AN EMPIRICAL ANALYSIS OF THE EFFECT OF AGENCY COST ON DIVIDEND – POLICY OF NIGERIA COMPANIES
INTRODUCTION
THE CONTROVERSY AS TO DIVIDENDS HAS REMAINED A KEEN AREA OF STUDY IN FIANCÉ LITERATURE. THIS IS EPITOMIZED BY WHAT BLACK (1976) REFERS TO AS THE ‘DIVIDEND PUZZLE’. THE PUZZLE REFERRED TO WAS THAT DESPITE THE CONSIDERABLE RESEARCH, THERE IS STILL A LACK OF CONSENSUS AMONGST RESEARCHERS, MANAGERS AND INVESTORS AS TO THE CONSEQUENCES OF AND THE MOTIVE FOR PAYING CASH DIVIDENDS.
ONE FACTOR CONTRIBUTING TO THIS CONTROVERSY IS THE FACT THAT DIVIDEND POLICY MEANS DIFFERENT THINGS TO DIFFERENT PEOPLE. ALSO THAT THE DIVIDEND DECISION ARE MIXED WITH OTHER CORPORATE DECISIONS AS FINANCING AND INVESTMENT. IT IS THEREFORE IMPERATIVE TO BE ABLE TO ISOLATE THE EFFECT OF DIVIDEND POLICY FROM THOSE OF OTHER FINANCIAL MANAGEMENT DECISIONS. AT THE HEART OF THE DIVIDEND PUZZLE THEREFORE IS TO ESTABLISH EH IMPACT OF CHANGE IN CASH DIVIDENDS, GIVEN THE FIRM’S CAPITAL BUDGETING AND BORROWING DECISIONS. WHERE THE FIRMS INVESTMENT OUTLAYS, BORROWING AND OPERATING CASH FLOW ARE FIXED, THE ONLY ADDITIONAL SOURCE OF DIVIDEND PAYMENT IS NEW SHARE ISSUES. THUS DIVIDEND POLICY REFERS TO THE TRADE-OFF BETWEEN RETAINING EARNINGS ON ONE HAND AND PAYING OUT CASH AND NEW ISSUE OF SHARES ON THE OTHER.
THE MODIGLIANI AND MILLER (1958,1961) ARGUE THAT IN A FRICTIONLESS WORLD, WHEN INVESTMENT POLICY IS HELD CONSTANT, TRANSACTION COST AND TAXES ARE IGNORED, DIVIDEND POLICY HAS NO EFFECT ON SHAREHOLDERS WEALTH. WITH HIGHER DIVIDEND PAYOUTS, RETAINED EARNINGS DECLINES TOGETHER WITH CAPITAL APPRECIATION, THUS LEAVING TOTAL WEALTH OF THE SHAREHOLDER UNAFFECTED. UNDER THE ASSUMPTIONS OF PERFECT CAPITAL MARKET, RATIONAL BEHAVIOUR OF INVESTORS AND ‘PERFECT CERTAINTY’ ABOUT THE FUTURE, THE VALUATION SHOULD FOLLOW THE PRINCIPLE THAT “…THE PRICE OF EACH SHARE MUST BE SUCH THAT THE RATE OF RETURN ON EVERY SHARE WILL BE THE SAME THROUGHOUT THE MARKET OVER ANY GIVEN INTERNAL OR TIME” (MODIGLIANI AND MILLER 1961). IF NOT SO THE DIFFERENTIAL IN RATE OF RETURN WILL BE ELIMINATED BY ARBITRAGE. THE CONVERSE ALSO HOLDS TRUE.
LITNER (1956) PROVIDES EMPIRICAL EVIDENCE THAT COMPANIES FOLLOW A DELIBERATE DIVIDEND PAYOUT STRATEGY. THIS EVIDENCE THUS RAISES A PUZZLE HOW DO FIRMS CHOOSE THEIR DIVIDEND POLICY?
IN COUNTRIES WHERE GAINS ARE TAXED DIFFERENTLY FROM DIVIDENDS THE PUZZLE IS COMPOUNDED. THIS TAX EFFECT ON DIVIDEND HAD RECEIVED MUCH ATTENTION IN EMPIRICAL LITERATURE (PORTEBA AND SUMMERS 1985) AND ALLEN AND MICHEALY (1977). TAX BURDEN FURTHER COMPLICATES THE DIVIDEND POLICIES OF FIRMS. AN INCREASE IN THE DIVIDEND PAYOUT REDUCES THE MARKET VALUE OF A COMPANY, WHENEVER DIVIDENDS ARE TAXED MORE HEAVILY THAN CAPITAL GAINS. BREALY (1997) ARGUES THAT THE FACT THAT INVESTORS PAY TAXES AT DIFFERENT RATES ON INCOME RELATIVE TO CAPITAL GAINS PROVIDE INCENTIVE TO HOLD PORTFOLIOS WITH DIFFERENT EXPOSURE TO DIVIDEND YIELD. THUS INVESTORS WILL PREFER TO HOLD PORTFOLIO EXPOSED TO HIGH-DIVIDEND STOCKS WHEN PERSONAL TAXES ON CAPITAL GAINS IS LOWER THAN TAX ON DIVIDENDS.
A NUMBER OF EXPLANATIONS HAVE BEE ADVANCED TO EXPLAIN THIS PUZZLE. OR THESE, THE IDEA THAT FIRMS CAN SIGNAL THE FUTURE PROFITABILITY BY PAYING DIVIDENDS (BATTACHARYA, 1979), JOHN AND WILLIAMS 1985, MILLER AND ROCK 1985, AMBARISH ET AL 1987). THIS THEORY HAS RECEIVED LIMITED EMPIRICAL VALIDATION SUCCESS, SINCE FIRMS THAT INITIATE DIVIDENDS EXPERIENCE SHARE PRICE INCREASES, AND THE CONVERSE IS TRUE FOR FIRMS THAT REDUCE DIVIDENDS (AHARONY AND SWARY 1980, ASQUITH AND MULLINS 1983). RECENT EMPIRICAL RESULTS PROVIDE MIXED RESULTS AS CURRENT DIVIDEND CHANGES DO NOT HELP PREDICT FIRMS FUTURE EARNINGS GROWTH (DEANGELO ET AL 1996 AND BENARTZI ET AL 1997). HOWEVER NONE OF THESE THEORIES HAS ADEQUATELY EXPLAINED THE DIVIDEND PUZZLE BEYOND ALL CONTROVERSIES, THUS INCREASING THE FOCUS DRAWN TOWARDS HYPOTHESES BASED ON INFORMATION ASYMMETRY: THE INFORMATION CONTENT OF DIVIDENDS AND THE AGENCY COST EXPLANATION OF DIVIDEND POLICY
THE BASIC OF THE AGENCY COST THESIS IS THAT IT TAKES INTO COGNIZANCE TWO POINTS WHICH THE M-M THEOREM IGNORES. FIRST IS THAT INVESTMENT POLICY CANNOT BE INDEPENDENT OF DIVIDEND POLICY AND THAT IN PAYING DIVIDENDS THE EFFICIENCY OF MARGINAL INVESTMENT MAY INCREASE. SECOND POINT IS THAT THE ALLOCATION OF PROFITS OF THE FIRMS AMONGST SHAREHOLDERS PROPORTIONALLY CANNOT BE ASSUMED WAY. ON THE BASIS OF SHAREHOLDER CHARACTERISTICS, DIFFERENT SHAREHOLDERS HAVE DIFFERENT CAPABILITIES TO INFLUENCE THE POLICIES OF THE FIRM. SHAREHOLDERS WITH MANAGEMENT ROLE GET PREFERENTIAL TREATMENT IN ALLOCATION OF THE FIRM’S PROFIT (LAPORTA ET AL 2000). THIS THEY DO BY ASSET DIVERSION, THEFT OR THOUGH INVESTMENT STRATEGIES THAT CONFER PERSONAL BENEFITS.
IN THE CONTEXT WEAK CORPORATE GOVERNANCE, OPERATING WITHIN A FRAMEWORK OF WEAK PUBLIC GOVERNANCE, CHARACTERIZED WITH LOOSE REGULATORY FRAMEWORK, THE POSSIBILITY OF THE FOREGOING IS STRONG. THIS STUDY SEEKS TO ANALYZE IF DIVIDEND DISTRIBUTION IS A METHOD OF ALIGNING MANAGERS INTEREST WITH THOSE OF SHAREHOLDERS IN THE NIGERIAN CORPORATE ENVIRONMENT.
1.2.STATEMENT OF RESEARCH PROBLEM
THE EVIDENT LACK OF CONSENSUS AMONGST ECONOMISTS, MANAGERS AND INVESTORS ABOUT THE SHARE PRICE CONSEQUENCES OF AND THE CORPORATE MOTIVES FOR PAYING CASH DIVIDENDS HAS SPURNED A LOT OF THEORIES. SEVERAL SCHOOL OF THOUGHTS HAVE EMERGED, ONE SUPPORTING THE RELEVANCE OF DIVIDEND POLICY, ANOTHER POSITING THAT DIVIDENDS ARE IRRELEVANT YET A THIRD ONE SUGGESTING A NEGATIVE IMPACT ON THE FIRMS VALUATION.
THE PURPOSE OF THIS INVESTIGATION IS TO DETERMINE THE IMPACT OF AGENCY COST ON DIVIDEND POLICY. MORE SPECIFICALLY ANSWER TO THE FOLLOWING QUESTIONS ARE SOUGHT.
IS DIVIDEND DISTRIBUTION A METHOD OF ALIGNING THE INTEREST OF MANAGERS WITH THOSE OF THE SHAREHOLDERS?
IS THERE A POSITIVE RELATIONSHIP BETWEEN DIVIDEND PAY OUT RATIO AND NUMBER OF COMMON SHAREHOLDERS?
IS THERE NEGATIVE RELATIONSHIP BETWEEN DIVIDEND PAYOUT RATIO AND LEVEL OF OWNERSHIP BY INSIDERS?
IS THERE A NEGATIVE RELATIONSHIP BETWEEN DIVIDEND PAYOUT RATIO AND THE FIRM’S RISK?
IS DIVIDEND PAYOUT RATIO NEGATIVELY RELATED ANNUAL GROWTH RATE OF SALE AND EXPECTED GROWTH RATE OF SALES.
The Modigliani-Miller theorem states that in a frictionless world, when investment policy of a firm is held constant, the dividend policy has no consequence for shareholders. Empirical reality is that different companies deliberately have different dividend policies. Empirical evidence therefore provokes the question as to how firms choose their dividend policies. The assumption of a perfect market is far removed from the situation that we have in emerging markets as Nigeria. These markets exhibit such peculiarities that tend to make them less efficient in processing information into the value of securities. The quality corporate governance in the Nigerian Capital Market is not up to the standard in developed markets of the West. The quality of corporate governance has implication for investment policy and other financial policies of the firm. Markets with poor corporate governance are likely to exhibit the dominance of insiders (Management) in determining financial policies. Insiders as agents of the shareholders, in the face of information asymmetry, largely determine the nature of finance policies. This is accentuated where the level of shareholder activism is weak, resulting in high agency cost, required to align the interest of management with those of shareholders. Literature suggest that dividend payments is one mechanism of reducing agency cost,
The fundamental objective of this study therefore is to determine the impact of agency costs on the dividend policy of Nigerian companies. The other key objective is to determine if the payment of dividends results in the alignment of management interest with those of shareholders of companies in the Nigerian capital markets.
RELEVANCE OF STUDY
The dividend payout policy is one critical decision which management has to make. It is the duty of management to fix dividend payments, hence fashion a dividend policy. The controversy is to the consequence of dividends for the shareholder value has remained since the seminal work of Modigliani and Miller (1958, 1961). A number of studies suggest that most firms have long-term target dividend payout ratio, and that firms engage in dividend smoothening by moving towr5ds the target payout each year. Managers believe that the dividend decision is associated with investment decision and the financial mix decision. Dividend decision feeds back on the investment decision, and has a immediate impact on the firm’s capital structure.
This study has significance at several levels. At the level of scholarship with respect to resting the dividend controversy, title empirical study has been conducted in emerging markets as Nigeria. This study thus contribute empirical evidence in face of numerous theories of dividends, giving the insight into the peculiarities of developing economies as Nigeria, with different institutional structures from those of developed economies.
In recent times the capital market has become a source of long term finance of companies in Nigeria. Investor enthusiasm is evident as IPO of some firms have been oversubscribed. With the quality of corporate governance and public governance, this study provides investors with information as to whether management of companies (agents) synchronize their interest with those of their principal the shareholders.
This study is also relevant for regulatory agencies with the sole objective of improving the market mechanism, protection of investors, and sustaining investor confidence in financial instruments. The impact of agency cost on dividend policy, points to the nature of alignment of interest of shareholders and management, thus regulatory authorities can fashion policies that would strengthen the workings of the capital markets.
SCOPE OF THE STUDY
This study covers companies quoted on the Nigerian stock exchange. The choice of these companies derives from the fact that data extracted from their financial statements are subjected to regulations of the Companies and Allied Matters Act 1990 and the Statement of Accounting Standards (SAS) issued by the companies. The exclusion of financial firms is based on the fact that banks and insurance firms are subject to specific rules and regulation that makes their dividend policy exogenously affected by factors unrelated to their financing needs. The study is covers the year 2005.
RESEARCH HYPOTHESIS
The agency problem is that of the relationship between managers and shareholder. The basic question is that of aligning the interest of mangers with those of shareholders and how this impacts upon the fashioning of financial policies of the firm. We raise the following hypothesis.
Hypothesis 1
Transaction cost are incurred in raising external finances from the capital market, when earnings are paid out as cash dividends. Thus dividend payout ratio is negatively related to past growth of revenues and predicted future growth of revenue of companies in Nigeria
Hypothesis 2
The second hypothesis relates dividend pay out ratio to the firm’s risk. Transaction cost is directly related to the firm’s risk – the firm’s operating leverage and financial leverage. Rozeff (1982) considers the firm’s beta as a estimator of financial and operating leverage. We hypothesizes therefore that dividend pay out ratio is negatively related to beta coefficient of companies in Nigeria.
Hypothesis 3
Our third hypothesis is states that dividend pay out ratio is positively related to the number of common shareholders, because agency problems and cost of monitoring increase as the number of common shareholders increases.
Hypothesis 4
Another variable to measure agency cost is the proportion of share hold by insider (directors). As the proportion of shares in the hands of insiders increase, it reduce the influence of outsiders on corporate policy, thus management will tend to increase their own personal benefits. We therefore hypothesize that dividend payout ratio is negatively related to proportion of shares held by insiders.
LIMITATIONS OF THE STUDY
One fundamental limitation of this study is that we unable to examine all the financing and payout choices facing the companies. Laporta et a (2000) state that “the prediction of these models that we test are necessarily limited by the fact that we do not look at all financing and payout choices simultaneously”.
Jensen and Mecklin (1976) argue that debt is a veritable mechanism of addressing the agency problems. This study does not take into cognizance this debt factor.
Corporate governance quality is a factor that is important in the agency problem. The incorporation of variables to capture the impact of corporate governance on agency cost, improves the study. This study does not include a corporate governance due to reduced information available and the fact that the Nigerian Capital Market does not have a corporate governance index
This study is a cross sectional study for the fiscal year 2006 and 2007. The paucity of information is the strongest limitation to this study.
