THE IMPACT OF DIVIDEND AND CORPORATE EARNINGS ON STOCK PRICES
This study was carried out to determine effects of dividends and earnings on stock price movement in Nigeria. This was done by examining the significance of cash dividend and corporate earnings on stock prices in the Nigerian Stock Exchange for a period of ten years from 1999 – 2008. The data sourced from Nigeria Stock Exchange reports and the company annual reports were analyzed using the regression tool. After the process of experimentation using this regression tool, the researcher observed that stock price movement is more significantly related to dividend than corporate earnings. Secondly, the optimization of corporate earnings influences positively stock price movement as many investors look at it as a significant factor for their choice for stock investment. This drive for such stock and the market price adherence to the law of demand and supply influences the stock price. Nevertheless, it is also observed that there is an autocorrelationship of the three variables, dividend, earnings per share and stock price in choice of stocks for investment. It is recommended, therefore, that Management should optimize their corporate earnings and derive a dividend and retention policy decision in an optimum manner to achieve the objective of maximizing the wealth of shareholders since the interrelationship of there decision have a significant impact/effect on equity share price.
It is also recommended that further works on this should be carried out in order to improve the body of existing knowledge in those areas in addition to a longitudinal study that will cover a time horizon of more than ten years should be conducted as this may enable a proper test on dividends and earnings. Management of this kind of investors should develop policies that will satisfy the investors and thus, enhance their firm’s value.
There should be a dividend pay out ratio that companies need to maintain so that they can enhance the value of their firms. Nevertheless, the study brings to the knowledge of all and sundry that investors in Nigeria are dividend driven and would therefore be willing to pay higher prices for stock that pay more dividend.
Finally, although factors like efficient market hypothesis, volume of equity, traded law of demand and supply etc influence investors decisions, but, suffice it to say that with available evidence, Nigeria investors are dividend driven as shown in the stock price movement/trend over the years.
TABLE OF CONTENTS
Title Page i
CHAPTER ONE – INTRODUCTION
1.1 Background of the Study 1
1.2 Statement of the Problem
1.3 Objectives of the Study 4
1.4 Research Questions 5
1.5 Hypotheses of the Study
1.6 Significance of the Study 5
1.7 Scope and limitations of study 6
1.8 Operational Definition of Terms 7
CHAPTER TWO – REVIEW OF RELATED LITERATURES
2.1 The Concept of Investment 11
2.2 The Nigeria Capital Market 12
2.3 The Stock Market 15
2.3.1 Trading 15
2.3.2 Importance of Stock Market 16
2.3.3 The Behaviour of Stock Market 17
2.4 The Stock Exchange 20
2.4.1 The Nigeria Stock Exchange 22
2.4.2 The Stock Exchange and Capital Formation in Nigeria 24
2.4.3 Broadening Ownership 25
2.4.4 Institutional Framework 26
2.4.5 Legal and Regulatory Environment 26
2.4.6 Savings Structure 27
2.5 The Stock Prices 27
2.5.1 Dividend Policy 30
2.5.2 Types of Dividend 31
2.5.3 Dividend Theories 32
2.5.4 Dividend Relevant Theories 32
2.5.5 Walter’s Model 33
2.5.6 Gordons Model 34
2.5.7 Bird in Hand Argument 34
2.5.8Dividend Irrelevance 35
2.5.9 Modigliani and Millers Hypothesis of Dividend 35
2.5.10 Methodology of Dividend Payment 38
2.6 Factors Determining Dividend Policy 40
2.6.1 Level of Profit 40
2.6.2 Perceived Further Profit 41
2.6.3 Existence of Profitable Investment Opportunities 41
2.6.4 Shareholders Preference 42
2.6.5 Liquidity 42
2.6.6 Available Sources of Fund 43
2.6.7 Existence of Legal Restriction 43
2.6.8 Perceived Impact of Dividend on Share Price 43
2.7 Information Content of Dividend 44
2.8 Relation of Stock Prices to Corporate Earnings 49
2.8.1 Stock Prices and Dividend 51
2.8.2 Growth Earnings and Dividend Distribution Policy 54
2.8.3 Linkages between Share Price, Earnings and Dividend 57
CHAPTER THREE – RESEARCH METHODOLOGY
3.1 Research Design 61
3.2 Nature and Sources of Data 61
3.3 Techniques of Data Collection 61
3.4 Population and Sample 62
3.5 Models 62
3.6 Analytical Techniques 63
CHAPTER FOUR – DATA PRESENTATION AND ANALYSIS
4.1 Introduction 65
4.2 Data Presentation 65
4.3 Data Analysis 67
CHAPTER FIVE – SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 Summary of Findings and conclusion 78
5.2 Recommendations 79
1.1 BACKGROUND OF THE STUDY
In a competitive economy, it is clear that investments are undertaken due to the available benefits perceived or which they provide to the investors. Investment in securities are for the purpose of earning income which could be in form of dividends, profits or/capital gains. With this in mind, it could be said that no right thinking investor will put his funds if he does not expect some form of returns. Apart from the above reasons, prestige, power, control etc. could also be adduced, but primarily, the motive is to earn some form of returns.
Stocks or securities are documentary evidence of ownership or entitlement to claim upon the income and the assets of the issuing organization, which may be a publicly or privately owned institution. Investments in securities are carried out through a market known as the stock market, commonly referred to as the stock exchange, an example of which is the Nigerian stock exchange and it is the centre point of the Nigerian Capital Market (NCM).
The stock exchange as the hallmark constituency of the capital market is many things at the same time. It is a place where debt and equity securities of varying types are traded transparently. It is a market that facilitates capital mobilization and allocation, as both governments and companies can raise funds through the market on long and most prudent terms through the offer of shares (by companies) and bonds (by companies and governments) http://www.tritune.com.ng/izii2007/managment.html
The Securities and Exchange Commission (SEC) is the apex regulatory institution of the Nigerian capital market and is charged among other things with the responsibility of approving the price at which securities of all companies quoted on the stock market are to be listed. The principal objective of vesting this role on the SEC is to protect the generality of the investing public who are unsophisticated and therefore cannot understand the nature and operation of companies sufficiently to be able to appropriate value on their securities.
Economic analysts have discovered a number of factors affecting stock prices on the stock market. Among the factors affecting stock prices are:
– Dividend policy of a company
– Corporate earnings and
– Volume of equity traded.
There has been a long standing controversy in academic circles as to which has greater impact/ influence on security prices. The dividend payment ratio is a major aspect of the dividend policy of the firm, which affects the value of the firm to the stock holders. The classical school of thought holds this view and they believe that dividends are paid to influence their share prices and furthermore, they believe that market price of an equity is a representation of the present value of estimated cash dividends that can be generated by the equity. The new classical schools of thought on the other hand, believe that the price of equity is a function of the earnings of the company. They believe that dividend payout is in no way relevant to evaluating the worth of an equity. What matters, they said is earnings.
Retained earnings provide funds to finance the firms long – term growth. It is the most significant source of financing a firm’s investment. Dividends on the other hand are paid in cash, thus the distribution of earnings utilizes the available cash of the company. When the firm increases the retained portion of net earnings, shareholders’ current income in the form of dividends decreases, but the use of retained earnings to finance profitable investments is expected to increase future earnings on the other hand, when dividends are increased, shareholders current income will increase but the firm may be unable to retain earnings and thus relinquish possible investment opportunities and thus future earnings.
Management therefore is in a dilemma to device a dividend and retention policy that divides the corporate earnings into dividend and retained earnings in an optimum manner to achieve the objective of maximizing the wealth of shareholders. The interrelation of these decisions and the impact/effect they have on equity share prices in the Nigerian capital market is the focus of this paper.
Attempts will also be made to explain movement of stock prices through a third approach known as “Efficient Market Hypothesis”. This hypothesis seeks to explain that security prices adjust to new information released to the market. Taking into consideration the basic assumption that the market is very rapidly processed so that securities are properly priced at a given time. An important premise of an efficient market is that a large number of profit maximizing participants are concerned with the analysis and valuation of securities. The hypothesis assumes that no stock price can be in disequilibrium or improperly priced for a very long time. There is almost instantaneous adjustment to new information. The hypothesis applies most directly to large firms trading on the major security exchange. It further assumes that information travels in a random, independent fashion and that prices are an unbiased reflection of all currently available information.
Having mentioned this, in Nigeria, the question of dividend payments by companies before 1988 have not been regulated by the company Acts but also by section 4 (5) of Decree No 30 of 1997 which gave a ceiling they must not exceed when they pay dividends to their shareholders. Today, the questions of dividend payments have taken a new dimension. Although, they are still being governed by the company and banking Acts for companies and banks respectively, dividend payments have now being liberalized. This could be evident in the productivity, prices and income board income policy guidelines (1988) which states that dividend payments have now being deregulated. The levels of distributable dividends are now at the discretion of individual companies.
The Securities and Exchange Commission evaluates new issues principally by the maintainable annual earnings method.
This method takes into recognition the profit of the time and asset of the firm. It is considered and believed that when a firm’s assets are judiciously used, earning are increased which in turn enhances the value of the firm. Conversely, loses reduce that value of a firm in the eyes of the investing public. It is also in this regard that one finds the issue very interesting and the question now (which is the subject matter of this study) is “what is the relevant impact of dividends and earnings on security prices movements in Nigeria?
Therefore, in critically analyzing the impact of dividend and corporate earning policy decisions on equity share prices in the Nigerian capital market, a theoretical framework of the effect of dividend policy decisions on the value of the firm would be considered.
1.2 STATEMENT OF THE PROBLEM
The volatility of the stock market and its attendant upward and downward swings in share prices have continued to confound critics and observers of the capital market. There have been diverse views as to the various reasons why share prices move the way they do. Various schools of thought have their own opinions as to the factors that influence share price movement.
Robert J Shriller in his article of 2nd January, 1987 questioned the volatility of stock market prices, “why are stock market prices so volatile?
He presents the standard derivation from 1871 to 1986 of the January to January percentage change in the real standard and poor composite stock price index as thus: The real price index rose 85% between 1927 and 1929, and fell 52% between 1929 and 1932. It rose 69% between 1954 and 1957. It fell 56% between 1973 and 1975. What is it that is so different about the demand for, or supply of, corporate shares from one year to the next that might account for such big price movements?
There is a contention in deciding on which of dividend and corporate earnings affects share price movements at the Nigerian stock exchange. At the Nigeria stock market, share price movements are every day affairs and have become synonymous with the market. This study therefore, has the major characteristic statement of problem in deciding the effect of dividend and corporate earnings on share price movements at the Nigerian stock exchange.
In the Nigerian context, the average investor in the capital market places a high emphasis on dividend payments, as most investors tend to be medium to long – term holders of stock. However, a larger part of investing public also do not have an in-depth knowledge of the various indices and variables at play in the market and therefore cannot fully appreciate the
requisite analysis of corporate earnings and dividend policies. This study therefore would critically appraise this problem.
1.3 OBJECTIVES OF THE STUDY
The broad objective of this study is to assess if stock exchange market is able to effect the federal belief that market price of share depends on streams of expected future dividends or corporate earning policy decisions. In other words, that market price of shares reflect fundamental values as contained in information released to the public through dividend policies.
The specific objectives of the study are as follows.
i. To find out the various variables at play in stock price movement at the Nigerian stock exchange.
ii. To determine the effects of dividend and corporate earning policy decisions on share price movements at the Nigerian stock market.
iii. To determine the relationship among the three variables dividend, corporate earnings and stock prices.
To accomplish the above objectives the study is designed to critically examine the contention of Graham and Dodd that stock prices bear a specific relation to dividends and earnings.
1.4 RESEARCH QUESTIONS
The research study will attempt to address the following questions at the end of the study.
i. What are the effects of dividend payment decisions on stock price movements?
ii. What are the relationship between stock prices and corporate earnings?
iii. What are the relationships among the three variables, dividend, corporate earnings and stock prices?
1.5 HYPOTHESES OF THE STUDY
Our hypotheses of the study are as follows.
H0 There is no positive correlation between dividend declaration and stock prices
H0 Corporate earnings of quoted companies do not have a significant positive effect on share price movements at the stock exchange.
H¬0 There is no positive relationship between dividend, corporate earnings and stock prices.
1.6 SCOPE AND LIMITATIONS OF THE STUDY
The fact that only the stock price of companies quoted on the public and that the legal requirement for public disclosure of dividend declaration applies only to such quoted companies makes it imperative that this study is limited to such companies.
The study covers a ten year period (1998-2007), and is based on reports of ten companies from financial and non financial institutions/companies. These are companies that filed all their returns with the stock exchange during this period. Data, used for the study were obtained from records maintained by the stock exchange in respect of share prices of these ten companies.
1.7 SIGNIFICANCE OF THE STUDY
This study will prove to be significant in the following ways;
It is believed that this work will add to the growing body of knowledge on the behaviour of stock prices.
It will enable management shape their dividend policy and increase their earnings when they know the degree of influence expected by these two variables.
It will be a contribution to the already established “Information content” of dividend hypotheses and the ability of prices in efficient capital markets to reflect fundamental value of revealed information released to the public through dividend policy announcements.
Moreover, the study will add to our knowledge of the level of efficiency of the Nigeria stock exchange market and will also help to assess the issue of rational behaviour of investors in the exchange and the level of “speculative bubbles” in exchange (if it exists).
There is an unconfirmed belief that investors and dealers in shares hardly undertake analysis before advice are given and investment decisions made. Perhaps, at the end of this study, more light will be shed on this, or the belief will at best remain unfounded.