Dividend policy is a framework that regulates financial decisions associated with profit payout. However, the effect of dividend policy is a subject of debate. Price earnings and stock value influence a firm’s dividend policy. However, economic analysts counter the assumption using different dividend theories. Two criteria facilitate the dividend theories in a decision-making process (Davila & Foster 2005). Dividend policy is determined by financial decisions.
The long-term decision and wealth maximization facilitate the recommendations of the financial manager. The assumption of the dividend policy can be classified into three groups. The first group believes that dividend payouts improve the firm’s growth and development. However, the second group believes that dividend policy controls the firm’s profit. The third group believes that the dividend decision has no effect on the firm’s earnings and profit. As a result, the third group postulated the irrelevant theory to validate their argument.
Modigliani & Miller Model (M&M) proposed that dividend policy decisions do not affect the firm’s valuation. Thus, dividend policy should not be considered in a firm’s financial decisions. M&M postulated four assumptions to affirm their views on dividend policy. The assumption states that in a perfect market, investors cannot alter the stock price index.
M&M used tax effect, flotation cost, and investment policy to validate their submission on dividend policy. Previous studies have been conducted to test the significance of Modigliani-Miller Model. Davila and Foster (2005) revealed that M&M theories were difficult to conduct using their assumptions. Previous empirical studies on dividend policy supported the assumptions of Modigliani & Miller Model (Fischer & Scholes 1974). The findings showed that dividend coefficient was not significant.
Barker, Farelley and Edelman (1985) conducted empirical studies on divided policy determinants using Modigliani & Miller’s Model. They analyzed 562 firms to determine the significance of the M&M model. The findings revealed that dividend policy is associated with a firm valuation. Baker & Powell (1999) revealed that a firm’s dividend policy affects stock value. Gordon’s theory argued that dividend policy affects a firm’s stock price.
The Bird in Hand theory (BIHT) is based on two assumptions. One, the rate of return on investment affects the investor’s decision. Two, investors align with defined investments than uncertain transactions. He argued that higher returns on investment decrease the cost of capital. Empirical studies revealed that the BIHT affects the firm’s dividends and earnings. Kent, Veit & Powell (2001) revealed that investors are rational on dividends than retained earnings.
Issa (2012) revealed that the Bird in Hand theory validates the significance of the dividend policy. The tax-preference model describes the significance of tax deductions on capital gains and dividends. Empirical studies revealed that tax preference affects the firm’s return on investment. El Khoury & Maladjian (2014) suggested that dividend payout affects the firms profit and valuation. Keim (1985) conducted empirical studies on 429 firms in the US.
He studied the relationship between return on investments and dividend yield. The findings revealed that the relationship between stock return and dividend yield is non-linear. Consequently, Morgan & Thomas (1998) tested the tax hypothesis on a firm’s stock return and dividends. The findings revealed that the tax hypotheses affected the firm’s return on investment.
Previous literatures have been used to analyze the determinants of dividend policy. The empirical studies used one dividend policy to test the significance of the determinants (Alsaeed 2005). Ahmed & Javad (2009) concluded that the determinants of dividend policy include profit, firm size, business risk, ownership, tangible asset, and maturity.
Mahira (2012) revealed that dividend payout, stability of dividends, legal constraints, ownership considerations, capital market considerations and inflation determines a firm’s dividend policy. Osman & Mohammed (2010) analyzed the significance of dividend policy in Saudi Arabia.
The inclusion criteria for the study were dividend payout, advantage, and zero tax deductions. The authors revealed that business risk, firm size, and profit influenced dividend policy in Saudi Arabia (Osman & Mohammed 2010). Previous literatures grouped the determinants of dividend policy into financial and non-financial markets. However, the determinants of non-financial markets include agency cost, ownership, advantage, tangible assets, and age.
Al-Malkawi, Rafferty, & Pillai (2010) analyzed the determinants of dividend policy on the GCC stock markets. The sample population was selected from non-financial markets. Consequently, data information for non-financial markets between 1993-2003 was used as sample population. As a result, the authors used seven determinant models to analyze the sample population. The results revealed that ownership, size, and profit influenced the firm’s dividend policy (Al-Malkawi, Rafferty, & Pillai 2010).
However, leverage ratio was not significant to the study. As a result, stocks listed on the GCC must update the dividend policy to support short-run target. The result was consistent with previous empirical studies on dividend policy. Mehta (2012) analyzed the determinants of dividend policy on UAE financial markets. He selected construction firms, energy companies, and telecommunication firms. Statistical regression method was used for the empirical study. The research findings revealed that profit and firm size influenced the dividend policy in the UAE.
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