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Middle-East Journal of Scientific Research 18 (3): 410-424, 2013

ISSN 1990-9233
IDOSI Publications, 2013
DOI: 10.5829/idosi.mejsr.2013.18.3.12200

Determinants of Dividend Policy: A Case of Banking Sector in Pakistan

Hashim Zameer, Shahid Rasool, Sajid Iqbal and Umair Arshad
Iqra University Islamabad Pakistan,
BZU Bahadur Sub Campus Layyah, Pakistan
Abstract: The aim of the study is to investigate the determinants of dividend policy of Pakistani banking sector.
For this purpose, we used data of 27 foreign and domestic banks operating in Islamic and conventional banking
in Pakistan listed at different stock exchanges as a sample. Applying stepwise regression analysis, these four
variables liquidity, profitability, last year dividend and ownership structure show highly significant relationship
with the dividend payout of Pakistani banks. Profitability, last year dividend and ownership structure
show positive impact on the dividend payout and liquidity show negative impact on the banking industry.
Size, leverage, agency cost, growth and risk show insignificant relationship and have no impact on the dividend
Key words: Banking








different and from the latest literature [8] states that the
existence of regulations constraining the actions of banks
may make the governance of these institutions different
from non financial firms. But there is limited research on
determinants of dividend policy of banking or financial
sector all over the world, as for my knowledge, this is the
first research on Determinants of dividend policy of
Pakistani banking industry. This research will prove a
milestone for future researches on dividend policy of
banking sector.
The purpose of this study is to investigate the
determinants of dividend policy of Pakistani banking
sector. This study will examine what are those factors
which affect the dividend policy of banks in Pakistan.
In Pakistan there is no capital gain tax in Pakistan till 2012.
Government has given extension till 2012, but there is 10%
withholding tax on dividend income. There is another law
that if a firm has earned profit but announces dividends to
its shareholders then government will charge 35% income
tax. In Pakistan many investors prefer capital gains over
cash dividends; investor preference may be a factor
which influences the dividend policy of Pakistani firms.
As described by [8] that regulations may banks different,
in Pakistan Securities and Exchange Commission has
implemented many changes in the capital market of
Pakistan. This paper will examine that is there any effect
of size, profitability, growth and cash flows of banks on
dividend policy. Is there any impact of ownership

Almost each company earns profit each year and that

profit is reinvested in business or distributed to
shareholders. The process that how much and in which
way profit is distributed among shareholders is called
dividend policy.
Dividend policy is one of the most debatable issues
in modern corporate finance and still a puzzle. Dividend
policy is one of the top ten unsolved issues in corporate
finance [1]. In 1976, [2] gave a statement about the
dividend policy that the harder we look at dividend the
more it seems like a puzzle with pieces that just dont fit
Dividend policy can be different for different
countries because of different tax policies, rules,
regulations and different institutions and capital markets.
There are three different views about the dividend policy.
First view is of [3], who argued that dividend policy
increases the shareholders wealth. The second view is of
[4] and [5], their view is that dividend policy is irrelevant
and the third view about the dividend policy is that it
decreases the shareholders wealth, this view is given by
[6] in 1979.
There is limited research on determinants of dividend
policy of Pakistani firms, no doubt the debate that is there
any difference between banks and non financial firms is
very old, as [7] left a question in 1985 that Are banks

Corresponding Author: Hashim Zameer, Iqra University Islamabad Pakistan, Bzu Bahadur Sub Campus Layyah, Pakistan .


Middle-East J. Sci. Res., 18 (3): 410-424, 2013

structure, last year dividends, risk, agency cost and

corporate taxes? This study also examine that does
dividends act as signaling device and also checks that
does banks in Pakistan smooth their dividends?.

deals with the financial restructuring, while poor

profitability results from high operating costs. These
problems deal with operational restructuring, [10].
To improve the poor performance of banking sector,
banking reforms were launched. These reforms can be
divided into three categories.

What Is Dividend and Why Companies Pay Dividend?:

Dividends are distribution of a companys profits which
it distributes to its shareholders, the amount of dividend
is depends upon the shares on own. Dividends may be in
form of cash dividends in which the company pays some
cash amount per share to share holder, or it may be in
terms of stock dividends, in which the company issues
new stocks to existing shareholders in proportion of their
existing shares. For investors dividends are return on their
There are many reasons that why companies pay
dividends, it may be the reason to reduce the agency cost
arise between managers and share holders or to reduce
the uncertainty of investor. As one goal of the investor to
receive returns on continuous basis, so they prefer to
invest in firms paying dividends. Firms paying more
dividends have easy access to capital market. Dividends
also effect the stock valuation.

First generation of reforms (1988-1996)

Second generation of reforms (1997-2001)
Third phase of reforms (2002-2004)
In early 1990s; in order to establish more marketbased monetary management system, SBP introduced
financial reforms. These reforms were introduced to
increase the competition, allow free entry of private banks,
standardize accounting and auditing system, strengthen
SBP supervision and manage the financial sector more
efficiently. In these reforms government partially
privatized the banks and liberalized the interest rates.
The SBP was granted greater power in February 1994.
The 1997-98 reforms initiative was aimed to improve bank
regulators and management, the markets and the courts to
confer effective regulations and governance in order to
enhance the efficient financial intermediation. To grow
faster, increase their share in the market, make easier for
the customers to take loans; partially private banks were
completely privatized
In third stage of reforms, focus was on improving and
strengthening the banking sector structure. It aims at
privatization, minimum capital requirement, prudential
regulation and technical enhancement. SBP strengthened
banks audit and supervision. SBP established standard
for rating overall banks.
Increasing the profitability requires effective policies,
hardworking and efficient management and a strong
restructured its financial sector effectively within a very
short span of time, but the profitability and sustainability
of financial sector depends heavily on strong corporate
governance, effective risk management and mitigation
system, macroeconomic stability, prudent supervisory
and regulatory framework, reorientation of banking
industry and a well diversified and competitive financial
system [11].

Banking Sector in Pakistan: Banking system in Pakistan

was started with the idea of founder of Pakistan Qauid-eAzam Muhammad Ali Jinnah. He proposed that State
Bank of Pakistan (SBP) will play a pivotal role in elevating
the Pakistans economy.
There are two type of restructuring mechanism: one
is market based solutions such as liquidation without
deposit compensation, sale or merger, shareholder capital
injection etc. and the other one involves the government
intervention like formation of asset recovery trust,
liquidation with deposit insurance, supply side solution.
Both types of restructuring mechanisms have been used
for the development of banking industry, sometimes
market base system and sometimes government
intervention in this sector.
[9] Proposed two types of restructuring mechanisms:
operational and financial restructuring. According to them
the function of restructuring mechanism is to return the
profitability and solvency of the banks. The bank
solvency would stem from shorter-term financial
restructuring measures such as long-term borrowing,
capital injection, swapping bonds for NPLs etc. While
increasing the profitability involves more tricky and long
term operational restructuring such as cost reduction,
effective risk management and improved internal
governance etc. Hence, the level of banks insolvency

Review of Literature
Types of Dividend Policies
Residual Policy: This theory states that firm will only pay
dividends from the earnings left after financing all positive
NPV projects. In this policy, the main concern of the

Middle-East J. Sci. Res., 18 (3): 410-424, 2013

managers is to invest more and more and in this case

dividend policy becomes irrelevant. Firms adopts this
type of policy because they more rely on internally
generated funds and are not willing to raise new capital
for saving floatation and other costs associated with
issuing debt and the managers think that high retention
cause more growth to the company.

Dit = The change in dividend per share of firm i from
time t-1 to t (i.e. D i t Di t-1)
D*i t = The target dividend of firm i in period t
Di t-1 = The actual dividend of firm i in period t-l
= The speed of adjustment in dividend to the
difference between the target dividend and last
period's dividend
= Intercept and
= A zero mean, constant variance, non-auto
correlated error term.

Constant Payout Residual Dividend Policy: In this type of

policy, firms pay a fix percentage of its earning to the
share holder each year called dividend payout ratio
calculated by dividend per share divided by firm earning
per share. If the earning of the firm reduces or firm face
loss in any year, the dividends will be reduced or
diminished, so this is the problem with this type of policy
and rare firms chose this policy.

Work of [7] and [13] are example of early work on

dividend policy. [7] Used [12] model and they have also
same view as [12] had. They said that Linter model can be
improved by adding last year earnings; they argued that
last year profits have a strong influence on the dividend
policy. [13] used model of [14] and argued that earning
effect more on the dividend policy instead of last year

Smooth Residual Dividend Policy: Many firms adopt this

type of policy. In this type of policy, firms pay fixed
amount of dividend to shareholder each year, firms dont
cut dividend after announcing the dividend. Firm using
this policy only increase the dividends when they are sure
that firms earning have increased.

Dividend Irrelevance Theory: [4] give irrelevance theory,

in which they state that In perfect capital market, where
there is no transaction cost, no taxes, no bankruptcy cost,
investor are rational, all investors have same
opportunities and information symmetry is there, dividend
policy is irrelevant. Dividend policy has no impact on
market value of firm or its cost of capital. It means that it
doesnt matter that firm pay dividends or retain cash.
But in real world there is no concept of perfect capital
market, there are transaction costs, investor and firms
have to pay taxes, there is information asymmetry.
This theory is foundation of modern corporate finance.
MM irrelevance theory suggests that value of firms is
dependent on present and future cash flows and dividend
doesnt affect the value of firm. [15] and [5] also has view
same to the [4].

Small Quarterly Dividend with Annual Bonus: Some

firms chose this type of policy. In this type of policy firms
pay low regular dividends, if the earning increases than
normal earning then firms pay additional dividend
designated as extra or special dividends. By designating
the additional amount of dividends as special dividends
firms avoid giving investor false hope. This type of policy
is chosen by those firms who have temporary shifts in
their earnings.
Theoretical Background
Overview: In his seminal work of dividend policy, [12]
conducted a research and makes interviews of to
management of 28 US firms and concluded that dividend
decision are mostly dependent on current year profits and
past year dividend. He also found that managers have
long term dividend payout policy and managers change
dividend when they are certain about future earning and
they are reluctant to reverse the decision in near future.
He also concluded that managers dont make sudden
changes in dividends they make partial adjustments in
dividends to target payout ratio. Linter has given
following mathematical model for partial adjustment

Bird In Hand Theory: In 1963, [3] presented the bird in

hand theory. This theory states that dividends are
relevant and they affect the firms value. As from the
name of theory we can guess the old proverb A bird in
hand is worth than two in the Bush, most investors are
risk averse, so they prefer the prefer cash in hand instead
of future capital gains, here bird is referred to cash
dividend and bush is referred to future capital gain.
He also discussed that dividend paying firms are seem
to be more profitable and have easy access to capital
market and paying dividends effect the valuation of the

Dit = ai + ci (D*i t Di t-1) + ui t


Middle-East J. Sci. Res., 18 (3): 410-424, 2013

Dividend Signaling and Information Asymmetry Theory:

In 1961, [4] found that dividends have a signaling effect;
giving dividends transmit information to the market.
Generally increase in dividends transmit positive signal to
the market and appreciate the price of stock and cuts in
dividends transmit negative signal to the market and it will
reduce the share price [16]. Also concluded that
companies use dividends as signaling device to the
market. He also discussed that managers can forecast the
firms future earning and they have proper knowledge
about the earnings of the firm and all the insiders have the
proper knowledge but the outsiders dont have the proper
knowledge about the firms earning and it creates
information asymmetry, so for information symmetry
between the insiders and outsiders managers announce

shareholders. And their view about the external funds is

that firms prefer debt over external funds because due
to sale of new shares, price of existing shares decreases
and it is against the existing shareholders and they
have view that risk free debt has no impact on
shareholders wealth. If the debt is risky it has less effect
on the existing shareholders rather than the effect of
issuing new shares.
Free Cash Flow Theory / Agency Theory: The concept of
this theory starts from agency problem and agency cost.
Agency problem refers to the problem arise between
principal and agent, principal are shareholder and agents
are managers. Main duty of managers is to run the
business efficiently and increase the shareholder wealth.
The agency problem arises when managers have excess
cash flow, they invest in low or negative NPV projects
and uses that cash for their leisure and comfort and this
is agency problem. So shareholders have to monitor the
managers, cost of monitoring is referred to agency cost.
To reduce the agency cost [21] give explanation that to
reduce the agency cost dividends are given to the
shareholders, when dividends are issued then managers
has less cash in hand and they cant misuse it. [22] argued
that when managers have less cash in hand, so for
financing new projects managers will move towards the
capital market and capital market impose some restrictions
to the managers for misusing the money and capital
markets also monitor the managers.

Tax Preference Theory: [17] Was the first scholar who

research dividend policy with context to the taxes and
concluded that higher pretax returns are the compensation
for the investors for facing tax disadvantage. Tax
preference theory states that investors consider taxes and
it plays an important role for personal investment
decisions as well as corporate investment decisions.
Capital gains are taxed at lower rate and it is taxed it
realized (when the asset is sold) but cash dividends are
taxed at higher rate and taxed when the company gives
dividend to the share holder so many investors prefer
capital gains.
Pecking Order Hypothesis: Pecking order hypothesis
states that firms prefer internally generated funds for
investment opportunities and for issuing dividends and
if internally generated funds are less then firms prefer debt
over external equity.
There are two different views about why firms prefer
pecking order hypothesis

Share Repurchase: Share repurchase are also used as

signals but it transmit different information as dividend
do, shares are repurchased by firms when they have no
profitable investment opportunity and it shows that
earning will be reduce in near future [23]. [24] States that
share repurchase will cause change in capital structure
and firm is fully financed by debt and its leverage ratio will
increase and also chances of bankruptcy also increases.

First view is given by [18] in 1961, he argues that

firms prefer internally generated funds over debt because
they want to avoid floatation and other cost associated
with the debt and firms prefer debt over external equity
because the cost of external financing is higher than the
cost of debt.
The other view is given by [19] and [20] they have
view that total benefits of debt financing are greater than
the floatation and other costs associated with debt in
terms of tax shield and financial distress risk. They argue
that firms depend upon internally generated funds
because firms want to maximize the wealth of existing

Clientele Effect: Preference of investor to receive a cash

dividend capital gain is referred to clientele effect. In the
clientele effect tax rate matters. The investors who are
paying heavy taxes want to invest in the stock that retain
cash and pay fewer dividends because they want capital
gains but the investors who are paying less tax want
return in form of dividends and they invest in high
dividend paying stocks. Mostly old age or retired
investors invest in dividend paying stocks. We are
studying Pakistani context, in Pakistan government has
given extension that no capital gain tax will be collected
till 2010.

Middle-East J. Sci. Res., 18 (3): 410-424, 2013

Banking Dividend Studies: Financial sector has some

different characteristics, so research on dividend policy is
less and from the sample research on dividend policy
banking sector also excluded.
In 1999, [25] find the effect of announcement of
dividend cut by money center banks has a contagion
effect in stock returns and they concluded that on stock
of non announcing money center banks there are
abnormal negative returns and on stock of large regional
banks it has lesser effect. The main factor which influence
the dividend policy of North American banks are growth
of profit and number of shareholders and there is no
significant impact of past growth level, beta and insider
ownership on dividend policy of North American banks,
but these variables have significant impact on the
dividend policy of other industries [26]. In 2005 [27]
worked in Nigerian banking industry and show the tax
effect on that industry, they identified following
determinants which affect the dividend policy of Nigerian
banking industry, current profits, financial leverage,
capital structure, past dividends and legal restrictions.
Share repurchase has strong influence for reducing
agency cost and a signal for future profits for North
American banks but for non financial sector these results
are opposite [28].[29] worked on public and private banks
and concluded that private banks give more dividend than
public sector banks and also concluded that dividend
policy is affected by control structure.[30] surveyed the
NASDAQ listed firms and identified four determinants
which affect the dividend policy, but their weights for
financial and non financial sector are different. For
financial sector the sequence of impact is profit stability,
past dividends, current year profits and projected profits,
for non financial sector their sequence is past dividends,
profit stability, projected profits and current year
profits.[31] found that for Indian banking industry past
dividends and current profits are the most important
determinants of dividend policy.

the firm share price or its capital cost. If there is no

significant impact of dividend policy, then it means it is
irrelevant [4]. Suggest that value of firm is only affected
by its business risk and basic earning power. From the
previous studies we have identified the following factors
that affect the dividend payout policies of the firms.
Leverage: High debt means that firms have high interest
expense, which will lead to a low net income and thus less
earning will be available for shareholders. Dividend
payments to shareholders may suffer the financing and
investment plans especially in case of high leveraged
firms. Earnings of highly leveraged firms are more risky
and volatile and accordingly pay low dividends [32], [33].
[21], [34] found negative relationship between financial
leverage and dividend payout ratios, providing support to
the free cash flow hypothesis of [21] that in case of free
cash flow managers prefers to pay dividends. Highly
leveraged firms tend to low dividends payouts in order to
reduce transaction cost of external capital [35]. [36] Found
negative relationship between leverage and dividend
payout ratios of firms listed in kualalumpur stock
exchange and concluded that highly leveraged firms retain
more instead of distributing profits to shareholders. [37]
also found negative relationship of leverage with dividend
payout In Jordan, concluding that firms using more debt
commits itself to fixed financial charges in forms of
interest payments, failure to pay these periodic interest
payments leads to business liquidation- so a risk is
associated with highly leveraged firms that results in low
dividend payments. [38] found negative and insignificant
relationship of leverage with dividend payout ratio of
companies listed on Karachi stock exchange and
concluded that leverage has no impact on firms dividend
policy. In order to fund increasing dividend payments
firms are willing to increase the level of debt in their
capital structure, as dividends act as signaling device to
the investors [39]. [40] explored positive relationship of
leverage and dividend payout, arguing that these findings
are consistent with the expected return pattern at different
levels of economic stability. [41] also found positive
relationship between leverage and dividend payout ratios.

Empirical Literature
Overview: The harder we look at dividend the more it
seems like a puzzle with pieces that just dont fit together
Numerous literatures on dividend policy provide no
evidence about generally accepted rules for the level of
payout ratios that maximize shareholders wealth [2].
Concluded his study with the question: what should the
firms do about dividend policy? We dont know [12].
Argued that last period dividends and current year
earning has positive influence on the dividend policy.
It is argued that there is no effect of dividend policy on

Size: [42], [43] concluded that size plays a prominent role

in explaining firms dividend policy. As firm grow, they
mature, have easy access to financial market and become
less dependent on internally generated funds which
allows them to pay higher dividends. Larger firms pay
lower transaction cost as compared to smaller ones for
raising new financing and pay more dividends [44]. [41]
also found positive relationship between firm size and

Middle-East J. Sci. Res., 18 (3): 410-424, 2013

dividend payments. Investor perceive that larger firms

less risky hence these firms have a better position in the
market and can raise more funds as compared to the
smaller ones and pay higher dividends. Additionally, the
management of large firms is inclined to pay higher
dividends [45]. [37] has concluded that size positively
correlate with dividend payout ratio. His study supports
the agency cost explanation, in large firms excessive
cash flow results in significant agency cost. Thus
dividend could play important role in reducing agency
cost. Size plays significant negative impact on dividends
reasoning that large firms reinvest their profits into assets
instead of paying dividends to shareholders [46]. [47]
using the data of 245 non financial companies found
positive impact of size on the dividend payout ratio.
Making comparison of Pakistani and Chinese listed firms
concluded that in Pakistan larger firms pay dividends
where as in china smaller firms offer more dividends [48].

follow a generous dividend payout policy. On contrary

young and new firms need cash reserves to finance
investment plans and pay lower dividends.
As dividends payments and investments both are
linked to the firms cash flow, so firms in growth stage
have investment opportunity, following pecking order
hypothesis pay low dividends [54]. [55] Suggested that
dividends announcements as a way for stock price
evaluation, because dividend announcements serve as
signal for growth and lack of investment opportunity. [56]
using America stock market data found that higher
dividend payouts were associated with higher future
growing firm. [21] suggested that highly growing firms
have relative lower amount of free cash flow (cash in
excess of funds required for all the projects having
positive NPV) as compared to firms having few growth
opportunities- having lower amount of free cash flow
reduces the agency cost and ultimately the need to pay
dividends. [57] Indicated that there is a direct relationship
between growth opportunity and financing needs,
reasoning that normally working capital needs exceed the
incremental cash flows from additional cash flows from
new sales. So dividend payout ratio is inversely related to
firms financial need to fund growth opportunities. [58]
stated that investment and dividends depend on each
other, In case of growth opportunities investment need
arises and dividend payments fall, on the other hand in
absence of growth opportunities firms pay dividends to
reduce agency cost. [46] found no relationship between
growth and dividend payout of listed firms of Karachi
stock exchange.

Liquidity: [49] Found positive relation between the

liquidity and profitability explaining that firms earning
stable cash flow (high liquidity) are in position to pay
higher dividends as compared to firms facing unstable
earning. [50] also found positive relationship between
liquidity and dividend payout policy suggesting that due
to shortage of cash, poor liquidity results in less generous
dividend payout policies. [51] argued that firms having
improved financial position initiates dividend increments
while companies facing financial problems triggered by
decreasing profitability and low liquidity levels are forced
to cut dividends. [46] also concluded that dividend
reducing firms face liquidity problems. [39] found negative
relationship between liquidity and payout ratio,
suggesting that increasing dividend payout ratios reduce
the liquidity and higher return on equity stimulates the
firm need to retain more to reinvest or lower the dividend.
In case of Indian firms [52] also found opposite relation
between liquidity and dividend payout ratios. [41]
explored that liquidity does not have a significant impact
on dividend policy.

Profitability: The decision about paying dividends starts

with firms profits; therefore it seems logical to think
profitability as threshold factor and profitability level as
one of the most significant variable in explaining dividend
payout decision.
The pecking order hypothesis provides some
explanation for the interrelationship of dividend payout
and profitability, taking into consideration the cost
associated with issuing debt and equity financing less
profitable firms find it difficult to pay dividends, while
highly profitable firms are in the situation to internally
generate funds to finance investment needs and pay
dividends. The classical work on dividend policy was of
[12]. After consulting 28 well established us firms he
developed a model for How managers make dividend
decision. His study concluded that dividends pattern of
a firm are influenced by its current year earning and past
year dividends. [59] surveyed the financial managers of
US firms and reported that both current and past year

Growth: [37] found negative relationship between growth

and dividend payout, suggesting that firms in growth
phase has investment opportunities, to finance these
opportunities from internally generated funds, firms have
to retain more and to pay very little or no dividend.
These findings are providing support to the pecking order
hypothesis. [53] found that mature companies are likely to
be in low growth phase and less attractive investment
opportunities, these firms dont have any incentive to
retain more as a result of less capital expenditure firms

Middle-East J. Sci. Res., 18 (3): 410-424, 2013

profits have influence on the dividend payout. [60]

using sample of Malaysian companies summarized that
profitability level measured by return on assets has a
positive and statistically significant impact on dividend
payout ratio. [21] concluded that firms earning high
profits prefer to pay more dividends if they have no
investment opportunity. [61] Found positive relationship
between profitability and dividend payout ratio,
concluding that Greek firms prefer to pay each year rather
than following a constant payout. [62], in case of Indian
firms concluded that dividend payouts fluctuate
depending on the firms profits. As explained by pecking
order hypothesis, [37] found a significant positive
relationship between profitability and dividend payout of
Jordan firms but 1% increase in profitability (Proxied by
EPS) leads to an increase of only. 167% to dividend yield.
In case of Nigerian banks [27] concluded that both current
year profits and past year dividends are the determinant
of current year dividends. [63] Reported that due to family
owned business environment in Pakistani context
biasness at the time of director announcements results in
huge pays and fringe benefits. Due to these extra costs
net profit are declined and it becomes difficult for the firms
to declare the dividends, mainly shareholder suffer in all
this game. [64] for diverse firms showed that dividend are
sensitive to firms profitability, but this relationship is non
linear when firms profitability achieve a certain point,
reinvesting profits again can return more profits in future,
the opportunity cost of holding dividends will increase
and tendency to pay dividend decrease. [39] found that
firm profitability is negatively correlated to the dividend
payout. [30] stated that in case when a firm needs to
plough back a major proportion of its profits to supports
rapid growth, low dividend may results. [41] found that
profitability is irrelevant in explaining the dividend payout

decrease when insiders executives, managers and

directors increase their ownership because in this case
interest of both managers and shareholder will align and
there will be no need to use dividends as a device to
alleviate agency cost. [65] stated that high agency cost
result in high dividend payout and its solution is firms
ownership structure. [66] suggest that firms having more
collateralize assets have lower agency cost between
stockholder and bondholder, as these assets cab be used
as collateral against the money borrowed. Managerial
efficiency of the firm can have influence on the dividend
payments trend with the agency cost framework.
Firms where management is more efficient, assets
turnover will be high and more value will be paid to share
holders- shareholders will prefer to reinvest because
agency cost will be low and less dividend payment will
result. [55] surveying the previous studies, concluded
possible reasons for why firms prefer to pay dividends.
There are resulting decrease in agency cost, market signal
of dividend payment (signaling theory) and bird in hand
theory. [67], in their study found that high dividend
payment in case of principal agent problem forces
management to move towards the capital market to fulfill
the financing need. In such environment high dividend
payout minimizes the agency cost. [58] found negative
relationship between agency cost and dividend payout.
[43] validate the view that high insider ownership
(lower agency cost), lower dividend payments will result.
[68] viewed that in agency costs and dividends payout
literature, two perspectives explain dividend payout
variation. First firms dividend payout ratio is the function
of tradeoff between agency cost reduction and increased
transaction cost resulting from need of external financing
as dividend payout ratios increase. Second, higher insider
ownership and external debt financing are substitute
means to reduce agency cost.

Agency Cost: The agency theory by [24] focus on the

conflict of interest between the owners and managers and
proportion of assets controlled by insiders. When there
is separation of ownership and control, managers tend to
invest much part of free cash flow prerequisite/self
interest that results in significant agency cost. To reduce
the agency cost owners may feel it in their interest to
incur bonding cost and distribute more individuals. [35]
supports the preposition that firms whose insiders have
a low proportion of equity; significant agency cost
results- ultimately firm spay dividends to reduce the
agency cost. [37] using firms common stock held by the
insider as the proxy for agency cost found significant
impact on dividend payout, arguing that agency cost will

Last Year Dividend: [69] Conducting a research on Greek

banking industry concluded that previous year dividend
are not predictor of current year dividend. They argued
that due to high earning volatility in banking industry,
managers dont follow the long term dividend payout ratio
that is unaffected by the firms financial performance.
[70], in case of Nigerian firms found that last year
dividend significantly affect the current period payout
and firms strive not to cut dividends payment from the
preceding years, instead they try to increase the payout
ratio. [71] viewed that firms usually set a target dividend
payout ratio and try to adjust dividend payments to this
target. Furthermore firms follow a stable dividend payout
policy and gradually increase the dividend according to

Middle-East J. Sci. Res., 18 (3): 410-424, 2013

target payout ratio. These findings point out that current

year dividends are also affected by previous year
dividends. [72] found that Indian firms set a lower target
payout ratio and face high level of adjustment.

have choice to distribute earnings in order to minimize

managers discretion and shield their own interest. [38]
using the data of Pakistani firms listed at Karachi stock
exchange found positive relation between insider
ownership and dividend payout. Because in such a
strategy dividends will go to pockets of directors, the
chance of dividend payout will be low if significant
amount of distributed earnings is paid to the outsiders.
[77] found strong negative relationship between insider
ownership and dividend payout ratios. This relationship
may be interpreted in different ways: first banks have
higher level of managerial ownership may choose to pay
lower dividends because owners/managers want to avoid
penalty cost of double taxation, second higher level of
insider ownership may lead financial institutions to retain
more money to invest in other opportunities. [78] found
that firms with higher level of institutional holdings and
high rate of return on equity distribute more earnings in
dividends. [43] found that greater the insider ownership
lower will be the dividends, while in case of large number
of shareholders firms will pay high dividends to overcome
the agency problem. [79] concluded that higher
institutional holding have no impact on the firms
dividend payout ratio. [47] Ramli (2010) concluded that
payout ratio increases as percentage of ownership of
large shareholders increases.

Risk: Generally it seems to exist a negative relationship

between risk and profitability because firms in risk
conditions are not able to distribute earning rather
preferred to retain [73]. measuring risk a year to year
fluctuations in earning, found inverse relationship.
He concluded that these firms which have relatively stable
earning can easily predict their future earnings. Such firms
have relatively low risk and pay higher proportion of its
earnings then the firms facing high variation in earnings.
[35] using beta value as a measure of risk found negative
and statistically significant relationship of risk with the
dividend payout. His findings also suggest that firms
facing high market risk payout lower dividends. [49]
Also found negative relationship between risk and
profitability, suggesting that it difficult for the firms to pay
high dividends experiencing high volatility, such firms
prefer to pay either low or no dividends. In case of
Nigerian banks [27] concluded that firms dividend
payment announcement convey information to the market
about the firms risk. [39] and [58] found that greater the
firms risk, lower will be its payout ratio. [74] proposed that
managers formulate change in corporate policies when
they anticipate changes in corporate earnings or business
risk. Two lines of managerial decisions have a significant
impact on stock prices, these are, 1. choice of capital
structure and 2. How much earnings to distribute as


Research Design: Our study is exploratory in nature that
we want to investigate the determinants of dividend
policy in context of Pakistani banking industry, which is
based on secondary data collected from annual reports of
the firms.

Ownership Structure: Ownership has been discussed

widely in context of dividend puzzle, literature yields
mixed findings. [37] And [35] viewed that greater the
percentage of insider ownership, lower will be the
dividend payout ratio. The plausible explanation is that
firms pay higher dividends to reduce cost associated with
the agency problem. In case of higher insider ownership
agency cost will be lower and firms will retain more.
Insider ownership serves as substitute for dividends to
reduce agency cost. [75] analyzing the data of 4000 firms
in 33 countries found that firms operating in those
countries where government legislation provides greater
shield to minority shareholder, pay more dividends and
dividends payments are the result of legal protection of
investors instead of agency problem. [76] In case of
Tunisians firms found no relationship between ownership
concentration and dividend payout ratio. Due to less
principal agent problem in Tunisians firms, owners dont

Population and Sampling: Our population is banking

industry of Pakistan listed at different stock exchanges.
Our sample size is the data of 27 banks (foreign and
domestic) listed at different stock exchanges of Pakistan.
For the purpose of this study we develop the database
using annual reports collected from the concerned banks
and library of state bank of Pakistan. The coverage is
restricted to the period of 2003 to 2009. We have selected
all those banks whose annual reports for at least 3 years
were available. There is a limitation in data that some
banks came late in Pakistan and annual reports of some
banks were missing.
Sampling Technique/Procedures: We use the convenient
sampling as the data of as much banks was easily
available, we have included in our sample.

Middle-East J. Sci. Res., 18 (3): 410-424, 2013

Research Instrument /Tools: We have used stepwise

regression analysis. Using this regression method, each
variable is being added to the model in view of its
estimation power over the dependent variable. Every time
a variable enters to the model, all the others are
reexamined. Those that lose their estimation power in
function of the new variable entered are being excluded of
the analysis and so on, until we have a set of significant

in profitability) is used as proxy for risk and natural log of

number of shareholders is used as proxy for ownership
Model and Variable Selection: We developed the
following statistical model using stepwise regression
Div = + 1 sz + 2 lvrg + 3 liq +
grth + 7 divt-1 + 8 risk + 9 own

Data Collection: Data for the thesis is collected from the

concerned banks websites, their head offices and from
the library of State Bank of Pakistan.

prof +

agnc +


= Dividend per share and it is dependent

= Constant
1, 2. 9 = Coefficients of the independent variables

Methodology: Variables and their proxies are selected on

the basis of past studies. We have selected following
variables which affect the dividend decisions of firm.
These variables are size, leverage, liquidity, profitability,
agency cost, growth, last year dividend, risk and
ownership structure.
For the size [43] used natural log of sales as a proxy
and [46] used natural log of total assets as a proxy.
For leverage, debt to equity ratio is used as proxy by [37]
and debt to total assets ratio is used by [80, 39, 69, 36].
For liquidity natural log of cash from operation is used by
[50], log natural of net cash flow of firm by [81, 80] and
current ratio is used by [39]. EPS is used by [37, 46] as a
proxy for profitability, ROA (EBIT / T.A) is used by
[41, 82, 30]. Another proxy for profitability, ROE
(Net income / Equity) is used by [39]. For agency cost free
cash flow is used as proxy by [43] and other proxy
which is used for agency cost is operating expense ratio.
For growth, annual sales growth is used by [50, 39] and
investment opportunity is used by [46]. Last year
dividend is used as proxy for Last year dividend by
[12, 80, 69, 82, 39]. Beta (variability in profitability) is used
as proxy for risk in by [58, 50, 49, 80] and other proxy
for risk is variability of earning which is used by [39].
For ownership structure natural log of number of
shareholders is used by [37] and number of shareholders
having more than 5% shares is used as proxy by [46, 43].
%age of total shares held by insiders is used by [43, 39],
whereas %age of institutional holding is also used as
proxy for by [49].
We used natural log of sales as a proxy for size, debt
to equity as proxy for leverage, natural log of cash from
operations as a proxy for liquidity, EPS as proxy for
profitability, free cash flow as proxy for agency cost,
annual sales growth as a proxy for growth, last year
dividend as proxy for last year dividend, beta (variability

whereas sz, lvrg, liq, prof, agnc, grth, divt-1, risk, own
represents size, leverage, liquidity, profitability, agency
cost, growth, last year dividend, risk and ownership
structure and all these variables are dependent variables.
We have generated following hypothesis:
H1 = There is positive relationship between size and
dividend payout.
H2 = There is negative relationship between leverage
and dividend payout.
H3 = There is positive relationship between liquidity and
dividend payout.
H4 = There is positive relationship between profitability
and dividend payout.
H5 = There is positive relationship between agency cost
and dividend payout.
H6 = There is positive relationship between growth and
dividend payout.
H7 = There is positive relationship between last year
dividend and dividend payout.
H8 = There is negative relationship between risk and
dividend payout.
H9 = There is positive relationship between ownership
structure and dividend payout.

Middle-East J. Sci. Res., 18 (3): 410-424, 2013


have easy access to external market, can raise funds at

lower cost as compared to less profitable firms and
ultimately distribute more as dividends. Discussing
positive relationship of both last year dividend and
profitability with the current and future dividend
payments in context of signaling theory and information
asymmetry, insiders/managers have more information
about the current situation and future prospects for the
company. This case is severe in medium and large size
firms where mangers are controlling on the behalf of
shareholders. Little information to the shareholders may
result in low investment from outsiders or under
valuation. Dividend signaling occurs only when firm
increases or decreases dividend payments. Last year
dividend or distributing current year profits as dividends
serve as a signal for the investors about the company
financial conditions and future growth opportunities.
When a signal goes to the market, level of information
asymmetry reduces and investors act according to their
perception about the signal. In this way, last year
dividend payment/current profits distribution result in
overvaluation and ultimately increased investment in the
company. As the investment level rises, future
expectation about high level of profits rises and a
relationship of high profits and increased dividend
payments is expected.
According to our findings liquidity is the single
variable that has a highly significant (p value = .005) but
negative relationship with the dividend payout,
suggesting that the firms that have a better liquidity
position pay low dividends. These findings are confirmed
by [39] that high return on equity stimulates the firms to
reinvest more, as dividend payment reduce the amount of
funds available for reinvestment, so firms pay low
dividends. Another explanation for this relationship may
be that banks have high need of liquid cash as compared
to any other industry, because their total operations
involve either payment are receipts of cash. Moreover,
banks try to lend more in order to increase their returns.
So in order to achieve smooth flow of operations and
increase the future return, banks tend to maintain high
level of liquidity. So, in such scenario negative
relationship between the liquidity and dividend payout
can be expected. Ownership structure also has high
significant (p-value=.014) and positive relationship with
the dividend payout we have used Log natural of
number of shareholders as a proxy for ownership
structure. When ownership is divided into large number

Following are the results of stepwise regression

analysis obtained by using SPSS.
Table 2 represent the overall model output. Value of
R2, .782 shows that overall model explains the 78.2%
variation in the dependent variable, dividend payout.
Value of R2 shows that suggested model provides the
substantial explanation about the dependent variable.
In ANOVA table (Table 3), model p-value is .000 that
depicts that relationship is highly significant. Overall,
figures shows that results are quite explanatory. Table 4
and Table 5; results about the different independent
variables shows that; profitability, last year dividend and
ownership structure have strong positive relationship
with the dividend payout, while liquidity has strong
negative impact on dividend payments. Future more,
effect of size, leverage, agency cost, growth and risk is
observed insignificant.
Coming towards the explanation of individual
variable, last year dividend has a positive impact and its
p-value .000, depicts highly significant relationship.
These findings reflect that previous dividend payment
records of any firm serve as a signal about future time
period. If past records show that firms pay high dividend,
then such a payment behavior can be expected about
the future and vice versa. Considering the dividend
payout policies, such a dividend payment behavior
provides support to the smooth dividend payout policy.
These firms dont cut but try to increase the payout ratio.
Such findings about the last year dividends are
conformed by [70] that firms strive not to cut the dividend
payments from the previous year, rather they trend to
increase it. Sustaining/ losing the previous dividends
payment pattern also suggest about the stability/volatility
of the earning. These findings suggest that in Pakistani
context, till 2009, earnings of banking industry was quite
high, resulting from flexible lending and leasing policies
that generates huge income in form of interest receipts.
The second most important variable that has highly
significant (p- value .000) and positive relationship with
the dependent variable is the profitability. The plausible
explanation behind the profitability level of banking
industry is discussed above. So, the firm earning high
also distribute more. Such findings about the profitability
are confirmed by [60, 61]. Another explanation about the
positive relationship of profitability and dividend payout
was provided by [35], that firms that are highly profitable

Middle-East J. Sci. Res., 18 (3): 410-424, 2013

Table 1: Variables Description




Natural log sales

ln sales

Holder, Langrehr, Hexter (1998)

Debt / equity

Al Malkawi (2007)


Used By

ln Cash from operations

Kanwal and Sujata (2008)



EPS after tax

Al Malkawi (2007), Hafez and Attiya javed (2009)

Agency cost

Free cash flow

(Net income + deprecation + interest

Holder, Langrehr, Hexter (1998)

capital expenditure)/ total assets


Growth rate

Last year dividends

Annual sales growth

Kanwal and Sujata (2008), Kania and Bacon (2005)

Last year dividend

Linter (1956), Baker, Farrellay and Edelman (1985),

Eriotis, Vasiliou and Zisis (2007), Aivazian, Booth,
Cleary (2003), Kania and Bacon (2005),



Variability in profit

DSouza (1999), Kanwal and Sujata (2008),

Amidu and Abor (2006), Baker, Farrellay and
Edelman (1985)

Ownership structure

Insider ownership

ln of # of shareholders

Al Malkawi (2007)

Table 2: Model Summarye


R Square

Adjusted R Square






a. Predictors: (Constant), last year dividend, Profitability, Liquidity, ownership structure

e. Dependent Variable: dividend
Table 3: ANOVAe

Sum of Squares


Mean Square














a. Predictors: (Constant), last year dividend, Profitability, Liquidity, ownership structure

e. Dependent Variable: dividend
Table 4: Significant coefficientsa
Unstandardized Coefficients

Collinearity Statistics









last year dividend


















ownership structure
a. Dependent Variable: dividend
Table 5: Excluded variablese

Collinearity Statistics

Beta In











Agency cost





Annual Sales growth









e. Dependent Variable: dividend


Middle-East J. Sci. Res., 18 (3): 410-424, 2013

of shareholders then each shareholder has only small

proportion of total ownership, referred to as small
investor. These small investors require and prefer current
period dividends instead of future period increased
returns, so a positive relation between ownership
structure and dividend payout is expected. Another
explanation may be that, in case of large number of
shareholders, level of insider ownership falls and firms
prefer to pay more dividends in order to reduce resulting
agency cost. These findings are confirmed by [83].
Our findings about the ownership structure are in contrast
with another study in Pakistan context by [46], that firms
where insider ownership is high pay more dividends
because in such a strategy large proportion of dividends
will go into the pockets of insiders.
Size, leverage, agency cost, growth and risk do not
have any significant impact on the dividend behavior of
Pakistani banks and stepwise regression excluded these
variables from the model [84-86].

ownership base is diversified, small investors require

current period dividends instead of future returns and
firms pay more dividends to control the agency problem
resulting from reduced insider ownership. Impact of
Liquidity is negative as it can be expected in banking
industry because their total operations are based on liquid
cash so even in case of high liquidity banks prefer to
maintain a substantial amount of liquid cash to smooth
out operations. Size, leverage, agency cost, growth and
risk do not have any significant impact on the dividnd
behavior of Pakistani banks.
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