Chapter 1 Introduction 1


Chapter 1
Introduction
1.1 Background of the Study
A company can use different sources of funds to manage required capital. Debt capital and ownership capital are main sources of financing. The holder of debt capital is called debt holder or lender of the company whereas holder of ownership capital is called shareholder. Debt holders receive interest and shareholders receive dividend. When a company earns profit, it can retain with in company or can pay to shareholder as a dividend. Dividend is the part of total earning which is distributed to the shareholders by a company. It can be distributing in cash and securities or combination of these.
Dividend Policy refers to a company’s policy which determines the amount of dividend payments and the amounts of retained earnings for reinvesting in new projects. This policy is related to dividing the firm’s earning between payment to shareholders and reinvestment in new opportunities. Ross et al (2005) define corporate dividend policy, simply, as determining the amount to be paid to the shareholders and that to be retained in the company to reinvest in profitable projects or for retention in case of future needs. Booth and Cleary (2010) defined dividend policy as an exclusive decision by the management to decide what parentage of profit is distributed among the shareholders or what percentage of it retains to fulfill its internal needs.
Dividend policy is a firm’s strategy with regards to paying out earnings as dividends versus retaining them for reinvestment in the firm. It is thus an important part of the firm’s long-run financing strategy. Every firm operating in a given industry follows some sort of dividend payment pattern or dividend policy and obviously it is a financial indicator of the firm. Thus, demand of the firm’s share should to some extent, dependent on the firm’s dividend policy (Abdullah Al Mausum, 2014). Dividend policy related with the determining the amount to be paid to the shareholder and retained in the company for future reinvestment in profitable projects or for other justifiable needs is one of the cardinal issues involved in financial management and as such it has consistently received serious attention of researcher, Ramadan (2013). Dividend payment is a major component of stock return to shareholders. Dividend payment could provide a signal to the investors that the company is complying with good corporate governance practices (Jo and Pan, 2009).
Dividend policy is one of the most important issues in corporate finance. Dividend policy is important for investors, managers, lenders and for other stakeholders. It is important for investors because investors consider dividends not only the source of income but also a way to assess the firms from investment points of view. It is the way of assessing whether the company could generate cash or not. Many investors like to watch the dividend yield, which is calculated as the annual dividend income per share divided by the current share price. It is important for manager because it helps to increase value of firm. Similarly, it helps to lender and other stakeholder to know about financial strength and weakness. The twenty-first century has seen dividend policy remain one of the most important financial policies used in financial management to achieve the objective of wealth maximization (Baker & Kent, 2009). Frankfurter and Wood (2002), posits that a number of conflicting theoretical models all lacking strong empirical support, define current attempts to explain corporate dividend behavior. Moreover, both academics and corporate managers continue to disagree about whether the value of the firm is independent of its dividend policy.
Many researchers have attempted to relate the dividend policy to share price of firm but they had conflicting results and still, there is no consensus among researchers about the impact of dividends policy on share price. The Miller and Modigliani’s(MM) theory states that shareholder wealth will remain unaffected by dividend policy, in that without tax as a consideration, investors place equal weight in receiving returns as dividends or capital gains as long as the firm’s investment strategy is not affected by dividend policy. Another finance scholar, Al-Malkawi (2007), suggested through his Bird-in-the-Hand Theory, that dividends are worth more than retained earnings to investors, citing the uncertainty of future cash flows. This theory argues that dividend is main factor to increase value of firm.
The issue of whether or not dividend policy has a relationship with market share price has been a topic of intense debate for many years. Some research shows there is direct positive relation between dividend scheme and market price, some study shows dividend is insignificant for market price of stock price.
In Nepal, there are few studies have been conducted about dividend policy. Commercial banking sector is a most attractive sector for investor. However, the share price of commercial banks is fluctuating. There are different factors that affect market price of stock So this research is going to study about whether dividend scheme of commercial banks is major factor for fluctuation of market price of stock or not. This research focus on dividend policy of the commercial banks and shows the relation with market price of the stock. There are number of factor that affect market price of stock. Dividend maybe one of major factor which affect price of stock. There are some of study that has been conducted to check the relationship between dividend policy and market price of stock in Nepal. Those studies show a direct relationship between stock price and dividend policy. But there is a lack of specific study about dividend policy of commercial banks and its effect on stock price. So this research focus on the commercial banks listed in NEPSE. This study examined the impact of dividend policy of commercial banks in their market price. The debate about dividend policy and stock price is tested in the Nepalese banking sector. This study showed that whether dividend policy of commercial banks is directly related with stock price or not.

1.2 Problem statement

The issue of whether or not dividend policy has a relationship with share price volatility has been a topic of intense debate for many years. The decision of whether or not to distribute earnings to shareholders has left the opportunity for many finance scholars and professionals to examine its various effects. Many academic works have provided evidence that both support and reject the idea that dividends reduce stock price volatility. Some argue that dividends signal to investors that the company is operating effectively, while others argue that when all other variables are fixed, the payout of dividends does not effectively reduce the stocks volatility.
Recently, studies on relationship between dividend policy and stock price have been growing in the world. But there are very limited studies about divided policy and stock price in Nepal. In 2012 Rabindra, Joshi conduct study to explain relationship between dividend and stock price in banking and nonbanking sector. He has focused on overall business scenario of Nepal. Studies about divided policy of commercial banks and stock price are rarely found in Nepal. So there is gap in the financial literature concerning the effect of dividend on stock prices particularly in hydro sector of Nepal. Such gap creates confusion to the investor, manager, researcher, government and other stakeholders. So the major problem of this study is: what is the impact of dividend on stock price of commercial banks listed in NEPSE?

1.3 Purpose of the Study
The main purpose of this study is to evaluate the impact of dividends on share price of commercial banks listed in NEPSE. To achieve this objective following specific objectives will cover by this research.
• To find the relation between the Market Price per Share and the Dividend per Share.
• To evaluate the dependency of share price on retained earning
• To assess impact of earning per share on share price.
• To analyze whether size, leverage and net worth per share has any impact on market price per share.
• To find out whether previous year dividend, previous year price earnings ratio and previous year market price per share has impact on current market price per share.

1.4 Research Hypothesis
Hypothesis is tentative statement about relationship between two or more variables. It is supposition that is previously accepted in order to interpret certain issue. This study has some hypothesis to achieve objectives. They are as follows.
Hypothesis 1:
H0: There is no significant relationship between market price per share and dividend per share.
H1: there is significant relationship between market price per share and dividend per share.

Hypothesis 2:
H0: There is no significant relationship between market price per share and retain earning per share.
H1: There is significant relationship between market price per share and retain earning per share.

Hypothesis 3:
H0: There is no significant relationship between market price per share and EPS.
H1: There is significant relationship between market price per share and EPS.

Hypothesis 4:
H0: There is no significant relationship between market price per share and lagged price earnings ratio.
H1: There is significant relationship between market price per share and lagged price earnings ratio.

Hypothesis 5:
H0: There is no significant relationship between market price per share and lagged market price per share.
H1: There is significant relationship between market price per share and lagged market price per share.

Hypothesis 6:
H0: There is no significant relationship between market price per share and lagged dividend per share.
H1: There is significant relationship between market price per share and lagged divided per share.

1.5 Rationale of Study
A number of studies on impact of dividends on stock price have been carried out in different parts of the world. Most of the earlier studies show the significant role of dividend policy on stock price. The corporate firms should follow the appropriate dividend policy to maximize the shareholders’ value. Dividend policy is considered as one of the important and critical variables affecting the share price. In the context of Nepal, very few studies {such as Pradhan (2003), Manandhar (1998), Rabindra Joshi, (2012)} have carried out by research scholars. There is a gap in the financial literature concerning the effect of dividends on stock prices particularly in commercial banking sector. This study will provide a deeper understanding on the true correlation between commercial bank’s dividend policy and stock price. The study will further investigate whether a company’s dividend policy is the best indicator of a less volatile stock, which can reassure them of a safe and stable investment.

So this study will fulfill the gap about the effect of dividend on stock price in Nepalese banking sector. The result of this study will be significantly useful to various groups that have directly or indirectly linked to capital market. Those groups are policy maker, financial analyst, researcher, investor and others.

1.6 Scope and limitations of the study
The limitations of the study are as follows:
1. This study is done based on quantitative data. But qualitative information like political situation, government rule, regulation and policies, NRB regulation etc. also have direct impact on market price per share.
2. The data are taken from secondary source.
3. Scope is limited
4. The dependent variable, market price per share used in this study is computed only on the basis of the year end closing price of the commercial banks. Inclusion of whole year average would have made the data for market price per share more reliable.
5. Some of the commercial banks are excluded because these companies have not listed on NEPSE and paid dividend
6. The finding of primary study is only based on limited person’s perception.
7. The study has not included some other important variables like, book to market price, profit after tax, liquidity and ROE that could affect share price.

1.7 Definition of terms
Dependent variable:
1. Market price per Share (MPS):
Market price per share is taken as dependent variable and it is defined as the closing price of the stock (at the end of the year). It is derived directly from the annual report of NEPSE. The share price in this study represent annually. In the previous studied researchers like Nazir, Nawaz, Anwar, & Ahmed (2010), Asghar, Shah, Hamid, & Suleman (2011), Hussainey, K., Mgbame, C.O., & chijoke-Mgbame, A.M. (2011) Rabindra Joshi(2015) Dr.NiharikaMaharshi and Sarika Malik(2015 use market price as a dependent variable to see the effect of dividend policy on stock market prices. Khan (2010) found that cash dividend retention ratio and return equity has significant positive relation with stock market prices.
2. Independent variable
a) Dividend Per Share (DPS)
In this study total dividend per share is taken as dependent variable. Total dividend per share refers to cash dividends and stock dividends paid to common stockholders are divided by the number of share outstanding. It is important variable that is used by Litner (1956), Gorden, Khan, Modigliani and Miller (1961)
b) Retained Earnings Per Share (REPS)
Retained earnings remaining income after distributing the dividend. Retained earnings per share is used as independent variable on this study. Retained earnings per share is calculated by deducting dividend per share with earning per share.
In context of Nepal, Bhattarai (1995) found that there was a negative relationship between MPS and stockholders’ required rate of return.
Control Variables
a) Size (SZ)
Size is one of the control variables of this study. It is the total assets of the commercial banks. A transformation using the base 10 logarithm is then applied to obtain a variable that reflects orders of magnitude (Hussainey et al., 2010). The figures were obtained directly from annual report. This variable has been used by (Smith and Watts, 1992; Kouki and Guizani, 2009; Chae et al., 2009).
b) Leverage
The total debt to total assets ratio is taken as leverage on this study. Total debt is sum total of current liabilities and long term debt. And total assets is sum total of current assets and fixed assets of company. Each year’s debt ratio is calculated by averaging the debt ratio of companies. This variable has been used by various researcher like Lev and Kunitzky (1974), Gaver, and Gaver, (1993), Gul, (1999), Kallapur and Trombley, (1999) and Habib et al. (2012).

1.8 Structure of the study
This study is divided in to five chapters.
First chapter
This contains the introduction which includes background of the study, statement of problem, rational of the study, hypothesis scope and limitation of the study and definition of terms.
Chapter II
It deals with the conceptual framework and review of literature that includes the conceptual framework, review of literature or empirical works, review of Nepalese studies and concluding remarks.
Chapter III
This chapter describes the research methodology employed in the study. It deals with research design, nature and sources of data, selection of enterprises, method of analysis
Chapter IV
It deals with the presentation and analysis of secondary data and primary data to indicate facts on dividend practices and impact on market value of companies. It is about the results drawn from the analysis of the collected and processed data.
Chapter V
This chapter includes summary, conclusion and recommendation of the study. It presents the major findings and compares them with theory and other empirical and provides recommendation if it is necessary.