seen in the manufacturing sector. Within the sectors we saw that the dividend paid out differs among firms. One of the factors which we identified was the share price. The greater the share prices the greater the dividend amount being paid. In conclusion, dividend paid affects the value of the firm. The effect is unique to each sector and also to each firm within that sector. It is the imperative of the finance manager to design the dividend policy according to the conditions prevailing in the industry and the firm.

DoMS, IIT Madras

[DIVIDEND POLICY: RELEVANT TO VALUE OF A FIRM?] September 21, 2011

Dividend Policy: Irrelevant to the value of a firm

Introduction
The MM propositions had silenced all questions related to capital structure and its impact on shareholder value, and thus making the policy redundant as far as its impact on shareholder value is concerned. However the MM theory has possibly not had the same impact on dividend policy. In a world where there are no taxes and there is no retention of cash, the dividend irrelevance holds true, but the moment we consider the real world and the alternative scenarios and options that exist with the owners we find that dividend policies are relevant. But the question still remains, do they add value? Are dividends good news or bad news for the investors? To answer these questions a variety of theories have been proposed. These include theories like signalling theory, agency theory, risk-averse investors etc.

Methodology
In this paper we have tried to observe and thereby understand the impact of dividends on shareholder value in a real world scenario. We have considered twenty companies across five different sectors over different periods of time to try and obtain a relationship if any between dividends and shareholder value. The sectors and the respective companies considered are: Oil and Gas: GAIL and ONGC. Power: NTPC. Information Technology: TCS, Wipro, Tech Mahindra, NIIT and Aptech. Banking: SBI, HDFC, Axis Bank, Allahabad Bank and IDBI Bank. FMCG: HUL, ITC and Godrej Consumer. Manufacturing: TVS Motor, Tata Motors, MRF and SAIL

The time periods considered are 2006 to 2011. The different periods of time have been considered to reduce the impact of economic cycles as much as possible. However, we have considered only Indian companies and not taken companies in different countries so that we keep the variables impacting shareholder value at an optimum level in accordance with the principle of parsimony. Another important point is that our analysis has been only for cash dividends and not for stock dividends. This is because stock dividends, whether in the form of stock bonuses or stock splits, lead to a reduction in shareholder value and hence do not really warrant an analysis. So all dividends mentioned in the charts below are cash dividends.

Analysis
The analysis is divided into two parts1. Impact of dividends on net gains 2. Regression analysis Impact of dividends on net gain To analyze the impact of the dividend declaration on the share value of the firms, we calculated the net gains on the share of a particular company, that is summation of dividend gains and capital gains. The stock prices taken for calculating capital gains are closing price of the previous day and closing price of the day dividend is declared. The change in stock price and dividend gain are added to obtain the net gain/ loss. The details are showed in table 4 and graph is plotted in figure 1. We found that 12 of the 20 companies had a negative net gain. One company had no gain/ loss. Seven companies had a positive gain on declaration of dividends. With the fact that companies from different sectors at different time periods had been considered, one can safely assume that intrinsic DoMS, IIT Madras 6

[DIVIDEND POLICY: RELEVANT TO VALUE OF A FIRM?] September 21, 2011

company factors have not been at play in causing the net loss. So, one can safely state that dividends do not add shareholder value or the impact to shareholder value is very small. However at this time we refrain ourselves from stating that dividends erode value without adequate analysis. S NO Company Face Value Dividend Declared Date of declaration Dividend Gain Pre Closing Market Price 2 493.7 16 14 814.95 6 421.77 3.5 768.3 1.4 1 20 7.2 12 5.5 3 3 10 0.5 1.2 0.8 0.5 3 44 63.45 161.25 2306.7 398.32 1157.4 171.35 122.65 302.55 131.28 63.35 177.3 78.65 52.09 200.2 8350 Post closing Market Price 489.35 Change Net in Gains Share Price -4.35 -2.35 0 16 811.85 -3.1 10.9 415.77 -6 0 773.6 5.3 8.8 62.1 158.35 2286.9 394.19 1186.5 164.65 125.95 298.7 135.75 61.4 176.7 78.84 52.26 203 7969.8 -1.35 -2.9 -19.8 -4.13 29.1 -6.7 3.3 -3.85 4.47 -1.95 -0.6 0.19 0.17 2.8 -380.2 0.05 -1.9 0.2 3.07 41.1 -1.2 6.3 -0.85 14.47 -1.45 0.6 0.99 0.67 5.8 -336

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

GAIL ONGC TCS WIPRO Tech Mahindra NIIT Aptech SBI HDFC Axis bank Allahbad bank IDBI bank HUL ITC TVS Motor SAIL Tata motors Godrej Consumer NTPC MRF

10 5 1 2 10 2 10 10 2 10 10 10 1 1 1 10 2 1 10 10

0.2 3.2 14 3 0.35 0.7 0.1 2 3.6 1.2 0.55 0.3 3 10 0.5 0.12 0.4 0.5 0.3 4.4

23-11-2010 01-12-2010 19-04-2010 23-04-2010 30-04-2010 21-05-2010 13-08-2010 11-05-2010 03-05-2010 20-04-2010 30-04-2010 30-04-2010 14-10-2010 21-05-2010 10-01-2011 28-12-2010 20-05-2004 11-10-2004
26-02-2010

25-11-2010

Table 4: Dividend declared and Net Gains for 20 companies

DoMS, IIT Madras

[DIVIDEND POLICY: RELEVANT TO VALUE OF A FIRM?] September 21, 2011

Net Gains
45 40 35 Net Gians in Rs. 30 25 20 15 10 5 0 -5 Net Gains

Company

Figure1: Plot of Net gains calculated in Table 4

Regression analysis To add rigor to the analysis we decided to perform regression analysis for one company from each of the sectors over a period of six years. In this section, one company is chosen from four sectors and net gains are calculated after dividend declaration in a way similar to previous section. The net gain from the shares of companies was regressed at different points against time. This analysis helps in minimizing the impact of short term macroeconomic factors in the analysis. The sectors and the respective companies considered are: Information Technology: Wipro Banking: HDFC FMCG: HUL Manufacturing: TVS Motor

From the graph plotted (Fig 2) we can see that net gains for all four companies after declaration of dividends is almost close to zero for almost all of the years. This again proves that the impact of dividends on shareholder value is minimal if not null at all.

DoMS, IIT Madras

[DIVIDEND POLICY: RELEVANT TO VALUE OF A FIRM?] September 21, 2011

Net gain for 4 companies after dividend declaration

30 25 20 15 Net Gina in Rs. 10 5 0 2011 -5 -10 -15 2010 2009 2008 2007 2006 WIPRO HDFC HUL TVS Motor

Year

Figure2: Net gains for four companies over 6 years after dividend declaration

Conclusion
The essence of the catering theory is that managers give investors what they currently want. In the case of dividends, catering implies that managers tend to initiate dividends when investors put a relatively high stock price on dividend payers, and tend to omit dividends when investors prefer nonpayers. Our empirical work focuses on the prediction that the rates of dividend initiation and omission depend on the current dividend premium, or the difference between the current stock prices of payers and nonpayers. Dividends are highly relevant to share value, but in different directions at different times. Moreover, managers apparently recognize and cater to shifts in investor demand for dividend payers. Investor attitudes toward dividends have changed over time. Once dividends are initiated, increases and decreases appear to be governed more by firm-level profitability than by the relative valuations of payers and nonpayers. Thus, in terms of aggregate economic significance, catering explains the number of payers but not the total payouts by existing payers. As a result, we suggest that catering be taken as a building block in an overall descriptive theory of dividend policy.

DoMS, IIT Madras

[DIVIDEND POLICY: RELEVANT TO VALUE OF A FIRM?] September 21, 2011

References
1. 2. 3. 4. 5. www.capitaline.com www.economictimes.com www.moneycontrol.com www.bseindia.com

Black, Fischer, The Dividend Puzzle, The Journal of Portfolio Management, winter 1976 6. Sujata Kapoor, Impact of Dividend Policy on Shareholders Value: A Study of Indian Firms, 2009
7. Mark E. Holder, Fredrick W. Langrehr, J. Lawrence Hexter, Dividend Policy Determinants: An investigation of the Influences of Stakeholder Theory, Autumn, 1998 8. Do Dividends Really Matter? :Merton H. Miller http://www.chicagobooth.edu/faculty/selectedpapers/sp57.pdf 9. Realizing the Impact of Stock Dividends: Market Analysis, Research & Education A unit of Fidelity Management & Research Company http://consultant.fidelity.com/download/3451879142/Realizing_the_Impact_of_Stock_Di vidends.pdf 10. Dividends vs. Capital Gains: Which is better?: JOHN CURRAN http://curiouscapitalist.blogs.time.com/2010/02/08/dividends-vs-capital-gains-which-isbetter/ 11. http://www.scribd.com/doc/28162428/Theories-of-Dividend-Policy

Appendix
1. Tables for EPS vs Dividend per share

TCS
16.00 14.00 12.00 10.00 8.00 6.00 4.00 2.00 0.00 50 45 40 35 30 25 20 15 10

Dividend per Share Earning Per Share

Figure 1.1: EPS vs Dividend for TCS

DoMS, IIT Madras

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Infosys
45.00 40.00 35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 Oct/09 Aug/09 Aug/10 Feb/10 Oct/10 Jun/09 Jun/10 Dec/09 Dec/10 Feb/11 Apr/10 Apr/11 114 113 112 111 110 109 108 107 106 105 104 103 102 101 100

Dividend per Share Earning Per Share

Figure 1.2: EPS vs Dividend for Infosys

Kotak Mahindra Bank

0.80 0.70 0.60 0.50 0.40 0.30 0.20 0.10 0.00 Oct/10 May/10 Mar/11 Jun/07 Nov/07 Sep/08 Feb/09 Jul/09 Dec/09 Apr/08 7.00 5.00 13.00 11.00 9.00 Dividend per Share Earning Per Share 17.00 15.00

Figure 1.3: EPS vs Dividend for Kotak Mahindra Bank

DoMS, IIT Madras

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SBI
35.00 30.00 25.00 20.00 15.00 10.00 5.00 0.00 Jan/09 Jan/10 Sep/08 Sep/09 May/08 May/09 May/10 Sep/10 Jan/11 May/11 110.00 100.00 130.00 120.00 Dividend per Share Earning Per Share 150.00 140.00

Figure 1.4: EPS vs Dividend for SBI

Maruti Suzuki
8 7 6 5 4 3 2 1 0 Jan/07 Jan/08 Jan/09 Jan/10 Jan/11 90 85 80 75 70 65 60 55 50 45 40 Dividend per Share Earning Per Share

Figure 1.5: EPS vs Dividend for Maruti Suzuki

DoMS, IIT Madras

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Tata Motors
25.00 20.00 15.00 10.00 5.00 0.00 55 50 45 40 35 30 25 20 15 10 Dividend per Share Earning Per Share

Jun/07

Figure 1.6: EPS vs Dividend for Tata Motors

2. Share Price and Announcements

Figure 2.1: Dividend, Bonus and Splits and Share price in Rs. for TCS

DoMS, IIT Madras

May/10

Mar/11

Nov/07

Sep/08

Feb/09

Dec/09

Apr/08

Oct/10

Jul/09

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Figure 2.2: Dividend, Bonus and Splits and Share price in Rs for Infosys

Figure 2.3: Dividend, Bonus and Splits and Share price in Rs for Kotak Mahindra Bank

Figure 2.4: Dividend, Bonus and Splits and Share price in Rs for SBI

DoMS, IIT Madras

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Figure 2.5: Dividend, Bonus and Splits and Share price in Rs for Maruti Suzuki Ltd.

Figure.2.6: Dividend, Bonus and Splits and Share price in Rs for Tata Motors

3. D/E ratio, Dividend Paid per Share and Value of the firm
Parameter\Year D/E DPS (in Rs.) Change in Value of the firm (%) Mar-11 0.0 65.00 29.49 Mar-10 0.0 23.50 12.35 Mar-09 0.0 37.25 22.36 Values Low Low Increasing

Table 3.1: D/E ratio, Dividend paid per share and value of firm for TCS

Parameter\Year D/E DPS (in Rs.) Change in Value of the firm (%)

Mar-11 0.0 65.00 11.19

Mar-10 0.0 23.50 23.74

Mar-09 0.0 37.25 32.02

Values Low High Decreasing

Table 3.2: D/E ratio, Dividend paid per share and value of firm for Infosys

DoMS, IIT Madras

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Parameter\Year D/E DPS (in Rs.) Change in Value of the firm (%) Mar-11 0.03 7.50 83.13% Mar-10 0.05 6.00 49.79% Mar-09 0.06 3.50 24.61% Mar -08 0.07 5.00 7.69% Mar-07 0.06 4.50 Values Low Low Increasing

Table 3.3: D/E ratio, Dividend paid per share and value of firm for Maruti Suzuki

Parameter\Year D/E DPS (in Rs.) Change in Value of the firm (%)

Mar-11 .93 20.00 4.15%

Mar-10 1.1 15.00 18.48%

Mar-09 0.97 6.00 75.30%

Mar -08 0.7 15.00 36.57%

Mar-07 0.56 15.00 36.59

Value High High Decreasing (Expect 2009 Because of Debt)

Table 3.4: D/E ratio, Dividend paid per share and value of firm for Tata Motors

4. Net Gains calculation companies after dividend declaration

Year WIPRO Face value Div Declared Dividend Gain Pre Closing MP Post Closing MP Change in Share Price Net Gains HDFC Face value Div Declared Dividend Gain Pre Closing MP Post Closing MP Change in Share Price Net Gains HUL Face value Div Declared Dividend Gain Pre Closing MP Post Closing MP Change in Share Price Net Gains DoMS, IIT Madras 2011 2 2 4 464 450.75 -13.25 -9.25 2 4.5 9 456.05 449.35 -6.7 2.3 1 3.5 3.5 274.7 284.45 9.75 13.25 2010 2 3 6 421.77 415.77 -6 0 2 3.6 7.2 398.32 394.19 -4.13 3.07 1 3 3 328.45 328.45 0 3 2009 2 2 4 164.55 168.99 4.44 8.44 2 3 6 220.14 238.94 18.8 24.8 1 4 4 232.9 226.05 -6.85 -2.85 2008 2 2 4 275.52 272.19 -3.33 0.67 2 2.5 5 309.5 302.97 -6.53 -1.53 1 3 3 193.7 193.05 -0.65 2.35 2007 2 0.5 1 347.34 342.48 -4.86 -3.86 2 2.2 4.4 205.23 201.21 -4.02 0.38 1 3 3 205.1 199.65 -5.45 -2.45 16 2006 2 2.5 5 342.09 335.94 -6.15 -1.15 2 0.55 1.1 161.26 163.1 1.84 2.94 1 2.5 2.5 209.45 224.45 15 17.5

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TVS Motor Face value Div Declared Dividend Gain Pre Closing MP Post Closing MP Change in Share Price Net Gains

1 0.5 0.6 63.35 61.4 11.1 11.7

1 0.5 0.5 58.23 59.68 1.45 1.95

1 0.7 0.7 24.6 25.65 1.05 1.75

1 0.7 0.7 12.25 12.93 0.68 1.38

1 0.15 0.15 31.7 32.28 0.58 0.73

1 0.6 0.15 50.3 52.38 2.08 2.08

Table 4.1: Net Gain calculation for 4 companies after dividend declaration

DoMS, IIT Madras

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