Impact of Announcing Dividends on Share Prices of Corporations Listed in the Saudi Stock Exchange - Dissertation Example

?Impact of Announcing Dividends on Share Prices of Corporations Listed in the Saudi Stock Exchange Background of the problem The purpose of all efforts to ensure full disclosure of pertinent information concerning listed companies is to enhance the efficiency of the financial markets as a tool for valuation. The complete dissemination of available information throughout the market reduces information distortions and allows market participants to decide their market actions under conditions of reduced risk of the unknown. Because of the need to come as close as possible to full and simultaneous availability of information to all market participants, it becomes necessary to measure how efficiently prices respond to the informational content of sudden and unexpected announcements, one of which pertains to dividends. In the past, research tended to confirm the absence of impact of dividend announcements on shareholders’ value on condition that taxes and market imperfections are not present. For this reason, companies would prefer to invest its excess funds (which are not needed for business operations or expansion) in positive net present value projects available to it, in lieu of a dividend payout. It is also generally accepted that market valuation of stocks is dependent upon future earnings – when future earnings are lacklustre, the stock’s market value would go down or remain flat. Should companies pay out all its earnings, therefore, funds that may be reinvested for future productive undertakings are depleted, creating a dampener for new dividend declarations. Also, if dividends were taxable, shareholders may put off the declaration of additional dividends in order for their tax liabilities to be prevented from increasing. Despite these disadvantages to dividend declarations, however, companies continue to resort to cash dividends in order to signal information about future earnings (Uddin & Chowdhury, 2008). What is interesting in Saudi Arabian situation is that Saudi Arabia is a non-tax economy, and one would tend to believe that market imperfections are kept to a minimum. The country therefore presents some interesting possibilities towards confirmation of certain principles espoused by Modigliani and Miller, particularly concerning the signalling theory of dividends. This therefore leads to the objective of the study, stated below. 1.1 Objective of the research study The objective of the study is to determine the impact of dividend announcements on the share prices of corporations that are listed in the Saudi Stock Exchange. The purpose is to determine the degree to which informational content is conveyed by unexpected announcements of dividends, as discerned from the stock price changes beyond levels ordinarily expected. This information would be important to all participants in the stock market, including regulators, policy formulators and investors. 1.2 Statement of the problem The study addresses the problem of how market efficiency may be determined through stock price movements in relation to their corresponding market-moving announcements – that is, the release of announcement of dividends other than that already expected by investors. Knowing how this may be determined, the study shall also apply this method in assessing the efficiency of the Saudi Arabian stock market in factoring in the information content of these announcements. 1.3 Main research question The main research question may be stated thus: How efficiently does the announcement of dividends get factored into the prices of stocks trading in the Saudi Arabian stock market? 1.4 Research subquestions The study proposes to answer the main research question by seeking answers to the following subquestion: Q1: How may extraordinary stock price fluctuations be reliably measured? Q2: By what criteria may unexpected dividend announcements be determined, vis-a-vis expected dividend declarations? Q3: Having distinguished extraordinary stock price fluctuations from regular movements, and unexpected dividend announcements from expected ones, how to what extent do extraordinary stock price fluctuations around the time of release of unexpected dividend announcements correlate with such announcements? 1.5 Scope and limitation of the study The study shall be limited to the Saudi Arabian registered companies which are listed in the Saudi Arabian Stock Exchange, distinguished as to blue chip companies, growth companies and speculative stocks. Stock prices pertaining to stock exchange transactions of the past five years shall be the limitation of data for consideration; the purpose of the five year limit is to avoid unwieldy accumulation of data, while ensuring that a data sample sufficient for the statistical test is available.. 1.6 Ethical considerations The study shall not rely on opinion surveys or interviews, therefore there will be no need for compliance with full information to respondents and assurances of confidentiality. There is an ethical need, however, to assure that the data to be derived from secondary sources should be carefully considered for accuracy and reliability. Furthermore, the sources of the secondary data must be given due credit; the secondary data necessary to conduct this study exists in its collated form because of their effort. For the secondary source not to be duly acknowledged is an ethical lapse which would render this paper less than acceptable. 2. Review of academic literature Early attempts. There are a number of studies that have been written through the years on the effects of dividend announcements on the price performance of stocks listed on stock exchanges. One of the earlier studies was conducted in 1972 by Pettit, at a time when there had been only a limited number of empirical investigations seeking to gauge the market’s reaction to events that generate information that affects the valuation of companies’ equity. The methodology chosen was to employ a linear regression equation with the actual return and the conditional expected return on the stock, with the expected return determined by the capital assets pricing model. The data used were the monthly and the daily closing prices of the selected stocks. Findings of the study support the proposition that the market factors in the information provided by dividend and earnings announcements in its determination of the stock price. Two conclusions may be drawn concerning the regulation of company disclosures. Firstly, if the information contained in the announcement may be conveyed to market in a different way, then there would be a broader choice of financial alternative that the firm may find available. Secondly, the resorting to dividends to convey information about the firm is an inefficient channel, because of its imperfections and inefficiency in embodying the firm’s future prospects (Pettit, 1972). Woolridge (1983) analyzed the effects the unexpected dividend changes on common stock valuation, together with preferred stock and bonds. It examined the likelihood of two potential effects: a wealth transfer effect, and a signalling effect. It is noted that studies that preceded this one found that positive dividend change announcements tended to produce positive common stock price change, and vice versa. The data source were 225 randomly selected firms listed in the New York Stock Exchange (NYSE), and observed their share price movements vis-a-vis the dividend announcements. The methodology employed was known as the Comparison Period Return Approach, or CPRA. Mean daily returns around and on the release of the announcement are taken and compared, in an attempt to ascertain the market’s view on changes in dividends. Expected returns are computed using the Capital Asset Pricing Model, or CAPM, to be used in the comparison. The study confirmed the corroboration of the dividend change with the stock price, consistently with both the signalling theory and the wealth transfer hypothesis on the valuation of stocks. Liljeblom (1989) noted that the announcement of stock dividends and stock splits are usually made in connection with other corporate news releases. Although earlier studies determined the stock valuation impact of “pure” stock dividend announcement in terms of stock price changes on the announcement date, such studies would tend to exclude the greater number of events where “contaminants” would naturally be present in the form of simultaneous associated announcements. It is this situation that the study sought to factor in. Using daily individual stock returns, the study employed mean and cross-sectional regressions of the earnings per share (EPS) in order to find the unexpected average EPS change; thereafter the cumulative average excess returns that are experienced around the release of the stock dividend announcements are then determined and charted. The evidence favored the existence of a corroborative effect between the occurrence of the dividend announcement and the change in stock price (Liljeblom, 1989). Most of the studies up to this time relied upon the CAPM to determined expected stock return, and a regression method of sorts to discover extraordinary returns at or about the dividend announcement date. In Bar-Yosef & Sarig (1992), a new method for measuring the unexpected component of stock returns due to dividend announcements. The method calls for the comparison of the reaction of stock and option prices to dividend announcement, by means of a Box-Jenkins time-series based measure. This new method is more closely correlated with the market’s reaction to the announcement than other alternative measures of unexpected dividend announcements compared to earlier model based attempts. It provides another, more reliable, alternative for studying stock price reactions to such announcements. Alangar, Bathala, and Rao (1999) take a slightly different track in relating stock price changes to dividend announcements. The study recognizes the presence of pre-announcement information asymmetry in the stock, and seeks to relate the information content of unexpected dividend announcements (imputed into the stock price) to the degree of information asymmetry. The contemplated dividend-change announcements include corporate releases on initiations, large increases, large decreases, and omissions pertaining to dividends. Initiations refer to dividend payments for the first time or after a lapse of three years. Large dividend increases are designated as those dividends of at least 50% of the preceding quarterly dividend, and large decreases as those exceeding 50% of that of the previous quarter. Proxy used for information asymmetry is the proportion of stock held by institutions. Omitted from the study are regular dividend declarations such as dividends distributed on a regular quarterly basis. The study sees dividend change announcements (i.e. the unexpected dividend declarations) as having greater information content when pre-announcement information asymmetry is higher. The hypothesis is tested using linear regression models. The study concludes that companies make use of dividends as a costly signalling mechanism in order to convey the firm’s future prospects. The evidence evaluated confirms the view that the information content of dividend-change announcements is positively related to the degree of pre-announcement information asymmetry exhibited by the stock before the unusual dividend is announced. The preceding studies analyse stock prices in the context of trading patterns in the developed Western countries. An interesting study in an alternative context, and one whose findings run counter to the studies examined so far, is that of Conroy, Eades and Harris (2000). The pricing effects of dividends and earnings announcement in this case are studied in the context of the Japanese stock market. Securities regulations in this country require that managers should simultaneously announce the year’s dividends and earnings, together with forecasts of the next year’s dividends and earnings. Conroy, et al. also relied on “surprises” in the announcements, pertaining to news that has not yet been factored into the market and which deviated from the common outlook in analysts’ forecasts. The study found that information content of dividends is marginal, and is restricted to the announcement of the dividends for nest year. It therefore concluded that it found consistency with Modigliani’s and Miller’s dividend irrelevance proposition – that is, the surprises contained in the dividend announcements did not have any material impact on stock prices (Conroy, Eades and Harris, 2000). Moving forward to the more recent studies, an empirical investigation into the effect of dividend on stock price in the Dhaka Stock Exchange as an emerging stock market was conducted by Ali and Chowdhury (2010). In this study, there was no clear distinction that the dividend announcement was ascertained to be an unexpected dividend declaration. It did specify, however, that the observed price changes were observed over a period of 44 days surrounding the dividend announcement dates. The objective, however, parallels the earlier studies in seeking to determine whether dividend announcements convey relevant market-moving information that may result in a price reaction. Methodology was described as a standard event methodology to analyse stock price behaviour in response to the dividend announcement; statistical technique employed included a pooled t-test computation for the stock prices. One industry was singled out for observation – this is the banking industry, of which 25 listed banks comprised the objects of investigation of the empirical study. The findings of the study, similar to that of Japan, found that there did not appear to be any strong price reaction in the market in response to the dividend announcements. It did remark, however, that while dividend announcements did not convey much information to the market, this may be due to comparatively stronger price reactions that may be attributable to news such as insider trading and other factors that would tend to cause greater volatility in stock prices. The regularity with which such news occurred was not clear in the study, but appears to have a connection to the degree of development of the Bangladeshi emerging market (Ali and Chowdhury 2010) In the search for relevant academic articles relating to the research topic, only one article was found concerning the effect of dividend announcement on shareholders’ value, in the Saudi Arabian Stock Exchange. Uddin and Usman (2008) conducted an empirical study on the impact of some 178 announcements of dividends, within the period 2001 to 2005, among counters listed and trading in the Saudi Arabian stock market. The study found that there had been a 2.20 percent market share loss to investors on stock prices after the dividend announcement had taken place. The lost value is recovered, however, from the acquired cash dividend received by investors / shareholders, who earned approximately 7 percent on the net cash dividend received after announcement. 3. Methodology 3.1 Research design and strategy The study is an empirical study that will determine the nature and speed of the reaction of stock prices to dividend declaration. It shall employ an essentially quantitative approach to stock price determination in light of the information content attributed to dividend announcements relating to publicly listed equities in the Saudi stock exchange. 3.2 Sources of data Data shall be sourced through the database of the Saudi Arabian Stock Market, which would have a soft form of the prices of all stocks traded in the Exchange. The data to be gathered will include the last trading price of the stock for each trading day of the exchange in the last five years. Other data sources shall include the published audited annual reports of the companies under consideration, to determine dividends declared and distributed in the past five years. 3.3 Data gathering techniques Data shall be gathered from institutions maintaining the pertinent databases. These would include the Stock Exchange, the news releases of listed companies, and other such sources of secondary information. Published annual reports of these companies shall also be referred to in order to gain information concerning dividend declaration and announcements, as well as information on corporate earnings and profitability that may qualify the dividends declared. 3.4 Methods of data analysis The data shall be analysed through methods suggested by academic literature. These would include the use of linear regression modelling for which data appropriate for the purpose are deemed available and capable of being acquired. The pertinent statistics shall be compared for the three groups of counters – blue chips, growth stocks, and speculating trading stocks. The principal criterion should be that the stocks chosen must have a track record for dividend declaration within the past five years, and must therefore be in a position of assured profitability, though the level of profitability may fluctuate over time. The fluctuations (higher or lower than expected) would tend to influence dividend declarations, creating the possibility of unexpected dividend declarations. Time Table of Activities Activity Description Time duration Time schedule Preliminary research Enhanced literature review 1 week Data gathering Acquisition of soft copy of stock prices from the Saudi Arabia Stock Exchange; collection of annual reports and news releases from companies Determination of dividend announcements Dates for the announcements are determined and the meeting of the criterion for “unexpected” announcements assured Statistical computation The appropriate linear regression modelling is conducted and assessed. 1 week Preliminary draft written and assessed The preliminary findings are determined and first draft of the dissertation written Final draft written The draft is revised for errors and rewritten into final form Bibliography Abbondante, P 2010 “Trading Volume and Stock Indices: A Test of Technical Analysis” American Journal of Economics and Business Administration. Vol. 2 No. 3, pp. 287-292 Adelegan, O J 2003 “Capital Market Efficiency and the Effects of Dividend Announcements on Share Prices in Nigeria.” African Development Review, Dec 2003, Vol. 15 Issue 2/3, p218-236 Al-Kuwari, D 2009 “Determinants of the Dividend Policy in Emerging Stock Exchanges: The Case of GCC Countries.” Global Economy & Finance Journal, vol. 2, no. 2 September 2009, pp. 38-63 Alangar, S; Bathala, C T; & Rao, R P 1999 “The effect of institutional interest on the information content of dividend-change announcements.” Journal of Financial Research, Winter 99, Vol. 22 Issue 4, p429 Ali, M B & Chowdhury, T A 2010 “Effect of Dividend on Stock Price in Emerging Stock Market: A Study on the Listed Private Commercial Banks in DSE” International Journal of Economics & Finance, Nov 2010, Vol. 2 Issue 4, p52-64 Anderson, W 2009 “Alternative event study methodology for detecting dividend signals in the context of joint dividend and earnings announcements.” Accounting & Finance, Jun 2009, Vol. 49 Issue 2, p247-265; DOI: 10.1111/j.1467-629X.2008.00289.x Anon. 2010 “Shareholder-Level Capitalization of Dividend Taxes: Additional Evidence from Earnings Announcement Period Returns.” Quarterly Journal of Finance & Accounting, Winter 2010, Vol. 49 Issue 1, p61-80 Asamoah, G N 2010 “The Impact Of Dividend Announcement On Share Price Behaviour In Ghana.” Journal of Business & Economics Research, Apr 2010, Vol. 8 Issue 4, p47-58 Bar-Yosef, S & Sarig, O H 1992 “Dividend Surprises Inferred from Option and Stock Prices.” . Journal of Finance, Sep 92, Vol. 47 Issue 4, p1623-1640 Capstaff, J; Kl?boe, A; & Marshall, A P 2004 “Share Price Reaction to Dividend Announcements: Empirical Evidence on the Signaling Model from the Oslo Stock Exchange.”. Multinational Finance Journal, Mar-Jun 2004, Vol. 8 Issue 1/2, p115-139 Conroy, R M; Eades, K M; Harris, R S 2000 “A Test of the Relative Pricing Effects of Dividends and Earnings: Evidence from Simultaneous Announcements in Japan.” Journal of Finance, Jun 2000, Vol. 55 Issue 3, p1199-1227 Graham, J R; Kumar, A 2006 “Do Dividend Clienteles Exist? Evidence on Dividend Preferences of Retail Investors.” Journal of Finance, Jun 2006, Vol. 61 Issue 3, p1305-1336; DOI: 10.1111/j.1540-6261.2006.00872.x Hussin, B M; Ahmed, A D; & Ying, T C 2010 “Semi-Strong Form Efficiency: Market Reaction to Dividend and Earnings Announcements in Malaysian Stock Exchange.” IUP Journal of Applied Finance, Jul 2010, Vol. 16 Issue 5, p36-60 Joshipura, M 2009 “Price and Liquidity Effects of Bonus Announcements: Empirical Evidence from Indian Stock Market.” IUP Journal of Applied Finance, Nov 2009, Vol. 15 Issue 11, p5-23 Kosedag, A & Jinhu Q. 2009 “Do Dividend Clienteles Explain Price Reactions to Dividend Changes?” International Journal of Business & Finance Research (IJBFR), 2009, Vol. 3 Issue 1, p47-57 Liljeblom, E 1989 “The Information Impact of Announcements of Stock Dividends and Stock Splits.” Journal of Business Finance & Accounting, Winter 89, Vol. 16 Issue 5, p681-697 Liu, Y; Szewczyk, S H; & Zantout, Z 2008 “Underreaction to Dividend Reductions and Omissions?” Journal of Finance, Apr 2008, Vol. 63 Issue 2, p987-1020; DOI: 10.1111/j.1540-6261.2008.01337.x Mallikarjunappa, T & Manjunatha, T 2009 “Stock Price Reactions to Dividend Announcements.” Journal of Management & Public Policy, Jul-Dec2009, Vol. 1 Issue 1, p43-56 Mandal, N & Rao, N K 2010 “Semi-Strong Form of Indian Stock Market Efficiency: An Empirical Study.” Vilakshan: The XIMB Journal of Management, Mar 2010, Vol. 7 Issue 1, p1-16 Pettit, R R. 1972 “Dividend Announcements, Security Performance, and Capital Market Efficiency.” Journal of Finance, Dec 72, Vol. 27 Issue 5, p993-1007 Uddin, M H & Osman, D 2008 “Effect of Dividend Announcement on Shareholders’ Value: Evidence from Saudi Arabian Stock Exchange” The International Journal of Business and Finance Research. Vol. 2, No. 1, pp. 87-101 Wann, C; Long, D M; Pearson, D; & Wann, G 2008 “Liquidity Shock Induced Dividend Change: Market Reaction by Firm Quality.” Journal of the Academy of Business & Economics, 12/20/2008, Vol. 8 Issue 4, p137-151 Woolridge, J R 1983 “Dividend Changes and Security Prices.” Journal of Finance, Dec 83, Vol. 38 Issue 5, p1607-1615 Bibliography Abbondante, P 2010 “Trading Volume and Stock Indices: A Test of Technical Analysis” American Journal of Economics and Business Administration. Vol. 2 No. 3, pp. 287-292 Adelegan, O J 2003 “Capital Market Efficiency and the Effects of Dividend Announcements on Share Prices in Nigeria.” African Development Review, Dec 2003, Vol. 15 Issue 2/3, p218-236 Al-Kuwari, D 2009 “Determinants of the Dividend Policy in Emerging Stock Exchanges: The Case of GCC Countries.” Global Economy & Finance Journal, vol. 2, no. 2 September 2009, pp. 38-63 Alangar, S; Bathala, C T; & Rao, R P 1999 “The effect of institutional interest on the information content of dividend-change announcements.” Journal of Financial Research, Winter 99, Vol. 22 Issue 4, p429 Ali, M B & Chowdhury, T A 2010 “Effect of Dividend on Stock Price in Emerging Stock Market: A Study on the Listed Private Commercial Banks in DSE” International Journal of Economics & Finance, Nov 2010, Vol. 2 Issue 4, p52-64 Anderson, W 2009 “Alternative event study methodology for detecting dividend signals in the context of joint dividend and earnings announcements.” Accounting & Finance, Jun 2009, Vol. 49 Issue 2, p247-265; DOI: 10.1111/j.1467-629X.2008.00289.x Anon. 2010 “Shareholder-Level Capitalization of Dividend Taxes: Additional Evidence from Earnings Announcement Period Returns.” Quarterly Journal of Finance & Accounting, Winter 2010, Vol. 49 Issue 1, p61-80 Asamoah, G N 2010 “The Impact Of Dividend Announcement On Share Price Behaviour In Ghana.” Journal of Business & Economics Research, Apr 2010, Vol. 8 Issue 4, p47-58 Bar-Yosef, S & Sarig, O H 1992 “Dividend Surprises Inferred from Option and Stock Prices.” . Journal of Finance, Sep 92, Vol. 47 Issue 4, p1623-1640 Capstaff, J; Kl?boe, A; & Marshall, A P 2004 “Share Price Reaction to Dividend Announcements: Empirical Evidence on the Signaling Model from the Oslo Stock Exchange.”. Multinational Finance Journal, Mar-Jun 2004, Vol. 8 Issue 1/2, p115-139 Conroy, R M; Eades, K M; Harris, R S 2000 “A Test of the Relative Pricing Effects of Dividends and Earnings: Evidence from Simultaneous Announcements in Japan.” Journal of Finance, Jun 2000, Vol. 55 Issue 3, p1199-1227 Graham, J R; Kumar, A 2006 “Do Dividend Clienteles Exist? Evidence on Dividend Preferences of Retail Investors.” Journal of Finance, Jun 2006, Vol. 61 Issue 3, p1305-1336; DOI: 10.1111/j.1540-6261.2006.00872.x Hussin, B M; Ahmed, A D; & Ying, T C 2010 “Semi-Strong Form Efficiency: Market Reaction to Dividend and Earnings Announcements in Malaysian Stock Exchange.” IUP Journal of Applied Finance, Jul 2010, Vol. 16 Issue 5, p36-60 Joshipura, M 2009 “Price and Liquidity Effects of Bonus Announcements: Empirical Evidence from Indian Stock Market.” IUP Journal of Applied Finance, Nov 2009, Vol. 15 Issue 11, p5-23 Kosedag, A & Jinhu Q. 2009 “Do Dividend Clienteles Explain Price Reactions to Dividend Changes?” International Journal of Business & Finance Research (IJBFR), 2009, Vol. 3 Issue 1, p47-57 Liljeblom, E 1989 “The Information Impact of Announcements of Stock Dividends and Stock Splits.” Journal of Business Finance & Accounting, Winter 89, Vol. 16 Issue 5, p681-697 Liu, Y; Szewczyk, S H; & Zantout, Z 2008 “Underreaction to Dividend Reductions and Omissions?” Journal of Finance, Apr 2008, Vol. 63 Issue 2, p987-1020; DOI: 10.1111/j.1540-6261.2008.01337.x Mallikarjunappa, T & Manjunatha, T 2009 “Stock Price Reactions to Dividend Announcements.” Journal of Management & Public Policy, Jul-Dec2009, Vol. 1 Issue 1, p43-56 Mandal, N & Rao, N K 2010 “Semi-Strong Form of Indian Stock Market Efficiency: An Empirical Study.” Vilakshan: The XIMB Journal of Management, Mar 2010, Vol. 7 Issue 1, p1-16 Pettit, R R. 1972 “Dividend Announcements, Security Performance, and Capital Market Efficiency.” Journal of Finance, Dec 72, Vol. 27 Issue 5, p993-1007 Uddin, M H & Osman, D 2008 “Effect of Dividend Announcement on Shareholders’ Value: Evidence from Saudi Arabian Stock Exchange” The International Journal of Business and Finance Research. Vol. 2, No. 1, pp. 87-101 Wann, C; Long, D M; Pearson, D; & Wann, G 2008 “Liquidity Shock Induced Dividend Change: Market Reaction by Firm Quality.” Journal of the Academy of Business & Economics, 12/20/2008, Vol. 8 Issue 4, p137-151 Woolridge, J R 1983 “Dividend Changes and Security Prices.” Journal of Finance, Dec 83, Vol. 38 Issue 5, p1607-1615 Read More