Literature on Dividend Policy and Efficient Market Hypothesis (Research Paper Sample)

Dividend policy and efficient market hypothesis
Name:
Institutional affiliation
Table of Contents TOC \o "1-3" \h \z \u Literature on Dividend policy and Efficient Market Hypothesis PAGEREF _Toc474407666 \h 4Introduction PAGEREF _Toc474407667 \h 4Dividend Announcements and Market Efficiency PAGEREF _Toc474407668 \h 7Data and Methodology PAGEREF _Toc474407669 \h 8Research design PAGEREF _Toc474407670 \h 8Population PAGEREF _Toc474407671 \h 9Sample PAGEREF _Toc474407672 \h 9Data collection PAGEREF _Toc474407673 \h 9Data analysis PAGEREF _Toc474407674 \h 9Analytical Model PAGEREF _Toc474407675 \h 10Test of significance PAGEREF _Toc474407676 \h 11Data Analysis, results and discussion PAGEREF _Toc474407677 \h 11Introduction PAGEREF _Toc474407678 \h 11Findings PAGEREF _Toc474407679 \h 11Analysis for 2009 PAGEREF _Toc474407680 \h 12Analysis for 2010 PAGEREF _Toc474407681 \h 13Analysis for 2011 PAGEREF _Toc474407682 \h 14Analysis for 2012 PAGEREF _Toc474407683 \h 16Analysis for 2013 PAGEREF _Toc474407684 \h 17Analysis for all years PAGEREF _Toc474407685 \h 19Test of significance PAGEREF _Toc474407686 \h 20Test of significance for the year 2009 PAGEREF _Toc474407687 \h 20Test of significance for cumulative average abnormal returns for 2009 PAGEREF _Toc474407688 \h 20Test of significance of AAR for 2010 PAGEREF _Toc474407689 \h 21Test of significance for CAAR for 2010 PAGEREF _Toc474407690 \h 21Test of significance for AAR for the year 2011 PAGEREF _Toc474407691 \h 22Test of significance for CAAR for the year 2011 PAGEREF _Toc474407692 \h 22Test of significance for AAR for the year 2012 PAGEREF _Toc474407693 \h 22Test of significance for CAAR for the year 2012 PAGEREF _Toc474407694 \h 23Test of significance for AAR for the year 2013 PAGEREF _Toc474407695 \h 23Test of significance for CAAR for the year 2013 PAGEREF _Toc474407696 \h 24Evaluation of the findings PAGEREF _Toc474407697 \h 24Conclusion PAGEREF _Toc474407698 \h 25References PAGEREF _Toc474407699 \h 27
Literature on Dividend policy and Efficient Market Hypothesis
Introduction
Dividend policy is the policy employed by an entity to share fairly to its shareholders the profits generated but by doing so the company decreases its internal resources which it should accumulate for it to expand its operations. The concept of dividend policy at the contemporary times is one of the most debated topics as it bears the directions the company takes on future investments and therefore, it is important to strike a balance on future investment opportunities and shareholders preferences (Statman, 2010). Form the exempt above, it is clear now that the term ‘dividend policy’ refers to the practice that management follows in making dividend payout decisions over time to shareholders and as such this topic remains as one of the most contested issues in finance. Currently, there are three types of dividend policies employed by firms and they include; stable dividend policy, constant dividend policy and residual dividend policy (Sewell, 2011).
Stable dividend policy is the easiest and the most employed policy by many corporations as it is devised in such a way that is predictable so that there can be payment of a stable payouts every year, a factor which is considered by most investors. The policy helps the enterprise to distribute dividends to shareholders regardless of the profitability of the firm and as such this policy has excellently aligned the dividend policy with the long-term growth of the company especially in this era of market volatility (Borges, 2010). As such the approach has increased investors confidence as they have more certainty on the timing and the amount of the dividend they will receive in the near future.
Constant Dividend Policy gives out a certain percentage of the company’s earning every year and as such the company is able to protect itself from the fluctuations experienced in the market since it offers only a certain percentage of its profits to be paid out to the shareholders. The amount paid out to the investors largely depends on the amount of the profits the company has made and as such, if the earning are high, shareholders gets a larger dividend; and when the profits are very small, investors may not even receive any dividend(Sewell, 2011)..
Residual Dividend Policy as the name goes is a policy in which the enterprise pay out or offers to give to its shareholders what is left after it pays for its expenses but this approach is the most volatile of all approaches but it makes more sense in terms of business operations. Some scholars has viewed this policy as the most acceptable dividend policy that any company should exercise for it to experience growth, since there is no justification for increasing a company’s debt so that it can be able to pay dividends to shareholders (Al-Malkawi, Rafferty & Pillai, 2010).
On the other hand market efficiency hypothesis also known as the random walk theory, can be described as a proposition in which the current stock prices in stock market reflects the available information about the value of the enterprise in question (Patel & Prajapati, 2014). In this hypothesis, there is no way any firm can make or earn excess profits more than the market overall by utilizing the available information and it also postulates that profiting from predicting price movement is very difficult and unlikely. According to Karim (2010), any market is efficient if only the prices adjust quickly and without bias to new information and as such the current prices of securities reflect all the available information at any given point of any firm in the industry. Efficient market exists solely due to intense competition among investors to profit from any new information but rarely would any investor make any profit as security prices swiftly adjusts even before an investor has time to trade on and make any profit (Karim, 2010). Therefore, in any stock market there exists no room for any player to fool any investor and as a result, all investments in the efficient market are priced well and as such any investor gets what he pays for.
But fair pricing does not account for all securities to perform similarly, according to capital markets theory, the expected return from a security is primarily a function of its risk. Furthermore, the price of the security reflects the present value of its expected future cash flows which are largely influenced by many factors such as volatility, liquidity and risk of bankruptcy among other factors (Ravenscraft & Scherer, 2011). There are three assumptions which have acted as pillars for this efficiency; investors are assumed to be rational, the second speculates that if they are not rational, their random transactions will cancel each other out and the finally, all arbitrage opportunities will be used entirely.
There are three different types on efficient market hypothesis and their general difference can be attributed to the term “all available information” and they include:
Weak form efficiency which relies more on historical information to assess the stock prices and as such, an investor cannot obtain or gain from an investment which relies more on such information. This implies that the market is efficient depending on all information and that the past rates of return have no effect on the future rates and therefore the rates of return on the market are always independent (Candelon & Sy, 2015).
Semi-strong efficiency looks at all publicly available information, and therefore the investors cannot be able to profit consistently by trading on such information. This hypothesis also incorporates the weak-form hypothesis and it assumes that stocks adjust quickly to absorb new information and this is the reason why investors cannot benefit over and above the market by trading on new information.
Strong form efficiency reflects information on both privately and publicly available information, and it integrates both the weak-form and semi-strong efficiencies. And since all stock prices reflect all information in the market whether public or private thus, there is no single investor who can earn profits above the average even if he was supplied with new information.
From the literature above, it’s clear that information plays a crucial and fundamental role in stock markets and for instance, dividend announcement for example conveys important information which somehow aids investors in investing wisely. For instance, Walter came up with his model “The Walter Model” in which he stated that when any shareholder receives his dividends, he reinvests the amount received so that he can get higher returns. Walter concludes that if the rate of return which the firm will receive by investing will not earn good profits, the firm will be forced to give out dividends to its share holders. One of the intriguing fact about efficient market hypothesis even after thousand of published studies, economists have not yet come to a consensus about whether markets- particularly financial markets- are in fact, efficient.
Dividend Announcements and Market Efficiency
From the above enumerated literature, it is evident that if any market is efficient, the current stock prices reflects all published and broadly private information and as such, this paper aim to test the semi-strong form of market efficiency. And since the market reflects all the publicly available information, it is presumed that the market will directly react to an event and in this case it will be the dividend announcement. As it is also evident from the above there is no any chance for any investor to consistently earn abnormal profits especially by using the publically available information. Event studies have been conducted by various sc...