1. simply dividend policy is the set of

 

1.      Introduction

This
chapter mainly deal with previous literature such as book, research articles it covers a wide area of dividend policy,
share price, importance of share price for a company, about Colombo stock
exchange and the central depository system, and related theories of dividend
policy and share price, and finally empirical reviews of about dividend policy
and its impact on share price.

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1.1.   Colombo
stock exchange

Colombo
stock exchange is one of the rapidly growing stock exchanges in the world.
After 30 year of civil war internal as well as external investors are willing
to invest in Colombo stock exchange. CSE has 295 companies in 20 different
business sectors with a market capitalization of Rs. 2919.7 Bn. All public companies
are incorporated under the company act and any other all institution
established under the law of Sri lanka.

 

1.2.   Importance
of share price for a company

Share
price is a most important element for a company. It shows company’s
performance, profitability, and strength of the company to their stakeholders.
Which mean share price is the indication of the overall strength
and health of a company. When stock price
is high, company can attract potential
investors. And also it is showing that the company and its management are doing
a great job. Therefore, If the company has high and competitive share price in
the market, company performers may better than other companies.

 

 

 

2.      Theoretical
Background

 

2.1.   Dividend
policy

In
simply dividend policy is the set of procedures a company uses to decide how
much of its earnings it will pay out to shareholders. But some researchers
argued that investors are not concerned with a company’s dividend policy since
they can sell a portion of their portfolio of equities if they want cash. It is
called dividend irrelevance theory introduced by Miller and Modigliani, (1961).
 Dividend policy is one of
the most important policies used by firms,
because when company earn profits, management
can pay it as a divided or retain portion of earnings for re investment in the
firm so it is an important part of firm’s long run financing strategy.

 

2.2.   Determinants
of dividend policy

Determinants
of dividend policy is border concept. There are numerous factors affecting to
determines and measures of dividend policy such as investment opportunity,
Leverage ratio, free cash flow, tangibility of asserts, business risk, business
life cycle, firm size, profitability, dividend distribution tax, liquidity.
According to Labhane and Mahakud, (2016) investment
opportunity, financial leverage, size of the company, business risk, firm life
cycle, profitability, tax and liquidity are the major determinants of the
dividend policy. These results were robust across the period also. And the
research was confirmed that the pecking order, transaction cost, signaling
and firm life cycle is theories of the dividend policy. Yusof and Ismail, (2016) also
confirm that earnings, debt, size, investment and largest shareholder have a
significant influence on dividend policy, with earnings, firm size and
investment revealed to have a positive significant effect, while debt and large
shareholders have a negative significant effect. This research is carried out
in Malaysia by taking total of 147 listed companies. The study used fixed and
random effect and, pooled least squares model, robust standard errors on fixed
effects and random-effects models. Al-Kuwari, (2009) also witness
that the main characteristics of firm dividend payout policy were that dividend
payments related strongly and directly to government ownership, firm size and
firm profitability, but negatively to the leverage ratio. in addition to firms
pay dividends with the purpose of reducing the agency problem and maintaining
firm name, then the legal protection for outside investors was limited. In addition,
and as a result of the significant agency conflicts interacting with the need
to build firm reputation, a firm’s dividend policy was found to depend heavily
on firm profitability.

 

According to Walter and Brown, (1986) The abnormal share price behavior extends before and after the
ex-dividend day, and has implications for time-related variances observed for
the market as a whole. Major reason for their study, in North America, on the
day a stock has first been quoted ex-dividend, its price has tended to fall by
less than the amount of the dividend. Australian dividends likewise have been
discounted, by about 25% relative to capital gains. And they found an
exploration that North American discount have included higher taxes on
dividends than on capital gains. but this explanation begs questions of
marginal transaction costs, time lags embedded in arbitrage and the fact that
the tax positions of Australian shareholders are more complex than a simple
tax-driven preference for capital gains would suggest. 

 

2.3.   Relationship
between dividend policy and share prices – Theories

2.3.1.      Dividend
irrelevance theory

Dividend
irrelevance theory proposed by Miller and Modigliani, (1961) concluding
that there is no relationship between dividend policy and stock price. After
this investigation numerus researcher agued with this topic however they argued
that abovementioned relationship depends on nature of the capital market therefor
researchers argued that dividend policy does not affect the investor’s return
in a perfect market conditions. The main assumption is that there is 100 per
cent payout by management in every period. Other assumptions are

·        
Perfect capital market

That
mean no buyer or seller (or issuer) of securities is large enough for his
transactions to have an appreciable impact on the then ruling price. All
traders have equal and costless access to information about the ruling price
and all other relevant characteristic of share. No brokerage fees, transfer
taxes, or other transaction costs are incurred when securities bought, sold, or
issued, and there are no tax differentials either between distributed and
undistributed profits or between dividends and capital gains.

 

·        
Rational behavior

Which
means that investors always prefer more wealth to less and are indifferent as
to whether a given increment to their wealth takes the form of cash payments or
an increase in the market value of their holdings of shares.

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