Impact of Retained Earnings On The Maximization of Firm Value and Shareholders Wealth

IMPACT OF RETAINED EARNINGS ON THE MAXIMIZATION
OF FIRM VALUE AND SHAREHOLDERS WEALTH
BY
MUHAMMAD ALI TIRMIZI
INSTITUTE OF ENGINEERING AND MANAGEMENT SCIENCES

FOUNDATION UNIVERSITY ISLAMABAD
2012
IMPACT OF RETAINED EARNINGS ON THE MAXIMIZATION

OF FIRM VALUE AND SHAREHOLDERS WEALTH
By
Muhammad Ali Tirmizi
130/FUIMCS/Ph.D (MS)-2006
Ph.D Scholar & HEC Awardee
A Dissertation submitted to the
Faculty of Management Sciences

Institute of Engineering and Management Sciences
Foundation University Islamabad
In Partial Fulfillment of the Requirements For the
DEGREE OF DOCTOR OF PHILOSOPHY

IN
MANAGEMENT SCIENCES
2012
ii
TEAM OF SUPERVISOR, EVALUATORS & EXAMINERS
Supervisor
Evaluators
Prof. Dr. Mehboob Ahmad

mmehboobahmad@gmail.com
Prof. Dr. Amin Sarkar

aminsarkar@aamu.edu
Prof. Dr. Sajid Anwar

sanwar@usc.edu.au
Examiners
Prof. Dr. Khair-uz-Zaman

drkzaman2001@yahoo.com
Dr. Syed Hassan Raza

hassan_raza@aiou.edu.pk
Dr. Hummayoun Naeem

hummayoun@yahoo.com
iii
Supervisor
Bahria University
Islamabad.
Foreign
Evaluator
Alabama A & M
University,
Alabama, United
States of America.
Foreign
Evaluator
University of the
Sunshine Coast,
Queensland,
Australia.
External
Examiner
COMSATS
Institute of
Information
Technology,
Vehari.
External
Examiner
Allama Iqbal
Open University,
Islamabad.
Internal
Examiner
Foundation
University
Institute of
Engineering &
Management
Sciences,
Rawalpindi.
iv
DEDICATION
I dedicate my research work to my dearest parents, wife and son, with whose support and
encouragement I have been able to complete my doctorate with pride.
ACKNOWLEDGEMENTS
I humbly bow to Almighty Allah for giving me strength and faculties to complete my
doctorate with diligence, dedication and commitment.
I would like to pay my gratitude to my research supervisor and teacher, Prof. Dr. Mehboob
Ahmad, and grateful that he supported and guided me all through the process of my doctoral
research work. His valuable suggestions helped me to complete this dissertation free of
technical and theoretical flaws.
I am also grateful to Prof. Dr. M. Iqbal Saif, Head of the Department of Management
Sciences of Foundation University, Islamabad, who supported and encouraged me to
complete my doctorate under tough university schedules.
I am grateful to the respondents from corporate sector of Pakistan who completed and
returned research instruments to facilitate me in the testing, analyzing and reporting the
collected financial data in the prescribed time limits.
In addition, I am grateful to Higher Education Commission (HEC), Government of Pakistan,
for granting me scholarship under the scheme Indigenous Ph.D 5000 Fellowship Program
which included my university tuition fee and monthly stipend during the period 2006 to 2011.
Finally, I am highly grateful to my father, mother, wife and son with whose moral support,
encouragement and facilitation I have been able to finish my Ph.D dissertation with pride.
vi
TABLE OF CONTENTS
Page
APPROVAL SHEET...
ii
TEAM OF SUPERVISOR, EVALUATORS & EXAMINERS...
iii
DECLARATION......
iv
DEDICATION..
ACKNOWLEDGEMENTS.....
vi
TABLE OF CONTENTS.
vii
LIST OF TABLES....
xiii
LIST OF GRAPHS.......
xvi
LIST OF FIGURES......
xvii
ACRONYMS.........
xviii
ABSTRACT...............
xxi
Chapter #
Page
CHAPTER -1: INTRODUCTION......
CHAPTER -2: REVIEW OF THE LITERATURE......
REVIE OF RELEVANT THEORATICAL DEVELOPMENT..
2.1 Early Developments regarding Dividends and Retained Earnings (1950-60).
2.2 Dividend Policy and MM Theory (1960-80s).. 7

2.3 Pecking Order Theory and extended work on Dividend Policy (1980s2000s)...
......
2.4 Critical Analysis...
10
REVIEW OF THE EMPIRICAL WORK DONE...
14
SECTION - I: TREATING INDEPENDENT VARIABLES.
14
12
2.5 Studies conducted in United States of America... 14

2.6 Studies conducted in Canada 31
vii
2.7 Studies Conducted in United Kingdom 35

2.8 Studies conducted in European Union Countries. 38
2.9 Studies conducted in Australia.
42
2.10 Studies conducted in Korea and Japan.
43
2.11 Studies conducted in China, Taiwan and India
44
2.12 Studies conducted in African Countries... 46

2.13 Studies conducted in Turkey and Malaysia.. 48
2.14 Studies conducted by considering multiple countries..
50
55
SECTION - II: TREATING DEPENDENT VARIABLES 56

2.16 Studies conducted in USA and Canada 56
2.17 Studies Conducted in United Kingdom 62
2.18 Studies conducted in European Union Countries. 64
2.19 Studies conducted in Australia and India.
66
2.20 Studies conducted by considering multiple countries..
68
69
SECTION - III: TREATING MODERATING VARIABLE. 70

2.22 Studies conducted in USA, UK and Canada
70
2.23 Studies conducted in Australia and European Union Countries..
76
2.24 Studies conducted in China, Taiwan and Uzbekistan..
79
2.25 Studies conducted in African Countries... 80

2.26 Critical analysis
82
SECTION - IV: STUDIES CONDUCTED IN PAKISTAN... 84

SECTION - V: RETENTION POLICY AND REINVESTMENT 87
AFTER REVIEW OF LITERATURE THE PROPOSED PLAN OF ACTION..
91
CHAPTER-3: THEORETICAL FRAMEWORK....
94
......
3.1 Overview of Theoretical Framework of the study...
94
3.2 Modified Research Model
98
3.3 Definition of the Variables...
104
viii
3.3.1 Firm Value. 104

3.3.2 Shareholders Wealth
105
3.3.3 Retained Earnings (Retention Policy of the firm).
105
3.3.4 Dividend Payout (Dividend Policy of the firm)
105
3.3.5 Capital Budgeting Process and Decisions.
106
3.4 Operationalization of the Variables.. 106

3.4.1 Operationalized form of Dividend Payout, Firm Value and
Shareholders Wealth variables under Condition 1 representing
Model 1 of the study...
106
3.4.2 Operationalized form of Retained Earnings, Firm Value and

Shareholders Wealth variables under Condition 2 representing
Model 2 of the study...
108
3.4.3 Operationalized form of Capital Budgeting Process and

Decisions under Condition 2 representing Model 2 of the
study..
3.5 Interactions of the Variables
111
114
3.6 Hypotheses of the Study... 114

3.6.1 Hypotheses concerning retained earnings impact on Firm
Value
3.6.2 Hypotheses
concerning
retained
earnings
impact
shareholders wealth...
3.6.3 Hypotheses concerning dividend payout impact on Firm Value.
3.6.4 Hypotheses
concerning
dividend
payout
impact
concerning
interaction
of
firm
value
115
116
on
3.6.5 Hypotheses
115
on
116
and
117
3.6.6 Hypotheses concerning moderating affect of capital budgeting

process and decisions on the interactions of variables of model 1
& 2.
CHAPTER - 4: RESEARCH DESIGN.......
......
ix
117
118
4.1 Research Design of the Study..
118
4.1.1 Purpose of the study..
118
4.1.2 Type of investigation. 120

4.1.3 Extent of researcher interference... 120
4.1.4 Study setting..
120
4.1.5 Unit of analysis.. 121

4.1.6 Sampling design
121
4.1.7 Sample size (n)..
121
4.1.8 Time horizon.
121
4.1.9 Data collection Method.
122
4.2 Universe and the Sampling..
122
4.3 Rationale of the Selection of the Universe... 123

CHAPTER - 5: DATA COLLECTION......
125
5.1 Rationale and Selection of Tool...
125
5.2 Tool Development.... 125

5.3 Details of the Tool 126
5.4 Validity and Reliability of the Tool.
128
CHAPTER - 6: DATA ANALYSIS AND INTERPRETATION......
129
......
6.1 Data Analysis Plan...
129
6.2 Descriptive Analysis of Collected Data...
129
6.2.1 Respondents data... 130

6.2.2 Firm demographic data.. 132
6.3 Regression Analysis of Model 1 136
6.3.1 Impact of Dividend Payout on Firm Value.. 136
6.3.2 Impact of Dividend Payout on Shareholders Wealth.
138
6.3.3 Impact of Firm Value on Shareholders Wealth..
139
6.3.4 Impact of Dividend Payout and Capital Budgeting Process and

Decisions on Firm Value... 140
6.3.5 Impact of Dividend Payout and Capital Budgeting Process and
Decisions on Shareholders Wealth..
141
6.4 Regression Analysis of Model 2 143

6.4.1 Impact of Retained Earnings on Firm Value...
143
6.4.2 Impact of Retained Earnings on Shareholders Wealth...
144
6.4.3 Impact of Firm Value on Shareholders Wealth..
145
6.4.4 Impact of Retained Earnings and Capital Budgeting Process and

Decisions on Firm Value...
147
6.4.5 Impact of Retained Earnings and Capital Budgeting Process and

Decisions on Shareholders Wealth..
149
6.5 Comparison of Model 1 and 2
151
6.6 Analysis at Industrial Level.. 157

6.6.1 Performance of the sample
157
6.7 Sources of Financing 159

6.8 Profitability..
161
6.9 Reinvestment Activities...
164
6.10 Outcome of Recent Projects.
167
6.11 Managerial Ownership.
168
6.12 Capital Budgeting Techniques.
170
6.13 Discount Rate for Investment Projects. 173

6.14 Adjustment of Risk Factors.. 174
6.15 Average Growth...
176
6.16 Expected Growth.. 177

6.17 Financing Condition.
179
6.18 INTERPRETATION OF DATA.
180
CHAPTER - 7: FINDINGS AND DISCUSSION.......
183
......
7.1 SECTION-1: Discussion and Findings Relating Research Models...
184
7.2 SECTION-2: Discussion and Findings Relating Supporting Data.....
186
CHAPTER - 8: CONCLUSION AND RECOMMENDATIONS.....
190
8.1 Conclusion 190

8.2 Recommendations
xi
192
REFERENCES..
193
LIST OF PUBLICATIONS OF THE CANDIDATE. 214

APPENDIX A: RESEARCH INSTRUMENT 215
APPENDIX B: STUDY POPULATION.
234
APPENDIX C: RESEARCH SAMPLE..
239
APPENDIX
D:
EMPIRICAL
EVIDENCE
OF
INTERACTION
OF
VARIABLES OF THE STUDY...
245
APPENDIX E: FIRMS LEFT AFTER DATA COLLECTION PROCESS...
249
APPENDIX F: FIRMS DEFAULTED DURING DATA COLLECTION..
253
APPENDIX G: DISTRIBUTION OF RESEARCH QUESTIONNAIRES.
254
APPENDIX
H:
FIRMS
REPLIED
WITH
COMPLETELY
FILLED
QUESTIONNAIRES.
258
APPENDIX I: FACTOR ANALYSIS.
259
APPENDIX J: EXTENTION OF EQUATIONS...
265
xii
LIST OF TABLES
Table
Title
Page
Table 4.1 Randomly selected firms industry-wise distribution..
123
Table 5.1 Detail of the distribution of questionnaires in the sample...
126
Table 5.2 Industrial sector wise distribution of responded sample firms
127
Table 5.3 Empirical evidence regarding response rate of research studies.
127
Table 5.4 Cronbachs Alpha score of the variables of Model 1 and 2...
128
Table 6.1 Dividend payer and non-payer categories of the sample.
129
Table 6.2 Frequency of respondents designation 130

Table 6.3 Frequency of respondents gender...
130
Table 6.4 Frequency of gender of the respondents..
131
Table 6.5 Frequency of education level of the respondents.
131
Table 6.6 Frequency of ownership of the sample firms...
132
Table 6.7 Frequency of employees of the sample firms..
133
Table 6.8 Frequency of age of the sample firm...
133
Table 6.9 Frequency of the industrial classification of the sample firm..
134
Table 6.10 Frequency of the total sales revenue of the sample firms
134
Table 6.11 Frequency of the type of dividend payment by the sample firms
135
Table 6.12 Frequency of retention of earnings by the sample firms..
135
Table 6.13 Frequency of maintaining dividend policy by the sample firms..
136
Table 6.14 Impact of dividend payout on firm value
137
Table 6.15 Impact of dividend payout on shareholders wealth...
138
Table 6.16 Impact of firm value on shareholders wealth.. 139
xiii
Table 6.17 Impact of dividend payout and moderating variable on firm value.
140
Table 6.18 Impact of dividend payout and moderating variable on shareholders

142
wealth.
Table 6.19 Impact of retained earnings on firm value...
143
Table 6.20 Impact of retained earnings on shareholders wealth...
144
Table 6.21 Impact of firm value on shareholders wealth.. 146

Table 6.22 Impact of retained earnings and moderating variable on firm value 147
Table 6.23 Impact of retained earnings and moderating variable on
shareholders wealth. 149
Table 6.24 Regression results of model 1......
151
Table 6.25 Regression results of model 2.....
151
Table 6.26 Regression results of model 1 without moderator affect..
153
Table 6.27 Regression results of model 2 without moderator affect..
153
Table 6.28 Regression results of model 1 with moderator affect....
154
Table 6.29 Regression results of model 2 with moderator affect....
155
Table 6.30 Change in the values of R and R square for model 1 and 2..
156
Table 6.31 Indicators of sample performance at industrial level...
157
Table 6.32 Analysis results of the sources of financing of the sample..
159
Table 6.33 Analysis results of the sources of financing of the sample..
159
Table 6.34 Analysis results of the profitability of the sample...
161
Table 6.35 Analysis results of the profitability of the sample...
162
Table 6.36 Analysis results of the reinvestment activities of the sample..
164
Table 6.37 Analysis results of the reinvestment activities of the sample..
165
Table 6.38 Analysis results of the outcome of recent projects of the sample
167
xiv
Table 6.39 Analysis results of the managerial ownership in the sample firms..
168
Table 6.40 Analysis results of the use of capital budgeting techniques by the
sample... 170
Table 6.41 Analysis results of the use of capital budgeting techniques by the
sample... 171
Table 6.42 Analysis results of use of discount rate for investment projects by
sample... 173
Table 6.43 Analysis results of the adjustment of risk factors by the sample.
174
Table 6.44 Analysis results of the adjustment of risk factors by the sample.
175
Table 6.45 Analysis results of the average growth of the sample during
(2000 - 2009) 176
Table 6.46 Analysis results of the expected growth of the sample in 2 to 3 years
177
Table 6.47 Analysis results of the expected growth of the sample in 2 to 3 years
179
xv
LIST OF GRAPHS
Graph
Title
Page
Graph 6.1 Net profit as percentage of sales of the sample firms at industrial
level..
163
Graph 6.2 Reinvestment activities of the sample firms at industrial level...
166
xvi
LIST OF FIGURES
Figure
Title
Page
Figure 3.1 Thesis Research Model 97

Figure 3.2 Modified Research Model...
102
Figure 3.3 Simplified Interaction of variables in Modified Research Model...
103
xvii
ACRONYMS
APT
Arbitrage Pricing Theory
APV
Adjusted Present Value
ARR
Accounting Rate of Return
BHCs
Bank Holding Companies
CAPM
Capital Asset Pricing Model
CARs
Cumulative Abnormal Returns
CEO
Chief Executive Officer
CF
Cash Flow
CFO
Cash Flow from Operations
CFO
Chief Financial Officer
CRE
Corporate Real Estate
CREM
Corporate Real Estate Management
COR
Cost Over Run
ERC
Earnings Response Coefficient
EU
European Union
EVA
Economic Value Added
FCF
Free Cash Flows
FDI
Foreign Direct Investment
GMM
Generalized Method of Moments
IRR
Internal Rate of Return
ITC
International Trade Centre
IVS
Intrinsic Valuation System
xviii
KSE
Karachi Stock Exchange
MARA
Market Adjusted Return Approach
M&A
Merger and Acquisition
MM Theory
Miller and Modigliani Theory
MVA
Market value Added
NI
Net Income
NPV
Net Present Value
OLS
Ordinary Least Square regression
PBP
Payback Period
PI
Profitability Index
PO
Pecking Order
POR
Payout Ratio
RE
Retained Earnings
REIT
Real Estate Investment Trust
R&D
Research and Development
RIM
Residual Income Model
ROA
Return On Assets
ROE
Return On Equity
ROI
Return On Investment
ROIC
Return On Invested Capital
SECP
Securities and Exchange Commission of Pakistan
SMEs
Small and Medium Enterprises
SMEDA
Small and Medium Enterprise Development Authority,

Government of Pakistan
xix
SPSS
Statistical Package for Social Sciences
UK
United Kingdom
USA
United States of America
Value of the Firm
VCM
Value Creating Management
VECM
Vector Error Correction Model
WACC
Weighted Average Cost of Capital
xx
ABSTRACT
In this research study a mathematical model has been adopted and extended into two
conditions representing two research models that have; dividend payout, retained earnings,
firm value, shareholders wealth and capital budgeting process and decisions as variables.
Accordingly the current author has formulated a new theory named as Hybrid Theory of
Firm Valuation. This study statistically tests the theory by empirically evaluating the models
and the supporting variables. The hypotheses which are tested in the study have been deduced
based on extensive financial literature review that includes a vast array of financial models.
The size of the sample consists of 102 randomly selected listed Pakistani manufacturing firms
that belong to eight industrial sectors and are located in twelve cities of Pakistan. The data is
collected by means of an extensive but strategically developed research instrument. Linear
Ordinary Least Squares regression analysis is applied on the collected data. It suggests that
second model has greater predictability and strength as compared to the first model. The
inference of the tests of the models is also endorsed by the analysis of the supporting
variables of the study. The major findings of the study have revealed that retention policy
model is much congenial for the sample firms operating in Pakistan and application of the
payout of dividends model can be postponed until high growth and reinvestment period is
over. It is established that retained earnings has created higher impact on the firm value and
the wealth of the shareholders in the business environment of Pakistan. The investment and
reinvestment activities undertook by the sample firms during the study period (2000 to 2009)
supports the higher association of the variables of the second model. The empirical tests of
the models have supported the Hybrid Theory of Firm Valuation.
Key words:
Theory, Retained earnings, dividend payout, firm value, shareholders wealth,

capital budgeting process and decisions, reinvestment and investment of
internal funds, growth, listed manufacturing firms, Pakistan.
xxi
CHAPTER 1: INTRODUCTION
The topic impact of retained earnings on the maximization of firm value and shareholders
wealth has not been explored extensively in the past. Greater emphasis has been placed on
dividend payout behavior of the firms by finance researchers who explored and measured
dividend policy issues in international arena. The current author has seen a very limited
number of studies written on the topic of this thesis. Recent decade has produced some
valuable studies that have set the course of future studies in this area. A comprehensive
approach is required to explore a bigger canvas that may explain both sides of the story
relating to distribution of capital earned by a business firm.
The earliest study that initiated debate on distribution of capital in the form of dividends as
well as retention of capital for investment purposes was published by Lintner (1956). The
classic work of Lintner is still considered as foundation of corporate finance. Multiple finance
models have been developed based on his work. Graham and Dodd in (1951) discussed the
securities analysis techniques and concentrated on dividends affects. But, the work of Lintner
was more explanatory and comprehensive. In this area well-known theories have been
developed by corporate finance researchers by taking into account the dividend policy of the
firm. MM theory presented by Miller and Modigliani (1961) was also considered a valuable
asset of corporate finance until the time this theory was refuted by researchers in the last
decade. The current author has discussed in detail these and related theories in the subject of
corporate finance in chapter 2.
Despite the fact that a large number of studies, over a period of more than forty years, have
explored the issues concerning dividend policy in an international context, no one has yet
solved the dividend puzzle (Bhattacharyya, 2007). The current author has considered dividend
policy as one side of the coin. The other side of the coin is retention of earnings by firms
which are used by the firm in operating, financing and investing activities. In real world, if a
coin has only one side and other side is removed, it becomes worthless with no value. So,
both the sides of the coin make it valuable. We identify this fact as knowledge gap in
corporate finance literature. It can be understood by the help of the following formula:
1 = dividend payout ratio + plowback (retention) ratio
The current author has formulated Hybrid Theory of Firm Valuation based on above
mentioned formula and also based on the review of corporate finance literature. The current
author evaluated both sides of the coin and explored related issues in the business
environment of Pakistan to test the formulated theory. In Pakistan the research in the subject
of corporate finance is evolving and is at the embryonic stage of development. Recent decade
has produced some quality research in the subject of financial economics. But, there are
multiple uncharted areas in the subjects of corporate finance which need to be addressed in
Pakistan.
A study published by Mehar (2007) gained the attention of current author towards the issue
of lower dividend payout by the firms operating in Pakistan. In Pakistan retention rate is
much higher as compared to the payment of dividend of 23% of the incremental profits of the
company. The current author has studied multiple concepts that explained the retention and
use of earnings by a firm and came up with different point of views on this issue until the
time he read a study in the subject of mathematical finance by Sethi and Taksar (2002) that
addressed the issue concerning optimal financing problem of infinite horizon corporation.
This study is based on the work of Sethi and Taksar, accordingly adopted firm valuation
equation, derived by them, to evaluate impacts of retained earnings as well as dividend
payout on the value of the firm in the business environment of Pakistan. According to
Pecking Order Theory (Brealey and Myers, 2003, chap. 18, p. 511) retained earnings are the
primary source of financing used for the reinvestment activities by a firm and the
reinvestment procedure includes selection of viable projects by means of capital budgeting

process. This statement shows the importance of capital budgeting for a firm. This study
introduces capital budgeting process and decisions as moderating variable and shareholders
wealth as another dependent variable. So, the statement of the problem developed by the
current researcher is as follows:
What is the level of significance and application of reinvestment models of corporate
retained earnings in Pakistan and how these models effect the value maximization of the firm
and enhancement of shareholders wealth?
The main objective of this study is to test the mathematical models devised by the current
author based on the work of Sethi and Taksar and extends the scope of this research by
incorporating other related variables that can potentially alter the interactions of variables in
the research models. In this study two mathematical models have been devised through
modification of Sethi and Taksar (2002) model. The first model tests the interactions of
dividend payout with and without the influence of capital budgeting process and decisions
included as moderating variable on the firm value and shareholders wealth. And the second
model tests the interactions of retained earnings with and without the influence of capital
budgeting process and decisions included as moderating variable on the firm value and
shareholders wealth. This study further compares the strengths of the two models by
applying linear regression on the collected data. The current author has pooled manufacturing
firms that are listed at Karachi Stock Exchange (KSE) of Pakistan as population and
randomly selected firms to test the Hybrid Theory of Firm Valuation. A comprehensive
research instrument has been developed that incorporates operationalized form of variables
from multiple past research studies and publications to tap the responses of the respondents of
the sample. The sample firms were approached through postal and electronic mail. The firms
approached that belonged to eight industrial sectors, located in twelve cities of Pakistan. The
sample firms that responded with completely filled research questionnaires belonged to four
industrial sectors of Pakistan. A number of hypotheses were formed on the bases of review of
existing corporate finance literature and then tested the same using Ordinary Least Squares
linear regression analysis. Statistical Package of Social Sciences (SPSS) is used for statistical
analyses.
The major findings of the tests of the research models supported The Hybrid Theory of Firm
Valuation and revealed that investment and reinvestment of retained earnings model is
significant and suitable for the listed manufacturing firms operating in the business
environment of Pakistan. The dividend payout model is currently not feasible to be applied in
the case of listed firms operating in Pakistan. The basic reason behind this argument is the
higher growth experienced by the listed sample firms during the study period that ranges
from 2000 to 2009. In this period sample firms that responded have also reinvested greater
portion of their net income in value enhancing activities that include; business expansion
activities within the firm, new investments in long-lived assets and investment in real estate.
This study can benefit the policy makers in the Government of Pakistan as well as the listed
Pakistani manufacturing firms, local and foreign research organizations, finance and
economics research scholars who want to understand a wider picture of the flow and
distribution of capital earned by the listed manufacturing firms in Pakistan. The formulation
of a new corporate finance theory and modified version of the models used in this study, are a
small contribution from the current scholar. Therefore, it is hoped that this study will
contribute towards the existing knowledge base of the corporate finance. This study will also
facilitate interested parties to understand financial systems and models in the context of
Pakistan. The results of this research can also be used by academicians to develop case
studies that raise issues in this field and also researchers can explore financial models in
diversified forms of business environments. The models based on Hybrid Theory of Firm
Valuation tested in this research thesis can also be tested in other parts of the world to check
the robustness and generalizability of the results and inferences.
The layout of this research thesis incorporates the following chapters which are briefly stated
below.
Chapter 2 explains literature review of books and articles relating to variables of the study.
The proposed plan of action and formulation of the Hybrid Theory of Firm Valuation are
explained at the end. Chapter 3 explains theoretical framework of the study including
deductions of hypotheses, definition, operationalization and interaction of variables. Chapter
4 explains research design of the study. Also, Universe and sampling methodologies are
explained. Chapter 5 explains data collection process including tool development and
description. Chapter 6 presents data analysis plan, regression results of models. Also, analysis
of support data is presented in tabular form. Chapter 7 presents interpretation of the models
analysis in section one and supporting data analysis in section two. Also, salient findings are
presented by the current scholar. Chapter 8 concludes the study and some recommendations
are suggested at the end. References and appendices follow this chapter.
CHAPTER 2: REVIEW OF THE LITERATURE
This chapter presents review of the corporate finance literature.
REVIEW OF THE RELEVANT THEORETICAL DEVELOPMENT

The current author has reviewed and documented the relevant theoretical development in the
corporate finance literature relating variables of the study from the books of the following
authors: Brigham and Ehrhardt, 2001; Brealey and Myers, 2003; Mahapatra and Mahapatra,
2004; Copeland, Weston and Shastri, 2007.
2.1. Early Developments regarding Dividends and Retained Earnings (1950-60)

Dobrovolsky (1951) considered corporate retention decision as an active and primary
decision variable for a firm when savings are preferred over payout of dividends to the
shareholders. According to the author dividend and retention decisions are by-products of
each other when ownership and control functions are separated due to agency conflicts.
Retention decision is primary to a firm because growth oriented firms prefer to reinvest
earnings instead of paying dividends to the shareholders.
Lintner (1956) described distribution of income by corporations regarding dividends, retained

earnings and taxes by constructing a corporate dividend behavioral model. He conducted 28
interviews to determine factors affecting dividend policy. The stylized factors presented by
him describe dividend decisions of a firms as; (i) Firms that are at their maturity stage payout
larger portion of their earnings as dividends whereas, growth oriented companies payout
small part of their earnings, incase they have such funds available, (ii) The main focus of
managers in a company is on relative change in dividend per year rather than on absolute
levels of dividends payout per year, (iii) Sustainable earnings of the company determine
smooth dividends payout whereas, changes in earnings of the company has no effect on this
payout process, (iv) Managers always remain very critical of decisions regarding dividend
payout policy and have mindset to increase dividend payout per year.
2.2. Dividend Policy and MM Theory (1960-80s)

Miller and Modigliani (1961) extensively worked on the dividend policy variable in idealized
conditions. They presented MM Theory of dividend policy. According to MM theory the
value of the firm is unaffected by the dividend policy in a world without taxes, transaction
costs or other market imperfections. Also, this theory suggests that the value of the firm
depends only on the income produced by its assets and division of income in terms of
dividend and retained earnings is not useful for the firm. Authors developed MM Theory on
the basis of the following assumptions; capital markets are frictionless, individuals can
borrow and lend at the risk-free rate, there are no bankruptcy costs and business disruptions,
firms can only issue risk-free debt and risky equity claims, all firms are in same risk class,
only corporate taxes are enforced, all cash flow streams are non-growth, same information is
available to the principal and agent and change in capital structure has no effect on the
operating cash flows of the firm.
Friend and Puckett (1964) tested the effect of dividend payout on the share value by using
cross-sectional data and criticized the approach that linked higher dividend payout with
higher price to earnings ratio by the firm. The earlier work reported that dividend multiplier
was several times the retained earnings multiplier. Empirical work established that riskier
firms had lower dividend payout and price to earnings ratio. It was also reported that retained
earnings had measurement error and dividends had not. But, authors eliminated the
measurement error of retained earnings by using net income of the firm normalized by the
price ratio for the firm and at industrial level it was normalized by price ratio for the industry.
But, in-spite of these developments no test was performed to analyze the difference between
the impacts of retained earnings and dividends significance. And, no theory was formulated
in this area.
Farrar and Selwyn (1967) assumed a world with personal taxes in-addition to corporate taxes
and developed a model to represent maximization of after tax income by the individual. They
applied partial equilibrium analysis and assumed that shareholders have two choices;
shareholders can own shares in an all-equity firm and borrow to provide personal leverage or
buy shares in a levered firm. So, shareholders can demand for dividends or defer dividends in
an anticipation of future higher capital gains.
Brennan (1970) extended the work of Farrar and Selwyn (1967) into a general equilibrium
framework. They assumed that shareholders demand higher dividend yield on the firms
security investment at a given level of risk because dividends were taxed higher than the
capital gains.
Black and Scholes (1974) endorsed the assumptions of the MM theory and further added that
high payout to clienteles satisfies their demand and under this condition high or low
dividends have no effect on price or returns. So, value of the firm is not affected by its
dividend policy.
Ross (1977) worked on the irrelevance proposition of MM Theory which stated that market
knows the random stream of return of the firm and valuing this stream sets the value of the
firm. He developed a theory that stated that an increase in the use of debt by the firm will
represent unambiguous signal to the marketplace that firm has improved its prospects.
Miller and Scholes (1978) explained the case of a firm value that was facing disparity in
corporate and personal taxes regarding dividend income and capital gains. They added that if
the tax on ordinary personal income is greater than the capital gain tax, individuals will be
indifferent between the payments in the form of dividends or capital gains, when firm decides
to repurchase shares from the individuals. So, under this case value of the firm will be
unrelated to its dividend policy even in a world with personal and corporate taxes.
Bhattacharya (1979) developed a dividend-signaling model to explain the dividend payout

behavior of firms under tax disadvantage conditions. He indicated that dividend payout
signals to the market about the value of the firm. Author assumed that if investors believe that
firms that pay higher dividends per share have higher values, then an unexpected increase in
dividend payout will be considered as positive value enhancing signal. In-order to achieve
optimal dividend payout under signalling nature of dividends, tax disadvantage was tradedoff by higher dividend payout by the firm.
Rozeff (1982) suggested that even if we ignore tax considerations, optimal dividend policy
does exist. Author traded-off flotation cost of raising external equity with the increase in
dividend payouts that benefits firm by reducing agency costs. The author indicated that fast
growing firms could reduce their dependence on external equity financing by paying lower
dividends to the shareholders. So, growth was reported negatively related to the dividend
payout by the author.
Asquith and Mullins (1983) analyzed the affect of dividend initiation announcement on the
wealth of the shareholders. Authors considered firms that had mostly never paid dividends in
their life spans and when dividend initiation announcement was aired, the first two days
abnormal returns of the shareholders were maximized significantly.
2.3. Pecking Order Theory and extended work on Dividend Policy (1980s-2000s)
Myers (1984) suggested a Pecking Order Theory for capital structure. This theory categorized
the sources of financing used by the firm. According to author firms prefer retained earnings
(available liquid assets) as their main source of funds for investment. The second preference
was given to debt and third was external equity financing by the firm. Author added that firm
avoids issuing common stock or other risky securities in-order to save it-self from becoming
higher leverage firm because higher leverage may led to bankruptcy.
Miller and Rock (1985) constructed a signaling model based on the concept of net
dividends. They included and combined dividends and external financing variables to show
that they are merely two sides of the same coin which explains that every firm at certain point
in time faces financing sources and utilization constraints. Authors also linked announcement
effect on shareholders wealth with the firms earnings surplus. So, these authors explained
firms earnings surprises, unexpected dividend changes and unexpected external financing as
signals to the market about the value of the firm.
Masulis and Trueman (1988) constructed a model by considering investment and dividend
decision variables under fairly realistic assumptions which included; payment under same
effective marginal tax rate by all the firms, different tax rates on dividend income for
diversified group of individuals, zero effective capital gains taxes, regular taxation of
10
corporate equity purchase similar to dividend payment taxation and 80% dividend exclusion
from taxes on all dividends paid between two corporations. So, larger cost of deferring
dividends induces firms to optimally payout cash dividends to its shareholders.
Helwege and Liang (1996) tested the pecking order theory and found that firms with surplus
funds avoided to generated capital from the capital market and internal cash deficit showed
no predictability for the decision to obtain external funds by the firm. Authors found
consistency in results with the pecking order hypothesis.
Allen, Bernardo and Welch (2000) developed theory of dividends based on tax clienteles
which suggested that higher payout of dividends to the shareholders signal the market the
worth of the firm. Authors indicated that under higher tax on dividend payouts, an inclination
towards shares repurchase as a means of distribution of income by the firm was observed in
the developed part of the world.
Baker and Wurgler (2002) developed a theory in which the decision of dividend payout was
driven by the demand of the investor. Authors indicated that catering is the best explanation
of dividend initiation by the managers of the firm because managers initiate dividend payout
when investors put a relatively high stock price on dividend payer and when non-payer are
priced as compared to dividend payers, dividends are omitted.
Fama and French (2002) analyzed firms dividend and debt policies under the effect of tradeoff and pecking order models. Authors reported that firms that were highly profitable and had
fewer investments paid higher dividends to their shareholders. They also reported that firms
that had higher profitability and investments had lower leverage ratios and this fact
11
established consistency of finding with the trade-off and pecking order theories. Also, higher
leveraged firms have higher cost of capital and it makes firms riskier for investment.
2.4. Critical Analysis

The debate on firm valuation was stated in 1950s, which in result signified dividends and
retained earnings as active and primary decision variables. Early Research scholars identified
dividends and retained earnings as by-products that affect firm value. During 1960s after the
development of MM theory dividend policy became the center of attention and researchers
from around the world started working on dividend payout as predictor of firm value. In early
studies, firm valuation was examined in terms of change in per share value in idealized
conditions. During 1970s and 80s, multiple models of dividend policy like; dividendsignaling model, dividend initiation affect model, etc, were developed and tested by
considering real market data. Moreover, tax effect of dividends were extended to include debt
policy of the firm and effects of tax shield in case of corporate and personal taxes were
examined by international researchers.
The introduction of Pecking Order Theory in 1980s enhanced the concept of firm valuation
and in-addition to dividend payments investment sources were included as important
variables affecting firm value. Extensive research was done in respect of pecking order
around the world and corporate finance researches examined firm value by constructing
models that varied in scope and application.
During 1980s, 90s and2000s, further work on dividend policy was carried out and new
models like; dividends based tax clienteles, catering model of dividend initiation, trade-off
model, etc, were developed and affect of leverage was tested in respect to firm valuation.
Evidence cited above shows that an extensive research work was carried out by considering
dividend policy as an important decision variable for a firm. But, research on dividend policy
12
was carried out in isolation and the significance of retained earnings variable which is a part
of retention policy of a firm was altogether neglected. Minimal amount of studies regarding
retained earnings done in recent times are available on payment on online research databases.
So, retained earnings beside dividend policy, has not been extensively researched in the past.
This fact indentified a gap in the corporate finance literature. Moreover, dividend payout and
retained earnings are two important decision variables and during firm valuation process
impact of these variables should be examined in-order to access the affect of distribution of
net income of a firm in terms of dividend payout and retained earnings.
Review of existing available empirical studies has been carried out to support and check the
significance of the identified knowledge gap.
13
REVIEW OF THE EMPIRICAL WORK DONE

The empirical work reviewed in the context of the title of this research study covering the
variables of the devised models is comprehensively explained below:
SECTION - I: TREATING INDEPENDENT VARIABLES

The independent variables from the two devised models of this research study are; dividend
payout variable (dividend policy) and retained earnings (retention policy). The empirical
work done related to these variables covered a vast number of issues directly or indirectly
involving two variables. The studies reviewed and reported here mainly include testing,
analyzing or evaluation of formulated models by the authors concerned with respect to
geographical regions of the world.
2.5. Studies conducted in United States of America

Ghosh and Woolridge (1989) investigated the reaction of firms shareholders when common
stock dividends were cut to generate funds for investment. They also examined growth
oriented dividend cuts in the context of stock market reaction and performance of the sample
firms. They associated dividend cut with the principle of value maximization of the
shareholders. They selected US firms that exercised dividend cuts or omitted dividends
payout, and collected 49 dividend cut observations during 1962 to 1984. They also compared
two samples of firms that had cut dividends based on growth and earnings. The authors used
Market Adjusted Return Approach (MARA) and found that dividend cut announcements in
the growth oriented as well as earnings oriented cases affected negatively the stock price of
the firm and also reduced the capital of the shareholders. The authors concluded that a sample
firm that followed shareholders value maximization policy occasionally cut dividends to
14
accumulate funds for investments. The dividend cut announcements negatively affected stock
price of the sample firms and it resulted into decreased firm value and shareholders wealth.
Agrawal and Jayaraman (1994) evaluated dividend policies of all-equity US firms. They
defined all-equity firms as, those that use no long-term debt throughout a continuous fiveyear period. They finalized 71 matched pairs of all-equity US firms and collected data
during 1979 to 1983. They tested dividend payout model and applied multivariate regression
analysis on the collected data. They found that dividend payout and managerial ownership
were inversely related. The authors reported that all-equity sample firms paid-out higher
dividends as compared to levered firms. They concluded that all-equity sample firms were
smaller in size but paid higher dividends to their shareholders due to lower level of
managerial ownership structure in these firms.
Barclay, Smith and Watts (1995) analyzed leverage and dividend policy choices of multiple
USA based business entities. They assessed more than 6,700 US industrial firms and
collected 71384, 6780 and 70695 firm year observations during 1963 to 1993 for the analysis
of pooled, cross-sectional and fixed effects. They considered broad spectrum of financial
theories to understand the relative importance of each and every aspect of these theories that
create impact on the financial behavior of US industrial firms. The authors applied OLS
regression analysis and found stable value of the leverage and dividend policy. They
identified taxes at personal and corporate level as well as leverage as the determinants that
affected the firm value. They identified direct and indirect bankruptcy costs as factors that
decreased firm value. The higher asset in place firms with higher market to book value had
significant lower levels of leverage ratios. However, regulated firms had higher leverage and
dividend payout as compared to unregulated firms. Under signaling effect of dividend policy
15
under-valued high quality sample firms showed higher leverage and dividend payouts. The
tax effect of dividend policy was not supported by the findings of the study. But, results of
pooled regression analysis showed that large sample firms had lower leverage ratios and
higher dividend yields. The authors identified leverage and dividend policy as signaling tools.
Elston (1996) investigated the importance of dividend policy by considering sensitivity of

liquidity of firms investment policys considered as constraint under the framework of Q
Theory of investment. He defined cost of capital and creation of liquidity constraints as two
major ways through which dividend policy affect the investment mechanism of the firm. He
developed and modified dividend payout model to represent firm investment at a particular
time. The size of the sample was 220 large US stock issuing firms and financial data of 770
firm year observations was collected during 1975 to 1988. He applied GMM method to test
the model. He found that cash flow was significant for all groups of firms. The author
explained that increase in firm size showed greater dependence on the cash flow used to fuel
the investment demand. The author concluded that dividend policies of sample firms were
independent of the issues concerning investment decisions and liquidity constraints.
Sloan (1996) investigated the role of earnings and free cash flows in performance evaluation
of the firm. He discussed realization and matching principles of accounting and elaborated
their impact on the measurement process of firms earnings. He discussed two types of
dividend discount models. He used earnings and cash based models to forecast prospective
dividends of the firms. He identified earnings based model of discount cash flow as the best
available mechanism that can predict future direction of the firm. He considered the return
strategy of listed US firms for the period 1963 to 1993 and found that the hedged portfolios
of the sample firms generated abnormal return of 11%. The author concluded that the finding
16
of his study supported the manipulation mechanism of earnings. Sample firms used this
mechanism to raise the level of stock prices which in result temporarily raised the market
values of the sample firms.
Chung and Wright (1998) analyzed Tobins Q ratio to estimate the impact of corporate
investment behavior on market value of the firm. The major objective of the study was to
examine how Tobins Q contributes towards the valuation of corporate policy decisions?
The authors also examined cross-sectional association among the variables by considering
five years data of publicly traded large manufacturing firms collected during 1983 to 1987.
The data of the study comprised of 4,430 time-series and cross-sectional observations. They
considered the model of market value of the firm and further modified it to test the
associations of variables. They used regression analysis and found that low Q firms with
debt burden were positively associated with their market values and dividend payout of overinvesting firms with higher Q value had no association with their market values. Also,
negative association between financial slack and market value was reported. The authors
reported positive associations between debt ratios, higher payouts, financial slack (retained
earnings) and R & D investments with the market values of over-investing firms.
Fama and French (1998) investigated the association of earnings, investment and financing
with the firm value. They selected all the US based firms that had financial information
available relating the variables of the study. They collected data during 1965 to 1992. The
authors developed a regression model representing total market value of the firm that had
spread of value over cost. They found positive change in firm value linked with the increased
past, present and expected future growth in earnings. Firms payout of dividends and debt
also positively affected the firm value. So, the authors rejected the idea that taxes have effect
17
on the pricing of dividends. Similarly, the test of debt with the tax effect showed that they
were not related and taxes did not create variations in the association of value of the firm and
financing decisions. Leverage created negative affect on the firm value. The authors
concluded that sample firms earnings had information conveying characteristics.
Baker and Powell (1999) compared valuable views of 170 senior level managers from 113
regulated (termed as utilities) and 392 unregulated (termed as manufacturing) listed US
Corporations regarding four issues related to dividend payout behavior. They also
investigated the correlation between various determinants of corporate dividend policy. They
extended their study based on; the signalling, bird in the hand, tax preference and agency
costs explanation of dividend policy. They used survey instrument of Baker (1985). The
response rate of the survey was 33.7%. The authors applied chi-square test and analyzed the
views of the senior level managers of regulated and unregulated US sample firms. They
found that results supported the signaling explanation of the dividend policy. The authors
reported that the level of current and expected future earnings, pattern or continuity of past
dividends, concern about maintaining or increasing stock price, concern that a dividend
change may provide a false signal to investors and stability of cash flows were the most
important determinants of the dividend policy.
Chen and Steiner (1999) investigated the association between managerial ownership with
firms risk taking capacity, debt policy and dividend policy behaviors by employing nonlinear simultaneous equation estimation method. They also examined the interaction of
external shareholders with the firm management and the interaction of shareholders with the
bondholders under the influence of agency theory. They selected sample of 785 listed firms
and applied OLS regression analysis on the collected data. They found risk positively
18
associated with managerial ownership. The debt and dividend policies showed negative and
significant association with the managerial ownership. This association showed that under
enhanced monitoring and control of managers of sample firms, debt and dividends payout
levels reduced significantly. As a consequence, conflict between firms shareholders and
bondholders increased. The authors concluded that managerial ownership facilitated sample
firms to mitigate agency conflicts but conflict between firms shareholders and bondholders
aroused. Thus, low propensity to payout dividends by the sample firms indicated a trend of
stockpiling of earnings.
Dutta (1999) examined the relationship between managerial ownership known as inside
ownership of equity in US based Bank Holding Companies (BHCs) and also analyzed the
dividend and debt policy decision choices of these corporations. The size of the sample was
136 BHCs and the financial data was collected during 1994 to 1997. The author applied
simultaneous equations regression analysis also known as two-stage least squares
procedure on the three models representing inside holdings, dividends and debt linkages and
found negative association between insider holdings and dividends. He reported positive
association in the case of debt and dividends. The author concluded that banks in USA had
higher managerial ownership concentration and involvement in the form of equity
ownership. This phenomenon indicated higher level of capital retention by the banks in
USA.
Riahi-Belkaoui (1999) defined earnings determination as, the process of finding acceptable
level of reported earnings of the firm. He associated earnings determination as response to
wealth generation or net value added. The objective of his study was to test net value addedearnings policy model. This model was based on net value added of the earnings and it was
19
basically used to measure wealth generated by the firm. He further modified the initial
permanent net value added model. The size of sample financial data was 4,410 firm year
observations collected during 1976 to 1995. The author used descriptive and correlation
analysis and found that current earnings of the firm were significantly predicted by the net
value added and last year level of firm earnings.
Arnott and Asness (2001) discussed the role of dividend policy in forecasting the earnings
growth of the firm. The main focus of this study was to investigate the factors related to
dividend policies of a wide quantity of market-based firms. They had considered the model of
expected returns known as constant growth valuation model and further modified this
model in-order to represent dividend yield in terms of multiple of payout ratio and earnings
yield. Authors acquired data from multiple sources during the years 1950 to 2000 in the USA.
They used regression analysis and found that the yield curve had a weaker forecasting power
as compared to the payout ratio in the prediction of the earnings growth. The authors reported
that in an efficient market where constant expected returns on equity investment prevailed,
lower earnings yield directly linked with futures higher real earnings growth. They
concluded that low payout ratios and high retention rates of the firms led to lower earnings
growth. Thus, payout ratios were not the positive predictors of the future earnings growth for
the sample firms.
Kholdy and Sohrabian (2001) revisited pecking order and free cash flow hypotheses by
considering firms of different sizes. They used Vector Error Correction Model (VECM) to
estimate the causal relationship between cash flow and investment behavior of sample firms
and explained the long-term trends and short-term dynamics of the variables. They selected
aggregate firm level data from different USA published sources and collected 64 time series
20
observations during 1980 to 1996. The authors also segregated firms as, small, medium and
large based on their asset values. They applied co-integration tests to estimate the VECM
for each sized group of firms in the time series data and found that small sample firms used
more debt and borrowed twice as compared to the amount invested by the firms. Medium
sample firms were found busy in the maximization of shareholders value. Large sample
firms used retained earnings and debt extensively to fuel investments. The authors concluded
that results of their study conformed to the assumptions of pecking order and free cash flow
hypotheses.
Park and Morton (2001) studied Earnings Response Coefficient (ERC) which was used to
capture the sensitivity of returns generated from security investments to the unexpected
earnings. Park and Morton hypothesized the determinant of ERC different from persistent
earnings, opportunities for growth, risk associated with earnings, quality of the auditor and
the size of the firm. They named ERC as the mix of internally and externally generated
common equity capital. Park and Morton developed two hypotheses and tested the same
using regression analysis. They used cross-sectional data of about 15,000 firms collected over
eleven years. They concluded by saying that firms usually preferred internal equity for
financing investments. They further added that the choice of selection of sources of common
equity affected the cost of equity capital and it was evident from their results that internal
equity capital brought low cost of capital and had higher ERC. Firms having high growth
rate also had greater informational asymmetries during the period of greater positive
investment opportunities.
Opler, Pinkowitz, Stulz and Williamson (2001) analyzed the determinants of corporate cash
holdings and marketable securities. The size of the sample was 24 industrial listed US firms
21
and the data of 87,117 firm year observations was collected during 1952 to 1994. The authors
found that, on average, sample firms held 6% of cash to net assets. They reported that more
growth oriented and riskier small sized sample firms held excess cash and had lower market
to book values. Managers of the sample firms had ownership greater than 5% and this factor
reduced firms cash holdings level and higher amounts of cash was diverted to investment
related activities. The authors concluded that cash holdings were used as a tool by the sample
firms to counter as well as manage risk.
Upneja and Dalbor (2001) evaluated that; whether the financial growth cycle in the restaurant
industry of USA along with the affect of pecking order theory could explicate the capital
structure decisions of the managers. They also investigated the association of debt and value
maximization of the firm. The size of the sample consisted of all the USA restaurant firms
operational during 1991 to 1998. The authors formulated a total debt of the firm model and
tested it. They used Ordinary Least Square (OLS) regression and found positive association
of bankruptcy with the total debt and cash flows with the total debt of the sample firms. The
authors concluded that the requirement of short-term debt by the USA restaurant sample
firms made them risky investments. Thus, debt borrowings by the sample firms supplemented
their internally available funds and fueled the expansion activities.
Sethi and Taksar (2002) tried to solve the optimal financing problem of an infinite horizon
corporation. The basic aim behind this approach was to find a financing mix that contained
retained earnings and external finance as the sources of financing and contributed towards the
value maximization of the firm. The authors considered an earlier work done by Sethi (1978)
as foundation. The work of Sethi addressed the horizon problem of the firm by categorizing
the firms earnings level. The authors constructed optimal financing problem of a firm in the
22
form of a model and elaborated the investment mechanism of the firm by ranking the
available projects based on their expected rates of return and funds. They used Hamilton
Jacobi-Bellman equation and further derived it to generate firm valuation equation that
represented state of a firm where assets of the firm were kept at threshold level of funds and
if this level exceeded beyond this level, excess was paid out as dividends and if this level did
not increase from the threshold level then firm retained all of the earnings for the
reinvestment in the best available projects. So, the value of the firm was dependent on the
value threshold level of funds that varied with the stream of earnings of the firm over time.
This process altered the functionality of the inflow and outflow of firms capital. The authors
concluded that they comprehensively addressed the value function of the firm by taking into
account retained earnings and external equity as sources of financing and thus solved the
optimal financing problem.
Brien (2003) investigated the impact of industrial innovative competitive strategy of the firm
on its capital structure decisions. He considered R&D investment as the basis of lower
leverage. He associated financial slack, also known as corporate retained earnings, with
lower level of corporate leverage because financial slack provided financial cushion to the
firm in the time of cash flow volatility and also helped the firm in the continuous flow of
funds for innovative investment projects. The author selected 16,358 US listed firms and
collected 91,000 firm year observations during 1980 to 1999. He applied OLS regression
analysis to evaluate three models of leverage and found innovation based strategical approach
as drives of leverage at lower points and this outlook drove sample firms to achieve greater
value. The results of the study also supported pecking order theory. The author concluded
that sample firms strategic orientation was closely associated with its competitive position in
the market place. Financial slack and best strategic approach facilitated sample firms.
23
Deshmukh (2003) investigated the affect of asymmetric information on dividend changes. He

examined firms that changed their status from non-dividend paying to dividend paying by
going public. Also, implications of the pecking order theory were examined by the author. He
defined initiation of dividend by a non-dividend paying firm as, a function of asymmetric
information problems which makes a firm to initiate dividend payout if its optimum dividend
level is positive which is determined by changes in firm-specific attributes. The size of
sample was 1,371 financial and utilities firms that went public during 1990 to 1997 and
financial data of 6,171 firm year observations was collected to test the hazard model of
dividend initiation. The author found that firm size and cash flow were positively associated
with dividend initiation of the sample firms and this fact supported pecking order theory.
De Angelo, De Angelo and Stulz (2004) discussed the accumulation of retained earnings of
25 largest long-standing dividend paying US industrial firms and explained the factors that
compelled them to stop paying dividends to their shareholders. These largest industrial firms
had US dollars 1.8 trillion in excess cash holdings which was equal to 51 % of the total assets
of these firms. It showed conservative payout policies and higher level of agency problems
between principal and agent. So, the objective of this study was to test the association of
increase of dividends payout with the higher levels of earned equity of the sample firms. The
size of the sample was 25 large industrial firms and financial data was collected during 1973
to 2002. The authors applied univariate, multivariate and sensitivity analysis plus logit
regression analysis and found positive association between propensity to payout dividends
with the profitability level and size. The authors also found that firms level of earned equity
was the best predictor of firms probability to pay dividends. They concluded that the capital
and asset structures of the sample firms portrayed a clear picture of firms capacity to payout
24
dividend or to retain earnings and the change in dividend policy was directly linked with the
level of equity earned by them.
Aivazian, Ge and Qiu (2005) investigated the association of debt maturity with firm
investment. They selected all US based non-financial firms and collected financial data
during 1982 to 2002. They used investment model and applied GMM method to test the
associations of the variables. They found positive association of Tobins Q and cash flow and
negative association of leverage with investment. The authors reported significant negative
association between firms debt maturity and investment. They also found that high growth
sample firms faced under-investment problem. The authors concluded that increase in
investment was linked with the reduction of debt maturity levels for the sample firms.
Hubbard (2005) explained that in the USA the setback to the corporations as well as
shareholders was due to double taxation on corporate earnings and dividend payments. This
was considerably reduced after the Presidential order on January 7 th, 2003. The order targeted
three factors namely corporate earnings taxation, dividend taxation and corporate retained
earnings taxation. The order proposed to eliminate investor-level taxes relating to the above
stated factors. The objective of Hubbards study was to analyze the effects of this approach
on the US economy. These tax reforms led to integrated tax system and accordingly separate
treatment of corporate and investor income taxes. The dividend relief model will eliminate
double taxation of retained earnings and also devise a dividend reinvestment plan which
authorizes corporations to declare deemed dividends. He concluded that the hybrid reform
mechanism would streamline the bottlenecks in the tax system and contribute towards the
betterment of the economic system of America.
25
Grinstein and Michaely (2005) investigated the association between institutional ownership
and payout policy. They selected 654 publicly listed US firms and collected end of the year
institutional stock holdings data of 79010 firm year observations during 1980 to 1996. Firms
were grouped based on their market capitalizations and size. The authors developed and
tested models that comprised of dividends, stock repurchase and total payout associations
with the institutional holdings and found no association of dividend payout with institutional
holdings. The authors linked the finding with the shift in cash dividend to share repurchase by
the sample firms. This change made share repurchase less costly and easier to exercise. The
authors concluded that the sample firms that were involved in share repurchase activities had
higher institutional holdings.
Feng, Ghosh and Sirmans (2007) studied the involvement of CEO in direct selection of
dividend payout policies of Real Estate Investment Trust (REIT) firms of USA. They
discussed the optimal entrenchment hypothesis in the study. According to this hypothesis
close coordination of shareholders with their agents ensured that their activities were closely
monitored. They selected 236 REITs firms during 1999 and 2000 and found that they (firms)
had paid 144 % of their net income as dividends in the past five years. The authors used
descriptive, univariate and multivariate analysis and found that high entrenched group of
CEOs paid 60 % more dividends as compared to the low entrenched CEOs. They concluded
that CEO entrenchment badly affected the performance and growth of the sample firms
because entrenched CEO acted in the best interest of the shareholders.
Amihud and Mendelson (2008) identified liquidity and risk as factors that affected firm
value. They mentioned liquidity as the main factor that restricted timely payments of interests
and principal to the investors. They associated costs of less liquid firms securities with
26
informational asymmetries and linked transaction and brokerage costs with this problems.
The authors presented examples to explain positive association between liquidity of the
financial asset and the financial market. They suggested that a firm could increase its market
value by increasing the investor base and introduction of more stock dealers in the market.
They also suggested that initiation of dividends by low liquid firms could be achieved by
increasing trade volumes. They identified liquidity as the main factor that forced a firm to
indulge in share repurchase and stock payout activities. The authors concluded that market
value of the firm was dependent on the liquidity of its financial assets and firm value could be
enhanced by incorporating liquidity increasing financial policies.
Bhattacharyya, Mawani and Morrill (2008) initiated with the reference of an earlier study that
identified dividends among the ten most important unsolved problems of corporate finance.
The authors identified dividend payout as a sign that indicated financial position of the firm
that saved it from agency problems. They indicated that in advanced countries the prime
source of financial capital for new investments is retained earnings. Authors modified the
total compensation model and tested it by collecting data of 14,013 firm year observations of
US based firms during 1992 to 2001. They used descriptive analysis, tobit regression and
sensitivity analysis and the results satisfied the managerial compensation model. The authors
concluded that no formal theoretical model could clearly explain association between
managerial compensation and dividend policy. The model tested predicted the behavior of
two types of managers who were in two different situations regarding the use of available
capital. In these situations one manager invested in productive ventures and other paid
available capital as dividends to the shareholders.
27
Chen (2008) examined the association and affect of corporate governance on the firms cash
holdings policies by comparing the difference between new and old economy USA listed
firms. He defined new economy firms as, those firms that compete in the internet, computer,
software, telecommunications or networking industries, whereas traditional manufacturing
firms were defined by him as old economy firms. The size of the sample was 1500 listed US
firms and the financial data of 1815 firm year observations was collected during 2000 to
2004. He applied Wilcoxon two sample test and OLS regression analysis on the financial data
and found that new economy firms had 33% and old economy firms had 12.5% cash to total
assets ratios. Top executive ownership was higher in new economy firms and these firms also
had higher proportion of inside board of directors. The new economy firms also had lower
profits as compared to the old economy firms. The dividend payout ratio was 61% for old and
19% for the new economy firms. The author concluded that under effective corporate
governance system new US economy firms retained higher levels of cash to fund available
growth opportunities. But, in the case of old economy firms, shareholders demanded
dividends in-order to mitigate the agency problems.
Fargher and Weigand (2009) investigated the dividend initiation and the reasons behind the
initiation and continuous payout of dividends to the shareholders by the sample firms. The
authors indicated that firms normally started paying dividends when moved from faster
growth phase to a slower growth phase of their lifecycle. They selected a sample of 594 firms
that initiated dividend payout during 1964 to 2000. They used three-factor market model to
analyze seven years financial data representing pre and post event of dividend initiation. The
authors found increased return on asset before the dividend initiation for the entire sample,
but after dividend initiation, decline in return on asset was observed, which stabilized after
three years of event. The authors reported increased cash and short-term investments from
28
year (-3 to 0) and then declined from year (0 to +3). The authors concluded that lifecycle
stages of the firm could better explain the tendencies of dividend initiation capacity of the
firm. Dividend initiation benefited slower growth oriented firms higher than other firms of
the sample.
Puleo, Smith and Casey (2009) examined the relationship of corporate governance and
dividend policy in the highly regulated insurance industry of USA. They used agency
transaction cost trade-off model that was developed by Rozeff (1982). Rozeff model
elaborated the functional interaction mechanism of dividend policy with agency costs, where
the dividend payments compelled firms to acquire external capital from capital markets and
as a consequence agency costs were minimized. The authors used extended model of
dividend yield to test the association of the variables. They selected a sample of 55 insurance
firms and collected 241 firm year observations during 2002 to 2006. They found no
association between good corporate governance and dividend policy. The authors concluded
that their study had not supported the strong corporate governance theory in the case of
sample extracted from the US insurance industry.
Weigand and Baker (2009) investigated the perspectives of corporate distribution policy
modifications done in the past and reviewed the evolution of share repurchase concept as an
extension of cash dividend payout by the firms. They followed the Works of Lintner (1956)
and Miller and Modigliani (1961). They segregated payout policies based on the effects of
signaling, agency and risk hypotheses. They called appearing and disappearing of dividends
as, catering, which suggested that, stock movement was associated with the flow of
dividends along with their risk factors. They reported decreasing trend of dividends payout in
USA, UK, Germany, France and Japan. In these highly advanced market economies firms
29
switched from cash dividend payout to share repurchase. The authors identified two most
important factors that were responsible for the increased trend of firms share repurchase,
these were; adjustment of low stock price to fair price and the confidence of the managers in
the future prospects of the firm. The authors concluded that: Share repurchase is flexible
earnings disbursement activity used as a means to return capital to shareholders at the
appropriate time as compared to dividends payout mechanism.
Wu and Yeung (2009) investigated interactions of the types of firm growth structure with the
leverage ratio under the conditions of market imperfections. They explained market
imperfections as asymmetric information and agency conflicts. They selected three groups of
firms; lower growth type firms, mixed growth type firms and high growth type firms and
checked the consistency of trade-off theory, pecking order theory and market timing theory.
They collected financial data of 1,22,909 firm year observations during 1971 to 2005. The
authors applied pooled OLS regression and found negative association between profitability
and the group of sample firms. High growth sample firms used retained earnings heavily for
financing research and development as well as investments in intangible assets. However,
low growth type sample firms were debt oriented firms. The authors concluded that they
observed decreasing trend of leverage from low to high growth type sample firms which
supported pecking order theory.
Fuller and Blau (2010) explained a new dimension of payout of dividends to the shareholders
by a corporation. They adopted an integrated approach that combined signaling and excess
cash flow (free cash flow) hypothesis of dividend policy to explain the payout phenomenon.
The categories of firms defined by the authors were; higher earning, intermediate earning and
low earning good and bad firms facing informational asymmetry and free cash flow problem.
30
The size of the sample was 2,197 dividend paying listed US firms examined during 1980 to
2000. The authors used firm performance as the measuring methodology and applied
univariate and multivariate regression analysis of the non-monotonic argument on the
quarterly dividend per share model. They also tested models of total payout and Cumulative
Abnormal Returns (CARs) and found that the intermediate sample firms had the highest total
payout and low performance sample firms prior to the announcement of the dividends had the
highest Cumulative Abnormal Returns (CARs). Also, significant results for firm size were
reported by the authors. However, results were not significant in the case of growth
opportunities and dividend yield. The authors confirmed non-monotonic level of association
of dividend.
2.6. Studies conducted in Canada

Brav, Graham, Harvey and Michaely (2003) discussed the payout policies of the USA and
Canadian corporations by conducting surveys of 384 Chief Financial Officers and Treasurers.
They explored the key factors responsible for the dividends as well as share repurchase
policies. The objective of this study was to investigate the substitute nature of share
repurchase and change in dividend payout policies of the sample. A sample of 384 financial
executives was selected from 256 public and 128 private firms to answer a survey
questionnaire. The authors also conducted 23 one-to-one un-structured interviews from CFOs
and Treasurer of the sample public firms. They found that the sample firms were larger in
size and had higher sales and credit ratings. CEOs of sample firms took all the decisions
relating dividend policies. They observed that managers had cut dividends only under
extreme conditions and a drastic shift to stock repurchase from cash dividend payout was
reported. They also found that signaling model was not used by the sample firms. They
identified earnings per share, floatation costs, liquidity cost, issuance costs, credit rating,
31
capital structure and takeover resistance as contributing factors. The authors concluded that
the contributing factors identified by them set the direction of the payout policies of the
sample firms.
Booth and Cleary (2006) conducted research in Canada and tested a theoretical model
relating evaluation of firms investment decisions under the influence of financial constraints.
They identified financial constraints as the wedge between the cost of internal and external
capital and mentioned that financial constraints made acquisition of external capital more
costly. The authors adopted value of the firm model known as Investment Opportunities
Formula from the work of Miller and Modigliani (1961) and modified this model to
represent optimal investment by the firm in the initial startup phase and tested it empirically.
The size of the sample was 1,133 US firms and data of 20,394 firm year observations was
collected during 1981 to 1998. The test of the model showed positive and significant
association of retained earnings with the investment activities. The authors concluded that the
US sample firms faced higher cash flow volatility and this factor forced them to retain and
maintain an adequate level of financial slack used to fund growth projects.
Bhattacharyya (2007) documented almost all the research evidence (theoretical and
empirical) related to dividend policy. He segregated evidence based on dividend clientele
hypothesis, signalling hypothesis and agency hypothesis. He discussed the work of John
Lintner (1956) and termed dividend policy as an area where a lot more could be done to
understand the complete picture of the unresolved problem of dividend policy. He quoted the
work of Bond and Mougoue (1991) as an extension of Lintner work and explained the classic
work of Modigliani and Miller (1961) which introduced the concept of dividend irrelevance
in the perfect and efficient capital market. He linked dividend problem with the higher level
32
of taxation on dividends. The work of Miller and Scholes (1978) presented the concept of
conversion of dividend income to the capital gain income that could be attained by borrowing
an appropriate amount of debt. This process created tax shield in the form of compensation
on the interest payments. The author quoted the study of Peterson, Peterson and Ang (1985)
related to the tax shield used by investors. Author quoted the work of other researchers
relating investigations of the firms dividend payouts and share repurchases as well as
demand mechanism of dividends from the investors (shareholders). The author discussed
informational asymmetry and signalling models relating tax-clientele hypothesis and also
elaborated the work of Bhattacharyya (1979). Heinkel (1978) compared different productivity
levels of the firm under irrelevant dividend and asymmetric information propositions. The
author also discussed studies concerning free cash flow hypothesis and quoted the work of
Jensen (1986) that defined the relationships between free cash flow and interacting variables
based on principal and agent informational flow mechanism. The author concluded that over
the period of forty years corporate finance researchers had identified and reported multiple
stylized factors that explained the dividend policy of corporations but dividend puzzle was
not yet solved.
Bhattacharyya, Mawani and Morrill (2008) investigated the association of dividend payout
and managerial compensation. They adopted the model of dividend payout developed by
Bhattacharyya (2003). This model of dividend policy was based on agent-principal
framework and it linked uninformed principal with the informed agent. The authors
categorized firm managers as high and low quality with respect to the payout or investment
of the availability funds. The authors collected 707 firm year observations of non-financial,
non-professional service and non-government sector firms during 1993 to 1995. The authors
tested total compensation model by further extending it to represent log of firms retained
33
earnings model and applied tobit regression analysis on the model. They found negative
association of dividend policy with the managerial compensation of the Canadian sample
firms. The authors also found negative association between dividend payout and earnings
retention and positive association between earnings retention (retained earnings) and capital
expenditure and the beta (risk).
Li and Zhao (2008) studied the impact of informational asymmetries on the dividend policies
of the firms. They examined and tested the implications of the dividend signalling models.
They also examined the dividends payout and stock repurchases activities of sample firms in
effective informational environment. The authors selected a sample of Canadian Industrial
firms and collected data of 22,413 firm year observations during 1983 to 2003. They
formulated dividend policy model and further extended it to test it empirically. They applied
logistic and OLS regression and found that more profitable and large sample firms with lower
growth potential paid more dividends to their shareholders. The results of the study refuted
the signalling model of dividends. They found negative association of asymmetric
information with the dividend policy. The authors concluded that more informational
asymmetry faced sample firms paid less, initiated low and increased less dividends. Thus,
Canadian sample firms retained more earnings due to increased growth opportunities.
Kouki (2009) identified dividend policy as a controversial topic in corporate finance. The
purpose of his study was to test that, CEOs stock option compensation motivates him to
reduce dividend payout. The author tested this statement by using tobit model which could
be used under standard normal, logistic and extreme value distributions. The size of the
financial data used as sample was 176 firm year observations of Canadian listed firms
collected during 2002 to 2003. The author used pooled least squares for fixed and random
34
effect method and found that stock option and exercisable stock option were negatively
associated with the dividend payout ratio. He concluded that the negative association between
stock option and the dividend payout policy was significant. The tests of exercisable and unexercisable stock options were not significant. Also, higher leveraged firms showed higher
dividend payments to the shareholders of the Canadian sample firms.
2.7. Studies Conducted in United Kingdom

Groves and Samuels (1976) elaborated the foundation concept of retained earnings
association with the concepts of costs and deferred taxes. They presented a numerical
example that proved the case of the cost of retained earnings. They assumed two firms A
and B that had similar structures and capital characteristics. These two firms took different
decisions regarding payment of dividends. Firm A paid dividends and firm B retained all
of its profits. The authors explained that the firm A that had paid all of its earnings as
dividends had practically maximized the wealth of its shareholders greater and higher than
the firm B that retained all of its earnings for investment purposes. The retention activity of
firm B had affected the wealth per share of the shareholders. The retained earnings which
had not generated any positive net present valued income made their shareholders worse-off.
Thus, dividend payout maximized wealth of the shareholders and retained earnings did not
maximize the wealth of the firms shareholders. The authors concluded that in UK under the
imputation tax system retained earnings were the most expensive form of financing. Authors
suggested that UK firms could maximize the dividend payout to the shareholders if financial
resources were allocated efficiently.
Fox (1977) commented on the research note of Groves and Samuels (1976) and called their
research as special case. Fox did his analysis in the same framework that was employed by
35
Groves and Samuels and also took firm A and B cases. The author considered returns
function of these firms equal to each other due to equal values of market risk of the firms.
The author identified that optimal level of retained earnings and dividend payout could not
practically exist in the real business world. The author concluded that dividend decision could
never be the universal phenomenon for all the UK firms under imputation tax system. So,
optimal payout policy could not be a viable option for the UK sample firms. Sample firms
must retain earnings and stop payout of all of its earnings as dividends to the shareholders.
Howorth (2001) examined the pecking order demand for finance by the small UK firms. He
used case study methodology to study the complex inter-relationships between demand and
supply mechanisms of finance. He collected data by means of survey questionnaire and
interviews. He analyzed 13 cases of industries across England and observed growth trends in
these industries. He found pecking order behavior in financing by the sample of small UK
firms. He identified truncated pecking order behavior in the sample due to the selffinancing constraints created in the normal functioning of the firms by their owners. The
author concluded that, sample firms that followed Truncated Pecking Order was due to
firms profitability and personal wealth (equity) of the owner or manager and these factors
played significant role in the overall supply and demand of finance to the sample firms.
Dhanani (2005) analyzed issues of dividend policy. The objective of the study was to analyze
as well as register the views of UK corporate finance managers which were collected based
on theories of dividend policy. He also analyzed associations of firm size and industry
affiliations and evaluated their impact on dividend theories. The size of the sample was 1000
listed UK firms that were approach by means of survey questionnaires. Author got 25%
response rate from the survey. Author applied univariate test to analyze the responses of the
36
finance managers of the sample. Author found that dividend policy of the sample firms
affected and enhanced the value of the shareholders. He found greater payout of dividends by
sample firms belonged to financial and utilities industries. The dividend policies of the
sample firms created no affect on the capital structures and investment. The small growth
oriented UK sample firms treated payouts as a part of residual dividend policy as compared
to the sample firms that were available with lower growth opportunities and treated dividends
payout as their frontline signaling strategy. The author concluded that the respondents of the
UK listed sample firms treated dividends payouts as residual dividend policy. In UK, firm
value was considered less associated with dividend policy due to its disclosure
characteristics.
Renneboog and Trojanowski (2007) discussed the affect of voting power and control
measures of different types of shareholders on the firms payout policy under pecking order
and agency theories. They defined control structure mechanism known as the block of
shareholders, who basically control the functionality of the firm and directly intervene in the
decisions regarding firms payout policy. The authors selected 985 UK listed firms that were
listed for minimum three years during the period 1992 to 1998. The authors tested the
extended partial-adjustment model of John Lintner (1956) and applied GMM estimator to
generate results. They found that the total payout ratio of the sample firms was 27.3 % and it
showed earnings accumulation behavior. They also found that the voting rights held by the
block of directors acted as shareholders also reduced the firms payout ratio. The authors
concluded that the control structure of the sample firms established a strong affect on the
payout policy. Thus, total payout smoothing mechanism and pecking order theory was
supported by findings.
37
2.8. Studies conducted in European Union Countries

Sembenelli (1993) tested the following statement; firms in short-run are more willing to
reduce dividends in bad times than to increase them in good ones. The author selected listed
and non-listed private Italian firms as sample and applied least squares regression analysis
and Wald test of coefficients on the data. The author devised and extended asymmetric model
of dividend payout behavior and tested it. He found that higher level of debt was not
significant in association with the reluctance of dividend payout by the sample firm. He
reported slow speed of adjustment for dividends by the managers. In the case when cash
flows of the sample firms were reduced, managers quickly adjusted dividend payout to its
target ratio. Italian sample firms invested less and paid more dividends as compared to nonquoted Italian firms that invested more and paid out low dividends. The author concluded that
the results of the test of the model rejected the notion that, firms have higher propensity to
increase dividends than to reduce them.
Sanchez-Vidal and Martin-Ugedo (2005) discussed the use of financial policy to provide
evidence from Spanish market regarding pecking order theory by presenting two directional
analyses. First analysis examined the model of Watson and Wilson (2002). Whereas, second
analysis was of the flow of funds deficit model developed by Shyam-Sunder and Myers
(1999). The size of the sample was 1,566 firms collected during 1994 to 2000. They used
descriptive statistics, Hausman test and regression analyses and found that the results of
models showed that the majority of sample firms used retained earnings and debt as their
financing sources. The authors concluded that retained earnings and debt had similar
coefficients for the sample firms in Spanish capital market. Pecking order theory held true for
the majority of the sample firms and long-term debt was considered as the second financing
choice by the sample.
38
Jokipii and Vahamaa (2006) reexamined the cross-sectional anomalies of the free cash flow
investment. They selected 139 publicly trading Finish firms that had free cash flow portfolios
and collected financial statements data and the monthly stock market data during 1990 to
2004. The betas of the portfolios selected by the authors were also from the low systematic
group. The authors tested Fama-French three factor model and found that Finish stock market
contained all those cross-sectional anomalies that previously existed and had been reported in
earlier studies relating Finish stock market. The authors concluded that large capitalized
Finish firms received higher positive abnormal returns due to free cash flow anomalies.
DeAngelo and DeAngelo (2007) investigated the dominance of the full payout model
described by DeAngelo and DeAngelo (2006). The authors emphasized that investment and
payout policies could be considered equally important by management of a firm. The
assumptions of full payout model indicated that the shareholders value was generated when a
firm paid all of its earnings as dividends during its lifecycle. This was the reason authors
considered Lifecycle Theory. According to this theory a firm at the stage of inception, growth
and decline adopts multiple market adjusted payout policies depending on flow of free cash
flows. The authors explained the payout practices in Europe which showed higher payout of
dividends whereas in USA stock repurchase was higher. The authors concluded that full
payout model dominated and superseded completely the MM Theory. So, MM Theory must
not be taught as fundamental of corporate finance in business schools because dividend
policy was as relevant as investment policy and optimality of these policies ensured
maximization of shareholders wealth and value of the firm.
Eije and Megginson (2007) examined the cash dividend payments and share repurchases of
the firms operating in the European Union. They further examined the impact of privatization
39
on the cash dividend payments. The size of the sample was 6,949 firms that belonged to 15
EU nations and the data related to cash dividends was 60,729 and for share repurchases was
42,398 firm year observations collected during 1989 to 2005. The authors used panel
regression analysis and found that EU firms were retaining large amounts of capital and
paying out less as dividends to the shareholders. The authors also used Lintners famous
modeled regression equation involving cash dividends, repurchases and total payouts and
tested the strengths of their coefficients. They found weak affects of earnings on cash
dividends whereas share repurchase showed dependence on firms earnings. The authors
concluded that payout policies of EU firms were entirely different from US firms and
retained earnings showed no association with the likelihood to pay cash dividends by the
sample firms.
Filatotchev, Isachenkova and Michiewicz (2007) investigated the association of ownership

structure with the choice of financing strategies by managers of firms that belonged to the
transition economies of the world. They used survey questionnaire to collect responses from
100 Polish and 57 Hungarian firms selected by random sampling methodology in 2001. The
authors used Bayesian model and tested two models by applying regression analysis on the
data and found support for the pecking order theory. The authors reported that in transition
economies like Hungry and Poland firms selected combination of financing. The authors
concluded that a strong affect of corporate governance structure on the selection of financing
choices by sample firms of transition economies was established.
Garcia-Teruel and Martinez-Solano (2008) analyzed the determinants of cash holdings of

Spanish SMEs. The size of the sample was 860 manufacturing Small and Medium Spanish
Enterprises and the data of 5,160 firm year observations was collected during 1996 to 2001.
40
The authors constructed and tested firm cash level model and applied OLS regression
analysis and GMM method on the financial data. They found that on average Spanish SMEs
had cash holdings of 6.57% of the total assets. Sample firms had higher cash holdings due to
the availability of higher growth opportunities, cash flows and liquidity. But, increased
interest rate, higher leverage ratio, long-term debt and bank borrowings reduced the level of
cash held by the sample firms. Sample firms also maintained target cash holdings policy.
Cash holdings were not significant in the association with the firm size. This study also
supported the pecking order theory. The authors concluded that SMEs in Spain followed
optimal cash holding targets.
Pindado and Torre (2008) analyzed financial decisions as determinants of the corporate
ownership structure in the Spanish family and non-family controlled firms. They selected 135
non-financial listed Spanish firms and collected 1,098 firm year observations during 1990 to
1999. They developed two models based on ownership concentration and inside ownership
explanation and tested them by applying GMM methodology. They found higher level of
inside ownership and ownership concentration in family controlled sample firms. They
reported that the family controlled firms were smaller in size with higher level of free cash
flows, lower investment opportunities as compared to non-family controlled firms. They also
found negative association between ownership concentration and debt in the case of nonfamily controlled sample firms, whereas positive association was reported for dividend
payout and investments. In-addition, the authors reported negative association between free
cash flow and inside ownership. The authors concluded that in Spain family controlled firms
used cash holdings to finance investments as compared to non-family controlled firms that
used debt as their source of investment finance.
41
Vanacker and Manigart (2008) initiated their study with the objective to explore the financing
decision making processes of high-growth businesses. They focused on the application of the
pecking order theory without involving external financing. The authors analyzed incremental
financing decisions of firms that had shown extensive growth and used decision making data
of eight years. They identified retained earnings free from the problems of informational
asymmetries. The size of the sample was 2,077 Belgian limited liability firms studied for
eight financial years. They used multivariate analysis and descriptive analysis and found that
more profitable firms preferred internal financing to fund investment plans. The results of the
study were consistent with the extended pecking order theory.
2.9. Studies conducted in Australia

Partington (1984) analyzed dividend policies in Australia. He also examined the target
payouts of firms as well as association of target payouts with the industrial groups. He
compared sample firms planned versus actual target payout ratios and examined their
difference. He selected 152 large listed Australian firms and conducted survey research by
means of a questionnaire in 1980. The sample firms were large in size, mature and had
sufficient cash flows. Author used dividend policy model of Lintner (1956) and tested it
empirically. He found framework of Lintners dividend model significant in Australia. He
reported that industrial classification had no association with the dividend policies and
change in target payout ratios were useful for those sample firms that experienced decline in
profits and overall growth. So, the sample firms that had changed their target payout ratio had
lower level of payouts as compared to firms that had paid stable dividends to their
shareholders. The author concluded that 50% of the sample firms had well defined target
payout ratios.
42
Jones and Sharma (2001) examined the association of investment opportunity set and
corporate policy of the listed firms of Australia. They extended the empirical work of Gaver
and Gaver (1993) and applied factor analysis to narrow down the variables selection process.
The size of the sample was 810 listed Australian firms and data was collected during 1990 to
1998. The authors applied regression analysis on pooled and cross-sectional data and found
significant association of debt to book value of equity and dividend yield with investment
opportunity set. But, debt to equity ratio and dividend yield showed negative association with
the investment opportunity set for higher growth oriented Australian sample firms.
Ho (2003) discussed the dividend policies of Australia and Japan by examining ten year panel
data by selecting 2,235 firm year observations during 1992 to 2001. He used multiple
regression analysis and found that the readjustment in tax systems of Japan and Australia had
significantly impacted the payout ratios of the sample. The author concluded that the results
of the study supported the agency, signaling and transaction cost theories of dividend policy.
And, transaction cost was the main hurdle which restricted dividend payments in Japan as
compared to Australia.
2.10. Studies conducted in Korea and Japan

Gul and Kealey (1999) considered Korean Chaebol, which were defined as, concentrated
family owned giant conglomerates like; Daewoo, Doosan, Samsung, Hyundai, LuckyGoldstar, Hanjin, etc., supported by various governmental initiatives and cooperate debt and
dividend policies. The aim of the study was to test the hypotheses formulated by the authors.
The sample selected by authors consisted of 655 companies from Pacific-Basin capital
market. The authors selected data of 6,695 firm year observations for the period 1980 to
1994. They applied descriptive statistics, univariate analysis, factor analysis and financial
43
ratios on the data and found that growth oriented firms had not paid dividends. The authors
concluded that in Korea, Korean Chaebol and debt policies complemented each other.
Mizuno (2007) investigated Japanese corporate managers views about their firms payout
policies. He selected 310 Japanese listed firms that belonged to four industries and conducted
a survey research. The response rate of the survey was 22.2%. He found that most of the
Japanese sample firms identified dividends as the means to payout earned capital to the
shareholders. Japanese firms also emphasized on the stable payout of dividends. 36.2% of
Japanese sample firms had target dividend payout ratio and 68% Japanese sample firms
agreed that dividends could be paid to the shareholders after investment expenditures. Also, it
was indicated by the sample firms that when there was no prospect of firms earnings
maximization, increase in dividend payout could be stopped. In the case of selection between
debt payments and dividends payout from the free cash flow available to the firm, sample
firms selected debt payments as an important decision for them. Signaling and market timing
hypotheses of dividend policy were supported by the survey results. More than half of the
respondents experienced increase in dividends that indicated growth in the firms. 80% sample
firms clearly indicated that lower dividends payout drove share price to drop in the stock
market. 70% of respondents identified that change in dividend policy created change in the
firm value. The author concluded that Japanese listed sample firms paid greater importance to
dividend payouts instead of share repurchase. Thus, Japanese sample firms had shareholders
driven dividend policies.
2.11. Studies conducted in China, Taiwan and India

Irala (2005) introduced a measure that could reduce the conflict of interest between managers
and shareholders of a firm. He discussed a true measure of managerial performance that
44
linked the affect of managerial decisions on the value of the firm. This measure was known
as Economic Value Added (EVA). Author defined EVA as, it is the adjusted net operating
profit after tax for a period subtracting the capital change represented by rupee cost of capital
of the investment over that period. He explained that, this measure as a financial tool could
comprehensively measure series of events that could affect firm value. He linked managerial
performance to EVA and if firms adopt this tool to measure managerial performance then
managers must put-in their level best to maximize the return on the capital invested in value
enhancing activities without letting the cost of capital to rise. These active policies could lead
to increased value of the firm. The author also explained the link between EVA and Market
Value Added (MVA) as, a discounting technique of estimation, which elaborates Market
Value Added (MVA) as positive when all the future Economic Value Added (EVAs)
discounted at present values are positive or negative otherwise. The author emphasized to
use MVA with EVA method in-order to resolve problems of future estimations of mega-scale
positive return projects. The author concluded that proper application of EVA method could
bridge the gap between managers and shareholders by reducing agency problems.
Pandey and Bhat (2007) discussed dividend behavior of sample firms under the control
mechanism of Indian monetary policy. They used GMM estimator to test the formulated total
cost of dividend payout model developed by Desai, Foley and Hines (2002). The total size of
the sample was 571 Indian manufacturing firms and the financial data of 3,997 firm year
observations was collected during 1989 to 1997. The authors used panel data analysis and
found reduction in payout of dividends under monetary policy restrictions in India. They
concluded that target payout ratios of Indian sample firms were lower and acted as indicator
of unstable dividend policies. So, it showed that Indian sample firms were retaining earnings
for investments purposes.
45
Chiu and Liaw (2009) examined the association between organizational slack and
performance under the moderating affect of organizational strategic orientation. They tested a
model by selecting a sample of 529 Taiwanese high-tech companies and collected data of
4,368 firm year observations during 1997 to 2005. They defined organizational slack as,
firms resources exceeding its needs. They categorized organizational slack as; available,
recoverable and potential slack and indicated that higher level of slack led to better
achievement of organization goal under strategically formulated market based strategies.
They applied Hausman test and generalized least squares analysis on the data and found that
very little or too much of internally retained capital by the firm deteriorated its performance
and restricted growth.
2.12. Studies conducted in African Countries

Botha, Bosch and Van Zyl (1987) analyzed financial theories concerning shareholders
wealth maximization. The objective of the study was to investigate the affect of dividend
policy on the change in the shareholders wealth. The authors defined shareholders wealth
maximization as, the product of the number of shares owned by the shareholders multiplied
by the current share price in the capital market plus the dividends received in the following
year. The size of the sample was 33 industrial listed firms of South Africa and financial data
was collected during 1968 to 1982. The authors developed a model that represented change in
shareholders wealth and dividend policy and tested it by applying OLS regression on the
pooled data. They found strong impact of dividend payout on the wealth generation
mechanism for the shareholders of the sample firms. But direct affect of dividend payout
policies on the change in shareholders wealth was not established under the prevailing
conditions in the South African market. Optimal level of financing, investing and dividend
decisions could be achieved if a firm maintains an effective mix of retention and payout
46
decisions under the framework of strategies that could facilitate firm to achieve the goal of
wealth maximization of the shareholders.
Amidu and Abor (2006) examined the determinants of dividend payout ratios of the
Ghanaian listed firms. They used panel data methodology to estimate the financial data of 20
Ghanaian listed firms during the period 1998 to 2003. They tested payout model and applied
regression analysis on the collected data. They reported that about 70% of earnings were
retained by the sample firms in Ghana. They found positive relationship between dividend
payout ratio and profitability. They reported negative association between dividend payout
ratio and risk, institutional share holdings, growth in sales and market to book value of the
sample firms. The authors concluded that Ghanaian sample firms were dividend payers, but
under the influence of greater profitability and cash flows greater amount of profits were
invested by the sample firms in Ghana.
Ezeoha (2008) investigated the affect of firm size on the financial leverage of Nigerian
sample firms. Author selected a sample of 71 listed Nigerian firms and collected financial
data of 1207 firm year observations during 1990 to 2006. He used panel fixed-effect
regression analysis to analyze the sample. Author developed three models for the analysis and
evaluation of the financial data. The modeled equations represented total, short-term and
long-term debt. He found that in Nigeria, firms financed operations with short-term debt.
Long-term debt was minimally used by the sample. The author reported significant and
positive association between firm size and financial leverage. He concluded that Nigerian
sample firms had higher short-term liabilities that restricted their growth.
47
Isshaq and Bokpin (2009) studied the liquidity management practices of firms in Ghana
under information asymmetry problem. They selected 23 non-financial firms and collected
cross-sectional panel data during 1991 to 2007. They used and tested extended form of panel
data model representing liquidity holdings of the sample firm and found significant and
positive association between liquidity holdings of the sample firm and firms liquidity
demand, liquidity ratio, ROA, firm size and net near liquidity. However, leverage, average
interest rate, risk and investment resulted in positive but insignificant relationship with
liquidity holdings. The authors concluded that the sample firms actively managed their
liquidity levels and utilized retained earnings for financing investment projects.
2.13. Studies conducted in Turkey and Malaysia

Ugurlu and Aksoy (2006) identified predictors of financial distress, when they compared
failed and non-failed Turkish manufacturing firms operating in the turbulent economic
environment. The size of the sample consisted of 27 failed and 27 non-failed manufacturing
Turkish listed firms that were selected based on stratified random sampling method and
financial data was collected during 1996 to 2003. They used factor analysis to rank the most
important predictors of financial distress. The authors applied discriminant and logistic
regression analysis and found logistic regression as the best statistical measure to predict
firms bankruptcy. The authors identified eleven predictors that explained financial distress
for the sample of Turkish firms. They reported that Turkish sample firms were operating
under trade creditors pressures and sample firms that failed to survive in Turkey had lower
current asset turnovers. They also reported that non-failed Turkish manufacturing firms had
lower operating income and larger size which indicated that these non-failed sample firms
had higher leverage which made them to face financial distress. The authors concluded that
the utilization of fixed assets for non-investment activities by sample firms incurred them
48
depreciation costs, higher burden of short-term liabilities, lower liquidity levels, lower
working capital, lower operating income, higher levels of fixed assets and working capital
turnover and increased losses. Thus, financial distress struck Turkish sample firms and as a
consequence these firms filed bankruptcy. But, the Turkish sample firms that changed their
core businesses survived in the market.
Al-Twaijry (2007) investigated the impact of the factors that created variance in the dividend
policy of 300 listed Malaysian firms. He included earnings per share, cash available per
share, book value of the share, size of the company, past dividends, and past and future
earnings of the firm as the factors. He acquired financial data during 2001 to 2005 and
applied descriptive and OLS regression analysis. He found that 30% of the sample firms had
not paid any type of dividends and this percentage dropped to 24% in 2005. The author
reported that older and mature sample firms were better dividend payers as compared to new
firm and payout ratio created no impact on the earnings of the sample firms. But, payout ratio
impacted past and future earnings of the sample firms. The author concluded that lower
earnings per share of sample firms paid more dividends as compared to those that had higher
earnings per share.
Karadeniz, Kandir, Balcilar and Onal (2009) discussed issues related to the capital structure
of the Turkish lodging firms. The objective of the study was to find factors that affected
capital structure and debt relating decisions of the listed Turkish lodging companies. They
tested pecking order and trade-off theories by considering sample of four Turkish lodging
firms. They used panel data for the period 1994 to 2006 and considered 65 observations.
They developed dynamic fix effects panel data model and estimations were done by using
Arellano-Bond system method, known as Generalized Method of Moments (GMM)
49
normally used for the application of regression analysis. They found that Turkish lodging
sample firms relied on their internally available funds in the shape of retained earnings to
finance investments. The authors concluded that long-term borrowing of capital was not
practiced by the sample firms and due to the constraints of acquisition of external capital for
investment sample firms used internally available funds for investment purposes.
2.14. Studies conducted by considering multiple countries

Demirguc-Kunt and Maksimovic (1996) focused on long-term and short-term investments of
firms and the impact of difference in the financial systems and legal systems on the financing
needs of the firms. They considered the work of Myers and Majluf (1984) which explored the
concept of acquisition of capital by the firm for financing investments. The sample of the
study consisted of 19 developed and 11 developing countries including Pakistan. The authors
selected data of developed economies during 1982 to 1991 and for developing countries
during 1980 to 1988. They used extended growth models and applied regression analysis and
found that majority of the sample firms used internally available funds (retained earnings) to
finance their fixed investment activities, whereas short-term debt, long-term debt and equity
issues were used as external financing sources to fund short-term investment projects. In
Pakistan growth of firms were linked with long-term debt financing mechanism and shortterm debt with retained earnings was also used to finance investment projects by firms in
Pakistan.
La Porta et al. (2000) tested two agency models that were related to dividend payout to
minority shareholders. The authors analyzed common law and civil law countries. They
emphasized that effective dividend payout system could only operate under well developed
and properly enforced legal protection system for the shareholders. The authors selected
50
4,103 firms from 33 countries of the world and collected financial data during 1989 to 1994.
The models of dividend policy compared by the authors were termed as, outcome model
and substitute model. The test of the models revealed that common law countries had
higher dividend payout ratios as compared to civil law countries. Thus, outcome agency
model of dividend policy was supported by the findings of the study. The authors also
reported that in common law countries shareholders deferred current dividends in an
anticipation of higher returns from high growth firms that complied to the laws of minority
shareholders protection. They suggested that injustice with the minority shareholders at the
expense of inside shareholders could be eliminated by imposing the supremacy of corporate
law in the market that could equate inside to outside shareholders in-order to distribute equal
share of firms profits. The authors concluded that an effective legal rights protection system
for the minority shareholders could eliminate injustice in the market.
Pinkowitz, Williamson and Stulz (2007) evaluated issues relating firms liquid assets (cash
and marketable securities) in the context of corporate governance system that control
distribution of wealth to all the shareholders. The authors extended their study in line with
their earlier work (2006). The size of the sample consisted of 35 countries of the world and
firm level data was collected during 1988 to 1998. They tested firm valuation model that
included firms cash holdings, dividend policy and corporate governance and found that there
were multiple combined form of cash holdings and dividend payout strategies of the firms of
the sample countries for the minority shareholders that were protected by law. In low
minority shareholders protection rights nations, retained earnings contributed minimally to
enhance the value of the firm as compared to the nations that had good and effective minority
protection rights in-place and enforced. The authors reported higher payout ratio for the low
minority shareholders rights protection nations that were on the top of the corruption list.
51
Cheremushkin (2008) identified stockpiling of retained earnings for reinvestment in available

long-term investment opportunities as the most complex issue in the long-term financial
statements forecasting. He associated financial statements forecasting as an essential tool for
the performance evaluation of all types of firms. He considered retained earnings as the
fundamental factor that contributes towards earnings growth rate considered as an essential
part of firms valuation model. The aim of this study was to explore capital-driven approach
(for high growth an emerging firms) and mixed approach (for both the mature and developed
firms with new investments for expansion). He emphasized on the use of Microsoft Excel
worksheet for financial forecasting. He added that long-lived assets should be financed with
long-term debt and working assets with equity that is retained earnings. He concluded that
issues of long and short-term debt financing policies and project valuation issues could be
resolved with the help of Microsoft Excel worksheet.
Abor, Sarpong-Kumankoma, Fiawoyife and Osei (2009) investigated the effect of risk on the
financial policy of firms of emerging markets. The authors explained that high risk and
greater tangible assets holding Pakistani firms utilized lower level of debt as compared to
more profitable Pakistan firms that utilized internally available funds to finance investments.
The size of the sample consisted of 34 emerging markets including Pakistan and data was
selected during 1990 to 2006. The authors tested static panel model of financial policy and
applied regression analysis on the collected data. They found that financial leverage as the
measure of financial policy was positively associated with the business risk and growth of the
sample firms. They also found significant association between profitability and external
finance, whereas negative relationship was reported for profitability and debt maturity
variables. Thus, emerging market firms relied more on internally available funds as compared
to debt financing. The results of the study supported pecking order, agency and trade-off
52
theories. However, emerging market firms used long-term debt finance greater than shortterm debt finance. The authors concluded that sample firms that survived in emerging
markets used more debt when faced with lower level of financial risk and reduced cash flows.
Chen, Chou and Chou (2009) analyzed the impact of stock market liberalization on the valueenhancing potential earned by the firm due to the available investment opportunities and free
cash flows. They termed stock market liberalization as the channel which opened doors to
economic growth that could be achieved through enhanced capital flow and investments by
individual investors of a country. They explained and used investment opportunities,
corporate governance and free cash flow hypotheses to develop theoretical framework. The
authors selected fourteen emerging market economies including Pakistan and collected firm
level financial data during 1980 to 1990. They applied cross-sectional regression analysis and
found positive association of liberalization with the stock price of all the sample firms.
Results showed that high growth firms benefited more from the announcement of stock
market liberalization and it supported investment opportunities hypothesis. In the case of free
cash flow hypothesis, firms with higher levels of free cash flow got lower stock returns. The
corporate governance hypothesis was not supported by the results of the study. The authors
also tested data for six types of bank liberalization by applying GMM method and found
improved returns from increased level of investments by the sample firms.
Inci, Lee and Suh (2009) analyzed the dynamic relationship between earnings and capital
investment. They used capital investment model and further modified it to represent the
relationship between earnings and capital investment. They also tested the cash flow model to
analyze the cash flow impact on the capital investment. They selected 40 countries of the
world including Pakistan as sample and collected firm level data during 1988 to 2004. They
53
divided sample into common law and civil law countries as well as financially developed and
undeveloped countries to test the variance in the factors affecting proposed models. They
found that earnings of the firms in all the sample countries had enhanced capital investments.
So, positive and significant association of cash flows with the capital investment and reverse
relationship of capital investment and cash flow was confirmed by the results of the study.
The capital investment decisions were weak in the developing countries sample due to the
weak corporate governance and monitoring mechanisms. The authors reported strong and
positive relationship between earnings and capital investment in undeveloped sample
countries. The authors concluded that their study supported pecking order theory and
identified that retained earnings were heavily used by the firms in sample countries to finance
investment projects. The authors also emphasized to enforce well developed legal and
financial protection systems to protect the rights of the shareholders.
Seifert and Gonenc (2010) investigated the association of austereness of agency costs and
information asymmetries with the applicability of pecking order hypothesis. They
benchmarked US studies and compared results with them. Authors selected; Argentina,
Brazil, Chile, China, Colombia, Czech Republic, Hong Kong, Hungry, India, Israel,
Malaysia, Mexico, Pakistan, Peru, Philippines, Poland, Russia, South Africa, South Korea,
Singapore, Sri Lanka, Turkey and Venezuela as their sample. These emerging markets were
facing large number of problem that effected business operations of the firms. The authors
collected financial data of non-financial and non-utility firms during 1985 to 2004. They
formulated financial deficit model and tested it and found highest value of ratio of total
liabilities to total assets value in Pakistan. Firms in India, South Korea and Turkey were also
high debt burden countries. They also found long-term investments in assets, higher dividend
payouts and changing net working capital by the firms operated in the emerging sample
54
economies. Firms in emerging market countries after equity used debt to finance their
financial deficits. The authors reported that large firms relied more on equity as compared to
smaller firms. Pecking order hypothesis was supported only in the worst case when sample
firms dealt with higher informational asymmetries and agency costs.

In the first section, literature regarding independent variables of the study was reviewed. The
studies that were conducted in USA, Canada, UK, EU countries, Australia, Japan, China,
Taiwan, India, Korea, Turkey, Malaysia, African countries and other countries of the world
show that a large amount of research has been conducted across the globe on dividend policy.
Corporate finance researchers have used; stock dividends cut, payout initiation, managerial
ownership, leverage, market to book value, investment policy, Q theory of investment, debt
ratios, debt policy, R&D investments, forecasting of dividends, earnings growth, free cash
flows, opportunities for growth, risk, abnormal return, pecking order, shareholders
investment, cash holdings, and related variables were evaluated and examined in relation to
dividend policy. Multiple models that were different in scope and application were developed
and tested by authors who belonged to countries mentioned earlier.
Conversely, retained earnings was used as a source of financing and was dealt as secondary
variable in the models tested by corporate finance researchers. These facts indicate lack of
used of retained earnings as primary variable in previous research studies. In this research
retained earnings has been taken as primary variable of interest under the condition when a
firm retains all of its earnings. Moreover, dividend payout was also given equal preference
and incorporated as primary variable.
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SECTION - II: TREATING DEPENDENT VARIABLES

The dependent variables from the two devised models of this research study are value
maximization of the firm (firm value) and enhancement (maximization) of shareholders
wealth. The empirical work done related to above stated dependent variables covered a vast
number of issues directly or indirectly involving two variables. The studies reviewed and
reported here mainly included testing, analyzing or evaluation of formulated models by the
authors concerned with respect to geographical regions of the world.
2.16. Studies conducted in USA and Canada

Biddle, Chen and Zhang (2001) introduced a residual income valuation model. In this model
current profitability of a firm derived net capital investment and thus future profitability of
the firm was generated as its consequence. The authors linked firms current and future
profitability as well as capital investment to the available investment opportunities sets. They
used Residual Income Model (RIM) and this model was based on capital flows
profitability mechanism. They defined this model equal to profit earned on equity capital
over and above the cost of equity capital. They further extended this model by incorporating
current observables, residual income forecasts and basic dividend discount model to
formulate linear firm valuation model. The authors placed greater emphasis on the
profitability of the firm that directly influenced investment decisions and the results of these
decisions could increase or decrease the value of the enterprise. They proposed valuation of
residual income as an important step in the overall valuation mechanism of the firm. The size
of sample consisted of all the US firms that had available information related to the variables
of the study and data of 83,826 firm year observations was collected during 1981 to 1998.
The authors tested formulated model by applying regression analysis and found that current
growth rates of operating capital was positively related to the year ahead growth rates of the
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operating capital of the sample. This association supported the notion that, capital follows
profitability. Current residual income resulted into linear, positive and significant
association with the unrecorded goodwill. The authors reported increase in future residual
income as a result of positive net present valued investments by the sample. The authors
concluded that the results of the study established a non-linear convex relationship between
current and future residual income. The linear information dynamics predictions were refuted
as well as replaced by investment dynamics predictions in the firm valuation theory for
growth oriented firms.
Jensen (2001) purposed objective function and transformed stakeholder theory into
enlightened stakeholder theory, in-order to better understand and conceive the primary value
maximization objective of the firm. He added that, value maximization of the firm could be
considered after taking into account all the stakes and interests of all the stakeholders who
were affected or getting affected by the decisions of a particular firm. These stakeholders
included; customers, employees, managers, suppliers, local communities and government
officials. The author defined objective function as, enlightened value maximization that
was equal to the concept of enlightened stakeholder theory. This enlightened stakeholder
theory rested on the principle of long-term value maximization of the firm by taking care of
interests of all the stakeholders. The objective function of a firm could conform to the
corporate productivity, efficiency, welfare of society and managerial accountability. The
author distinguished fundamental aspects of stockholder versus stakeholder concepts, which
indicated that a firm could select one objective function from these two; value maximization
or interests of all the stakeholders. He replaced value maximization with value seeking
terminology. A firm could follow a single objective and on the basis of this objective,
performers can distinguish themselves from the non-performers. The author blamed
57
stakeholder theory for weakening the internal control of a firm by leaving management
unaccountable for their decisions relating value maximization of all the stakeholders. The
author rejected the traditional use of balance scorecard methodology of measuring
performance. He associated performance measurement of any business to the development
and implementation of its market based strategies.
Ardalan (2003) highlighted existing theories and major controversies associated with the
subject of finance. He reviewed paradigms of finance theories which included; functionalist,
interpretive, radical humanist and radical structuralist paradigms. He explained paradigm and
defined its three levels as; paradigm, metaphor and puzzle solving. The context of existing
controversies and theories in finance belonged to substructure of the functionalist paradigm.
The work in the subject of finance was just confined to the functionalist paradigm and no
effort was made to work in rest of the other paradigms. The author rested the foundation of
functionalist paradigm on the concept of positivism which define social world. He associated
paradigm with reality. The process start with a Paradigm which once studied by researchers
become metaphor and with some more efforts exerted by different schools of thoughts with
through understanding and knowledge of the issue resolve the problem. In this manner
problem in the area of finance were addressed across the globe. The author discussed the
controversies relating a single paradigm that once transformed into multiple metaphors bound
all the knowledge generated in the functionalist paradigm and thus controversies arose. The
author concluded that the knowledge generated in the field of finance was multifaceted based
on different paradigms reflecting different approaches adopted by researchers to solve social
issues in the area of finance.
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Gentry, Reilly and Sandretto (2003) introduced a comprehensive integrated valuation model
which represented a system through which learners of finance can assess the financial health
of the firm in a better way by understanding the basic concepts of firms intrinsic value
estimation. They named this model as Intrinsic Valuation System (IVS) that was capable of
integrating meaningfully the strategic information presented in the financial statements of the
firms and could analyze the worth and value of the firm. They also discussed the Free Cash
Flow model of firm valuation. This model represented the discounted free cash flow in terms
of return on the firms equity investments. They also solved firm valuation equations for
dividend, equity, debt and free cash flow to the firm. The authors associated true growth with
the retained earnings of the firm in the case when retained earnings were invested at a rate of
return over and above the calculated weighted average cost of capital for the firm. The
authors concluded that Integrated Valuation System (IVS) is useful in forecasting firms
value by calculating the forecasted value of equity and debt cash flows.
McCarthy (2004) evaluated strategic approach of the firms toward long-term value
maximization of the shareholders. The key factors identified by the author as agents of value
creation were; knowledge driven industries, speed of business processes, technological
advancement, mergers and acquisitions and globalization of businesses. He linked value
creation with financial and non-financial factors that must be identified and ranked by the
management according to the created value. The author also emphasized on the performance
based capabilities required to bring value for the shareholders. The mindset of the
management could be changed if firm achieve long-term value creation goals. According to
the author combination of short-term and long-term approaches were the keys that could
enhance the value of the firm by meeting and exceeding expectations of the shareholders.
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Negakis (2006) investigated the applicability of conventional models of firm valuation that
was developed based on the classical work of Feltham and Ohlson (1995), on the newly listed
firms that emerged to surface after large decline in the international markets in March 2000.
The author adopted firm market value model and further expanded it. He applied OLS
regression analysis on the financial data of 3780 firm year observations collected during 2000
to 2004. He found that R&D was significant in explaining growth of the sample firms. The
predictability strength of Residual Income was improved when the author included R&D
expenditure in the model. The author concluded that residual income did not out perform and
also not proved itself as a vital factor used to evaluate value of the firm against the use of net
income in conventional firm valuation models.
Baker, Saadi, Dutta and Gandhi (2007) conducted a survey research in Canada to get insight
of managers perception about their firms dividend policies. They assessed dividend policies
of the sample by considering bird in the hand theory, signaling explanation of dividends, tax
preferences and clientele effects explanation of dividends, agency theory of dividends payout,
life-cycle theory and catering theory of dividends payout. The size of the sample was 291
dividend paying listed Canadian firms that had paid cash dividends during 2001 to 2004.
They also compared study results with the results of the study conducted by Baker, Veit and
Powell (2001). Majority of the respondents of the survey were CFOs, vice presidents and
treasurers. The authors found that about half of the survey respondents indicated that they had
clear target payout ratios. Canadian managers emphasized on the stability of earnings
expected rate of return. Respondents placed dividend payout second to investments. Results
showed that signaling and life-cycle explanations of dividend payout were preferred by the
sample firms. The author concluded that their study established relevance of dividend policy
towards value creation of the firm as well as maximization of shareholders wealth.
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Benson and Davidson (2008) measured the stakeholder management by comparing it with the
value of the firm and CEO compensation under the framework of Jensen (2001) Enlightened
Value Maximization Theory. The authors appraised value maximization of shareholder
wealth theory. The size of the sample was 922 firms and data of 4706 firm year unbalanced
panel of observations was collected during 1991 to 2002. They tested market to book value of
firm model by applying regression analysis on the data. They found that management of all
the stakeholders were positively related to the firm value. Another model that contained CEO
compensation was regressor by the authors and it revealed that compensation to CEO by the
sample firms actually increased the wealth of CEO and showed no associations with the
management of better relations with the stakeholders. The authors found results of tests of
models in accordance with the Enlightened Stakeholder Theory.
McSweeney (2008) investigated the affect of maximized value of the firms shareholders on
optimization of economic and social benefits. He associated maximization of shareholders
strategy by the corporations as a capitalistic approach that only benefited few out of many.
He emphasized to trigger down the effect of wealth maximization strategy for the
shareholders to everyone in the society. He called ideology of wealth maximization of the
shareholders a fallacy. He rejected EVA because this measure did not measure uncertain
returns. He claimed that the funds acquired by firms from stock markets were just the
expansion of financial claims on the assets of the firms and did not represent funds
acquisition for financing major investment projects. He negated the notion that maximization
of shareholders wealth benefit whole society. He called shareholders wealth maximization as
a wrong approach adopted by the management of the firms. According to the author
managers must focus on the needs and expectations of the customers and utilize all their
energies and efforts in pleasing customers by creating new products or services that could
61
benefit shareholders for longer period of time and in this manner larger part of society could
be benefited. The author blamed larger dominant organizations of the world including
developed nations responsible for the application and support of the destructive model of
shareholders wealth maximization.
2.17. Studies Conducted in United Kingdom

Delaney and Wamuziri (2004) investigated the impact of merger and acquisition
announcement on the share prices of the UK construction firms and also evaluated the
abnormal returns received by the shareholders. The size of the sample was 46 UK bidding
and 33 UK target firms and the financial data was collected during 1996 to 2001. The sample
bidding firms underwent more than 10 million pounds bidding deals announcements related
to merger and acquisitions (M&A) of target firms in the construction industry of UK during
the study period. The authors used abnormal return models to calculate excess abnormal
returns received by the shareholders for 41 days and in this way they measured the wealth
generated by the sample firms for their shareholders. The authors found that the share price of
the target firm rose considerably during M&A announcement period and the bidding firm
experienced a slight increase in the share price. The sample of UK firms benefited due to the
takeover event and target firm experienced increased trading volumes in the stock market
which increased the wealth of the shareholders. The authors concluded that UK based
construction sample firms experienced growth by means of M&A events.
Trundle (2005) investigated shareholders value addition process. He evaluated the affect of
Corporate Real Estate (CRE) investment decisions on the firm value. He associated value
(wealth) maximization of shareholders goal with the value maximization objective of the
firm. He indicated that the market value of the firm must be greater and higher than its book
62
value which means the economic capital invested by the firm could increase the lifecycle of
the firm. The valuation process described by the author first estimated firms terminal value
and second discounted the cash flows to their present values at the cost of capital and third
non-operating assets were added to the present value of the free cash flows. This process was
termed as the net present value discounting method. The author placed greater importance in
the utilization of corporate real estate space with higher efficiency in-order to reduce costs
and increase productivity. He also indicated the importance of capital budgeting techniques in
the assessment of corporate real estate investment decisions and also emphasized on the
proper management of costs, flexibility, image, location, layout and duration of corporate real
estate decisions to maximize value of the firm. He identified weighted average cost of capital
as a valuable method used to access the costs associated with a new investment project. The
author concluded that corporate real estate operational strategy could be formulated by the
senior managers of the firm that could facilitate the firm in maximizing its market value.
Hughes (2008) evaluated the positive association of R&D and dividend payment with the
firm value. He used corporate valuation model that represented firm value resulted from
market value as a linear function of book value of firms equity normalized by the book value
of firm. He tested corporate valuation model by applying GMM method. He selected UK
based firm level data and collected 8,559 firm year observations during 1994 to 2005. He
found that increased R&D investment activities enhanced the value of the firm. Dividend
payout resulted into positive and significant association with the corporate value. Capital
contribution showed positive and significant association but firms earnings showed positive
but insignificant association with the firm value. The author concluded that corporate
valuation model was significant for UK based sample firms.
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2.18. Studies conducted in European Union Countries

Dockery, Herbert and Taylor (2000) examined the level of alignment and consistency
between the strategies of the European firms and the interest of shareholders in achieving the
firms shareholders wealth maximization goal. They investigated this phenomenon under the
framework of diversity of ownership and control that result from agency problems. The
authors selected a sample of 175 European firms that belonged to the seven European
countries and collected data during 1995 to 1997. They tested six models of market
capitalization value of European firms by applying OLS regression analysis. They randomly
selected financial executives of the sample firms to retrieve financial data. They found that
sample firms used more debt and had close ties with the financial institutions and the board
representatives. These factors compelled sample firms to pursue shareholders wealth
maximization objective. The authors identified; operating, investment and financial as three
main shareholders wealth maximization strategies that were utilized by the managers of the
sample firms.
Marsat and Williams (2008) analyzed the affect of stock prices in determining the firms
fundamental value. They explained that the intrinsic value of a firms stock was basically the
worth of the stock determined by analyzing the data relating firms fundamental business
activities. So, according to the authors price of the stock could be under-priced, over-priced
or priced fairly in the capital market. The gap between fair and unfair market value of the
stock with respect to the fundamental value could create deep impact on the decisions of the
investors. The authors proposed two primary mechanisms which were; the present value
model or dividend discount model and the combined asset valuation and discounting method,
useful in the assessment of the firms asset value. They conducted an experiment to test three
groups of 188 subjects that were finance students. These subjects were provided with the
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financial real and fair valued data of a listed manufacturing firm. The information provided to
the three groups of finance students were in different formats, which were; no access to the
firms stock price, no actual stock price and over valued stock price. The results of the
experiment revealed that the addition of noise to the stock price raised the standard deviation
as well as median of the three groups. This showed that price of the firms stock played a
significant role in the decision process of the subjects. The authors concluded that the
assessment of the fundamental value of the firm was a complex process for the subjects.
Dasilas, Lyroudi and Ginoglou (2009) conducted study to extend the work of Mitra and
Owers (1995). They investigated and analyzed the dividend initiation announcement affect on
Shareholders wealth and firm value. They also examined share price volatility of returns as a
result of firms dividend initiation announcement taken under the effect of high and low
informational environments. The size of the sample was 38 Greek listed firms that initiated
dividends and financial data was collected during 2000 to 2004. They tested change in share
price that resulted due to dividend initiation announcement, expected return of share and
volatility of stock with respect to firms informational environment models. The authors
concluded that dividend initiation announcement conveyed information in the form of share
price reaction that showed positive association between dividend initiation announcement and
stock price. This phenomenon increased the wealth of the shareholders due to increased
Cumulative Abnormal Returns. The volatility in stocks was reported greater for sample firms
in low informational environment.
Fiordelisi and Monferra (2009) estimated shareholder value creation process in the Italian
factoring and leasing firms. They also evaluated cost of capital and EVA of the sample firms.
The size of the sample was 13 leasing and 13 factoring Italian firms and financial data was
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collected during 1994 to 2004. They tested total shareholders value creation model and
found that all the sample firms generated positive earnings due to low level of operating
expenses. The findings of the study showed that, sample firms created shareholder value.
Nappi-Choulet, Missonier-Piera and Cancel (2009) investigated the relationship between

EVA and MVA used as proxies for the corporate real estate firms value creation process.
They defined Corporate Real Estate (CRE) as, property that is; industrial, office and retail
space used for business purposes, as an input into the production process by firms not
primarily in the real estate business. The size of the sample was 131 listed non-financial and
non-property owned real estate French firms and financial data of 786 firm year observations
was collected during 1999 to 2004. They found that the corporate real estate percentage of the
total portfolio of the firm generated no value for the industrial as well as service sector
sample firms that had highest level of corporate real estate assets ownerships. The authors
concluded that the increased amount of corporate real estate assets ownership by the sample
firms resulted into negative association with the firm value.
2.19. Studies conducted in Australia and India

McDonald (1998) evaluated the planning processes of business entities by focusing on
managerial decision making process used for the implementation of organizational strategies.
He emphasized on the structural alignment of strategies and current financial health of the
firm. In-order to achieve this task the author proposed Value Creating Management (VCM)
ideology. Under this ideology management of a firm must formulate viable strategies that
could create value. The author recommended VCM ideology as a change agent that could
create an organization culture congenial for shareholders value creation.
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Kilroy (1999) examined traditional value based management system of the firms and
introduced an approach that was base on shareholders wealth creation. He termed EVA as
fake financial tool that practically does not create value. Wealth for the shareholders could
only be created when management of the firm deliver over and above the expectations of the
shareholders. It could be done if managers adopt higher value strategies. The author
associated value creation with innovation and linked customer value creation with the
shareholders value creation. He linked innovative strategy formulation process with hybrid
thinking. The forms of hybrid thinking presented by the author were; intuitive, formative
and logical thinking. The author emphasized to adopt hybrid thinking process by the
managers of the firm. He emphasized on the deployment of firms creative development
concept that could be implemented to generate wealth for the shareholders.
Azhagaiah and Priya (2008) investigated the interaction and the level of impact of dividend
payout on the wealth of the shareholders. They also analyzed the impact of retained earnings
on the shareholders wealth. They indicated that net earnings of a firm were generally
dividend into two parts which included; retained earnings and dividends. They focused on
dividend and analyzed its role in the shareholders value creation. Authors randomly selected
28 chemical Indian listed firms and financial data was collected during 1997 to 2006. They
tested model of market price per share of firm and applied multiple regression analysis which
revealed that the market value of dividend paying sample firms was significantly higher than
the non-dividend paying sample firms. The increase and initiation of dividends by nondividend paying sample firms enhanced the wealth of the shareholders. Thus, dividend
payouts had positively impacted the shareholders wealth.
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2.20. Studies conducted by considering multiple countries

Cleary (2005) identified vital financial factors that affected corporate investment policy of the
sample firms. He examined the patterns of investment practices by the firms that experienced
variations in economic growth. He observed cyclical investment patterns by each and every
enterprise of the sample and linked this activity with the Accelerator Theory of Investment.
He selected Australia, France, Canada, Japan, Germany, UK and USA as sample economies
and collected firm level financial data during 1989 to 1997. He divided sample firms based
on increasing dividends, dividend cuts and no change in the payout of dividends. He
formulated firm investment in property, plant and equipment model and tested it by applying
regression analysis and found that investment decisions of the sample firms were strongly
linked with the investment opportunities and also showed strong association with the firms
cash flows (retained earnings). In the sample economies financially unhealthy firms relied
less on internal funds to finance their investments. The author concluded that unhealthy firms
of the sample economies showed weak association between investment and cash flow
because these firms had highest level of debt in their capital structures. This study satisfied
accelerator theory of investment.
Lindholm, Gibler and Levainen (2006) formulated a Corporate Real Estate Management
(CREM) model that added value to a non-real estate firms core business through a strategic
management framework. They examined direct and indirect value adding affect of corporate
real estate. They identified three main areas of corporate real estate strategy that included;
firm asset, property and facilities management strategies and linked these strategies with the
firms business level strategies that once combined could better pursue shareholders wealth
maximization goal. They mentioned cost reduction and profit maximization as facilitating
strategies that could enhance firm performance. They selected 26 survived firms based on
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convenience sampling technique from USA, UK, Finland and Netherlands and collected firm
level financial data with the help of a structured questionnaire, interviews as well as
published data. The authors found increase in profitability and revenue as the main indicator
of value addition, but the other value enhancing factors identified by the authors were cost
reduction and participating in the strategic process.

In this section studies related to dependent variables have been reviewed. The studies
involving firm value and shareholders wealth that were conducted in USA, Canada, UK, EU
countries, Australia, India and other countries, show that the concept of firm valuation has
been evaluated in diversified types of models. Corporate finance researches have developed
and tested new tools used to measure financial performance of a firm. The models developed
and tested across the world are so diverse and different in scope and application that the
original and simple concept of firm valuation is stretched to its limits. In-spite of the fact that
significant amount of evidence have established significant and positive association between
firm value, shareholders wealth, dividend payout and retained earnings, but no one has yet
solved the dividend puzzle and no theory was developed to signify the linkage between these
variables. So, in this research beside models testing, a theory named as, The Hybrid Theory
of Firm Valuation has been developed and tested by considering empirical data from
Pakistan.
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SECTION - III: TREATING MODERATING VARIABLE

The moderating variable from the two devised models of this research study is capital
budgeting process and decisions. The empirical work done related to above stated moderating
variable covered a vast number of issues directly or indirectly involving this variable of
highest importance to the corporate finance researchers. The studies reviewed and reported
here mainly included testing, analyzing or evaluation of formulated models by the authors
concerned with respect to geographical regions of the world.
2.22. Studies conducted in USA, UK and Canada

Brookfield (1995) examined the difference between traditional utilization of net present value
technique to evaluate capital investment and adjusted net present that catered uncertainty
(risk) part of the investment. In order to cater the risk factor of an investment project,
flexibility in managerial decision making could facilitate in correct assessment of investment
projects. The author suggested that if possible manager of a firm should wait until best option
is available for investment. He indicated that capital budgeting process based on real options
could reduce the likeliness of future losses of an investment project. So, correct form of
capital budgeting technique can prove to be a competitive advantage for a firm. The author
concluded that flexibility in the form of deferred current investment in an anticipation of
another option in distant future could enhance the value of the firm due to the benefit
embedded in the future opportunity in the shape of associated risk.
Byers, Groth, Richards and Wiley (1997) presented a methodology through which extensive
and effective analysis of a corporate investment could be accomplished by any type of
manager. They also explored the concept of capital investment analysis process. They
indicated that an economic analysis of a capital investment must be accomplished at the
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initial stage of the project life-cycle. This analysis covered risk factor and timings of the
return on investment for the project. They presented steps of capital investment project
analysis that included; identification of a good project, related costs and risks and sensitivity
analysis of the investment. Also, cash flow after tax could be considered during the analysis
of the project by the firm management.
Tannous (1997) developed and analyzed a contingent claims advertising budgeting model
that catered the product demand change in the market with respect to strategic advertising
used to enhance expected product demand. He also examined advertising, pricing and
production capacity decisions. He supposed firms proposed advertising budget of a product
that had stochastic demand factor and formulated a model that represented expected cash
flows of the product expected to be generated in the future after the implementation of
strategic and contingent advertising budgeting process. The test of model revealed that if firm
invests in strategic advertising under effective and efficient mechanism, the value of the firm
could increase. On the other hand, if costs associated with contingent advertising budget
could be controlled and minimized, the value of the firm could be maximized substantially.
He found positive impact of strategic and contingent advertising budget on price and demand
of the product, where increase in price was attributed to cover the costs of contingent
advertising. Thus, according to the author strategic advertising budget had greater potential to
increase the firm value as compared to contingent advertising budget. He reported that type
and nature of firms investment in advertising depended on the volatility in product demand
as well as product life-cycle. The author indicated that importance of contingent advertising
budget allocations were higher in the introduction stage of a new product, whereas strategic
advertising budgeting acted well during the decline stage of a product.
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Graham and Harvey (2002) analyzed capital budgeting and capital structure decisions of the
sample firms. They conducted a survey research by selecting a sample of 4440 US firms. The
response rate of the study was 9%. They found that 75% respondents used NPV as capital
budgeting technique. 47% of respondents issued debt when internal funds were insufficient to
fund the investment projects. Findings of the study confirmed the pecking order in financing.
Sample firms controlled under-investment problem by issuing short-term debt. Small sample
firms used PBP to evaluate capital investment projects. The authors found no association
between PBP, leverage and dividend policy.
Jagannathan and Meier (2002) investigated the frequent use of CAPM by the corporate senior
level managers in the estimation of projects cost of capital. They evaluated financial data of
US firms collected during 1951 to 2000. In this period US managers evaluated and selected
investment projects based on projects hurdle rates and historical information relating average
return on equity. The authors labeled CAPM as a bad model that must not be taught in
classrooms because risk premium calculated from the market beta values used in this method
contradicted the real value of risk and return. They formulated a model that represented NPV
of the project and supposed infinite continuity of the project selected under this model. They
recommended hurdle rate value that must be considered by the managers while evaluating
investment projects and if real option framework was adopted under optimal hurdle rate rule,
value of the firm could be optimally maximized. So, standard option pricing intuition could
be selected to invest in optimal net present valued projects. The authors indicated cost of
capital rule as misleading method but, it was still in use by sample firms that took optimal
capital budgeting decisions to maximize firm value. The gap between cost of capital and
hurdle rate methodologies was reduced when a firm grew old. The authors reported that small
sample firms used CAPM very rarely. They concluded that the use CAPM to calculate the
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cost of capital was a fallacy. The use of this method could not optimally maximize firm value
and wealth of the shareholders. The authors suggested that real option methodology could be
used by managers to maximize optimally the firm value and shareholders wealth.
Ryan and Ryan (2002) analyzed capital budgeting methods used for decision making by the
fortune 1000 firms of the USA. The response rate of study was 20.5%. Majority of the
sample firms were large in size and also had large capital budget allocations. The authors
found that 49.8% CFOs used NPV to evaluation investment projects. The second most
favorable capital budgeting technique was IRR. Sensitivity analysis and scenario analysis
were the most popular advance capital budgeting methods used by the respondents of the
sample firms. 50% respondents used on regular basis the EVA technique whereas 33%
respondents used MVA technique. 83.2% used WACC as the discount rate calculation
method. The authors concluded that most of the fortune 1000 firms used discounting capital
budgeting techniques for the investment evaluation process.
Grinstein and Tolkowsky (2004) studied the role of board of directors in monitoring the
capital budgeting process of large US corporations. They also examined different roles of
board of directors in the sample firms. They selected all US listed firms excluding financial
firms and collected financial data of 2262 firm year observations during 1995 to 2000. They
found that 17% of sample firms had special capital budgeting committees that monitored ongoing capital investment projects. Sample firms that had well organized finance committees
were larger in size with few growth opportunities and also had higher level of debt. 82%
sample firms had CEO the chairman of the finance committees which showed deep
managerial involvement in capital budgeting process. The sample firms that had capital
expenditure and M&A committees were highly profitable firms with higher levels of sales.
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The authors concluded that board of directors of the sample firms had multiple roles in the
capital budgeting process. The finance review committees benefited sample firms and also
facilitated them in enhancing firm value and shareholders wealth.
Bilici and Benli (2005) dealt with the problem of project selection methodology. They
indicated this problem as central to all the investment planning and evaluation processes that
required effective and efficient allocation of resources. They formulated a deterministic
model under binary integer program modulation that incorporated project starting as point
of analysis and concern. This model worked best with the managerial decision support system
that analyzed results based on managerial intuition. They modeled capital budgeting problem
representing project starting criteria of a set of projects. They also introduced capital
availability constraints that indicated that a project could only be initiated once and if the risk
of the firm was increased due to the selection of riskier projects by the management it would
push firms discount rate in upward direction. So, readjustment in the calculated value of the
net present values of the firms projects must be done immediately. The authors concluded
that effective capital budgeting decision making in the firm must employ scientific tools that
could provide competitive edge to the firm.
Ho, Keller and Keltyka (2005) investigated the level of importance managers gave to the
value of the firm while taking capital budgeting decisions and examined conditions under the
influence of non-financial (interpersonal information) factors that force managers to pursue
their own interests on the expense of the wealth of the stockholders. They conducted two
experiments to test the factors which were information bias and ambiguity. The authors
provided information to the managers simultaneously or sequentially during the process of
capital budgeting decision making in good (gain) or bad (loss) conditions. A sample of USA
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origin 30 managers were involved in the first experiment. The authors collected responses by
means of a questionnaire designed based on capital budgeting practices. Under bad
conditions criteria 83% of the respondents selected ambiguous projects in an anticipation of
higher returns in the future. In second experiment, authors collected responses relating
simultaneously ambiguity case and simultaneously unambiguity case. A total of 62 USA
origin managers responded. The authors found that the managerial selection of unambiguous
and ambiguous projects remained indifferent of information provided to them sequentially or
simultaneously. Also, simultaneously unambiguity case gave favorable results that showed
that under this and simultaneously ambiguity case conditions managers acted in their best
interests against the interests of the stockholders of the firm. The authors concluded that
interpersonal information had greater influence on the capital budgeting decision making of
the managers of the sample firms. And, good time drove managers to pursue self-interests
and bad time drove managers to work for the maximization of firm value and stockholders
wealth.
Tseng, Lin and Sundararajan (2005) examined the Cost Over-Run (COR) for the projects that
were under review by the management of the firm for funding and when an individual project
contributed towards total cost overrun of the entire investment portfolio of the firm. They
constructed a model that represented minimization of cost overrun by over funding
(budgeting) the project in-order to eliminate the under-investment problem. Under the
framework of this model authors devised strategies that could facilitate firms in the reduction
of their portfolio cost overrun and adjustment of budgetary allocation for the portfolios could
be aligned. So, if projects with cost overrun were funded at their upper bound, the problem of
costs overrun could be minimized substantially. It is also known as mean variance adjustment
methodology approach. Here, decision maker can be risk neutral, risk averse or variance
75
minimizer. The authors indicated that the size of the project in a portfolio also affected the
level of funding it required from the total budget and a riskier project came for funding
required longer lead period because of higher cost overruns. The authors concluded that
budget allocations must be monitored and controlled in the project execution period.
2.23. Studies conducted in Australia and European Union Countries

Maccarrone (1996) formulated an integrated model of capital budgeting process based on
normative contingency theory. The steps in capital budgeting process presented by the
author included; identification of investment opportunities, development of evaluation plan,
selection of investments, authorization of accepted investment projects, implementation and
control and post-auditing process. The author selected large Italian firms and analyzed their
capital budgeting practices in the light of normative contingency theory. He linked capital
budgeting process with the strategic planning process of a firm and emphasized that these two
processes must be implemented in harmony.
He emphasized on the identification of
investment project as a critical phase where; investment, firm internal functioning and
external environmental must be analyzed with the involvement of employees of the firm. The
author added that investment projects concerning expansion, R&D and new product
development must be initiated with the involvement of concerned departments of the firm.
The author claimed that problems associated with capital budgeting process that involved
investment project selection methodology could be resolved by adopting integrated approach
led by decentralized form of firm management.
Pawlina and Kort (2003) investigated the impact of product market uncertainty on the
optimal replacement timing of a production facility of the firm in a continuous time
framework. They also examined strategic interactions related to capital budgeting strategies
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of the firm, dependence of optimal replacement of facility on the uncertainty in context of

firms initiatives of facility replacement, the level and nature of uncertainty and optimal
replacement of firms facility and affect of demand uncertainty on optimal threshold
interactions. The authors considered two firms that were identical, competing in the same
product market and firm value was dependent on randomly changing process of value but the
value was irrespective of time effects. They formulated two models; first for equilibrium that
was achieved in the process of facility replacement by the firm and second model
incorporated the factors of change in demand to represent investment increase in uncertainty
condition. They indicated that the replacement of existing production facility with high
technology facility facilitated firm to reduce per unit cost of production and increased
profitability. They tested two models and found that the investment time was inversely
related to the product market uncertainty function. They found optimal thresholds as the
outcome of replacement strategy that represented strategic moves which were effective, when
a firm invested first, later or at the same time when its competitor indulged in investment
activities. The authors added that uncertainty drove facility replacement decision and the
sample firms that took decision to replace production facility first as compared to its
competitor, got reward in the shape of higher profitability at lower costs of production and
competitive advantage in the market. The authors concluded that in imperfect competition
and uncertainty conditions the strategic approach of sample firms decision of asset
replacement under random effect depended on lower costs as well as higher present value of
future cash flows.
Holmen and Pramborg (2006) analyzed capital budgeting practices related to foreign direct
investment of Swedish firms done under the effect of political risk. They also investigated the
use of other capital budgeting techniques. They selected 145 Swedish firms and collected
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survey responses in 2003. The response rate of the survey was 29%. 63 sample firms that
responded were small and 32 were large and they were ranked based on the level of per
annum sales. They collected firm level data during 1995 to 2002 and applied logit regression
to analyze survey data. The authors also used economist intelligence unit index to calculate
political risk for the individual sample firm. They found that managers of Swedish sample
firms that had capital constraints commonly used payback period to evaluate FDIs in the host
countries with higher political risk. Higher political risk made very difficult for the firms
management to acquire accurate market data and as a result costs of the investment projects
increased. The use of NPV method by the sample firms was reduced with the increase in
political risk factor and the use of payback period method increased. The authors concluded
that political risk significantly affected the FDIs of the Swedish sample firms and the sample
firms adjusted political risk by raising the cost of capital of the capital investments.
Truong, Partington and Peat (2006) investigated the affect of Capital Asset Pricing Model
(CAPM) and new theoretical developments on the capital budgeting practices of the
Australian firms. They also analyzed other related issues of capital budgeting. The size of the
sample was 356 Australian firms that belonged to nine industrial sectors of Australia. A
survey questionnaire was used to conducted research in 2004. Response rate of the study was
24.4%. The authors found that most of the firms used net present value, payback period and
internal rate of return as project evaluation techniques. 88% of the sample firms used cost of
capital to evaluate their investment projects on regular basis. CAPM was used by very low
percentage of Australian sample firms. About 84% of respondents indicated that they
regularly used weighted average cost of capital method. 57% of respondents used discount
rates whereas, 22% used cost of debt plus risk premium as project evaluation method. 5 to 10
years was identified as the project forecasting period and fixed discount rates was used to
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evaluate projects. The authors concluded that their survey research signified NPV as the most
used capital budgeting technique by the sample firms.
2.24. Studies conducted in China, Taiwan and Uzbekistan

Tsamenyi and Tauringana (2004) analyzed capital budgeting practices of foreign firms and
analytical approach used to cater environmental risk in Uzbekistan. The higher failure rate of
foreign investments in Uzbekistan compelled authors to initiate this study. The authors
randomly selected a sample of 90 foreign firms operated in Uzbekistan and acquired data by
means of a research instrument, interviews and analysis of published data. The response rate
for this research was 40% and the respondents who filled the questionnaires were finance
directors of the sample firms. Authors found that 61% sample firms perceived low investment
risk in Uzbekistan and identified presence in the market as the main and important factor
that was the basic cause of investing in Uzbekistan. 63.9% sample firms used PBP whereas
rest of the sample used NPV. Majority of the sample firms indicated that their projects were
profitable. Most of the sample firms had no budget control systems in-place to gauge the
budget variances in their investment projects.
Jiang, Chen and Huang (2006) examined the association between capital expenditures and
corporate earnings. The size of the sample was 357 listed Taiwanese manufacturing firms and
financial data was collected during 1992 to 2002. The first five years of the study represented
capital investment period and the rest of the six years of study represented performance
period. The authors applied regression on the data and found that on average 72% of capital
expenditure of the sample firms increased whereas total assets increased by 77%. Overall
earnings of the sample showed appreciation and per year operating income increased by
157%. This showed tremendous positive performance in the terms of profitability. So, it was
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confirmed that capital investment positively and significantly impacted the future corporate
earnings of the sample firms.
Lin and Ji (2007) analyzed methods used for valuation of oil and gas portfolio projects under
the framework of real options theory. The methodology of real options used for the valuation
of investment projects comprised of factors which were; costs linked with the investments,
present value of the cash flows expected from the investment, end of the cash flows generated
from the investment, risk-free rate and expected cash flow volatility. These factors when
applied determined the real contribution of the investment project towards the value creation
for the investment. The authors considered a model developed by Black and Scholes and
extended it to represent maximization of firms value under real option theory. They
mentioned that in real business world when a manager select a single oil and gas project from
the mutually exclusive oil and gas project, he or she usually reject the NPV generated results
and rely on his or her intuition and judgment to calculate the value of the project. This
technique was considered as flexible managerial approach employed to select investment
projects as well as to access the risks attached to individual evaluated projects. The authors
concluded that managers of oil and gas sectors could use real options technique along with
net present value technique to evaluate and select investment projects.
2.25. Studies conducted in African Countries

Toit and Pienaar (2005) investigated the methods of capital investment. They also
investigated the methods used to evaluate mutually exclusive projects by the sample firms.
They also compared survey results with the international capital budgeting best practices. The
authors selected 524 South African listed firms to conduct a survey research. The response
rate of the study was 13%. They found that 46% of the sample firms had more than Rand
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(currency of South Africa) one billion of total assets. However, the size of annual capital
budget of Rand one billion portfolio sample firm was Rand 50 million. The most popular
capital budgeting technique used by the sample firms was internal rate of return and the
second method used was net present value. They also found that capital intensive firms
preferred discounted cash flow method to evaluate the capital investment projects. They
blamed net present value technique because by using this technique managers of the sample
firms added very little amount of wealth to the shareholders. The authors concluded that the
capital budgeting practices of the sample firms were comprised of old fashioned methods that
added least value to the firm and in result wealth of the shareholders suffered.
Elumilade, Asaolu and Ologunde (2006) investigated the affect of capital budgeting on
investment decisions which translated into firm growth. They also evaluated the use of capital
investment techniques by the sample that contributed toward the economic development of
Nigeria. They emphasized on the effective implementation of capital budgeting process
loaded with new ideas that could facilitate firms in Nigeria to maximize value. They selected
a sample of 94 Nigerian listed firms that belonged to 11 industrial sectors and collected
financial data for the year 1980, 1984, 1988, 1989, 1992 and 1995. The response rate for the
study was 51%. They found that that PBP, ARR and NPV were continuously used by 28.7%
of the Nigerian sample firms. 23.9% of sample firms depended on their past experience to
employ measures for discounting investment returns and 18.1% selected WACC to calculate
the cost of equity capital for their investment projects. 44.7% financed their investment
projects with equity as compared to 18.1% that used debt. 41.5% considered five years as the
timeframe for the implementation of the new project. The authors concluded that capital
budgeting process was essential for the growth of Nigeria and it would be achievable by
means of good decision making by Nigerian government in the best interest of the people.
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Corria and Cramer (2008) analyzed cost of capital, capital structure and capital budgeting
practices of South African listed firms. They also analyzed the conformity of surveyed firms
practices with the finance theories in-order to check improvements in the evaluation
techniques of corporate investment projects. They also evaluated the use of CAPM, market
risk premium and debt to equity ratios. They used a sample of top 150 South African listed
firms. They adopted a research questionnaire which was further extended to collect responses
from the sample. The response rate of the study was 15%. Authors found that the sample
firms mostly used NPV and IRR and least used PBP and ARR methods. Earnings multipliers
were frequently used by the CFOs. Sample firms normally used scenario and sensitivity
analyses to evaluate projects risks. Breakeven analysis was third method used by the sample
firms. Respondents always used discount rate for the entire firm and risk matched discount
rate for the evaluation of their investment projects. 71% of survey firms used CAPM, 80%
used their firms betas in the calculations of cost of equity capital, 68% used discount cash
flow technique and 32% used price to earnings ratio method and 18% used EVA. Majority of
sample firms had flexible target capital structures which showed that firms used less debt as
compared to equity in their capital structures. The authors reported that latest methods and
techniques of project evaluation were used by limited number of respondents due to their
complex nature of industrial application. The latest capital investment evaluation techniques
and methods were also minimally used by the firms of developed country.
2.26. Critical analysis

In this section studies related to moderating variable capital budgeting process and
decisions have been reviewed and reported. The studies conducted in USA, Canada, UK,
Australia, China, Taiwan, Uzbekistan, European Union and African countries show that
capital budgeting process is considered as backbone of success of any investment. The
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correct use of capital budgeting technique can potentially provide competitive advantage to
the firm and embedded risks with the investment can be minimized. So, in this manner value
of the firm can be enhanced significantly. Hence, literature cited in this research study has
provided significant evidence that has identified capital budgeting process that includes; use
of capital budgeting techniques as well as evaluation of potential investment projects with
respect to associated risks, cash flows and discount rates. And, capital budgeting decisions
that includes; selection of viable, higher net present valued and economic value added
investment projects, as essential part of a progressive business entity. These undeniable facts
compelled current author to incorporated capital budgeting process and decisions as
moderating variable of the study.
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SECTION - IV: STUDIES CONDUCTED IN PAKISTAN

The empirical work done in Pakistan that addressed issues concerning the variables included
in the two devised models of this research study are reviewed and reported here. The current
author mainly included studies that presented testing, analyses and evaluation of formulated
models by the authors concerned. This research study has explored these issues in detail
based on the empirical work published in reputed national and international research journals.
Kanwer (2003) investigated the factors that influenced dividend payout decisions in Pakistan.
The size of the sample was 317 listed Pakistani firms that belonged to 13 industrial sectors
and the financial data was collected during 1992 to 1997. He developed a model of dividend
yield based on known determinants of dividend payout and applied ordinary least squares
regression on it. He found that 70% of the observations related to dividend yield were
missing because majority of the sample firms were not in a practice of paying dividends to
their shareholders. The size of firm was not significant in explaining the dividend payout
behavior whereas surplus and increased investment opportunities were negatively associated
with the dividend payout.
Mehar (2007) analyzed long-term return behavior relating change in dividend payouts to the
shareholders. He selected 180 Pakistani listed firms and collected financial data of 3960 firm
year observations during 1981 to 2002. He dividend listed Pakistani firms into the Modaraba
firms, the local subsidiaries of the multinational corporations and the other firms. He
formulated a dividend model and applied ordinary least squares method to test the model of
dividends. He found negative association between dividend and liquidity position of the firm.
He reported that only 23% of the sample firms converted their incremental profits into
dividends whereas rest of the sample firms retained their profits for investments in Pakistan.
He identified lack of established corporate bond market in Pakistan as the basic reason of
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lower dividend payout by the Pakistani listed firms because debt could not be issued by firms
without an established bond market in the country. This was the main reason that compelled
Pakistani listed firms to borrow debt from commercial banks. The debt borrowed by sample
firms was to finance investment projects. The author reported strong correlation between
payout of dividends and structure of governance in the sample firms. The author concluded
that excess retention of profits by sample firms should be restricted. Sample firms should not
be owned by families and every decision relating dividend policy must be approved by a
higher authority that govern and manage the affairs of the board of directors in sample firms.
Naeem and Nasr (2007) examined the trends and determinants of the payout policies in
Pakistan. They also identified strengths of determinants of payout policy. The size of the
sample was 108 listed financial and non-financial Pakistani firms and financial data was
collected during 1999 to 2004. They used OLS and GMM methodologies to test the
formulated dividend payout regression model. They found instability in the dividend payout
practices of the sample firms. Also, most of the sample firms were not paying dividends to
their shareholders in Pakistan. The authors reported that non-financial sample firms paid
higher amount of dividends as compared to financial sector sample firms. They found
negative association between investment opportunities, liquidity of the firm and dividend
payout. The major factor that played significant role in the decision making process relating
dividend policies of the sample firms was the lagged dividend. The authors concluded that
Pakistani listed sample firms had instable dividend policies. This showed stockpiling of
earnings by the sample.
Ahmed and Javid (2009) analyzed factors that can empirically define the cross-sectional
differences in dividend policies relating smoothing behavior of dividends. They indicated that
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in Pakistan only few listed firms continuously pay dividend to their shareholders. They
selected a sample of 320 non-financial listed Pakistani firms and collected financial data of
1830 firm year observations during 2001 to 2006. They adopted and tested dividend model.
The authors applied GMM method and found that the target payout ratio of the sample firms
vary significantly. They rejected the dividend smoothing hypothesis in the case of sample
firms. They reported positive association between net earnings, ownership concentration,
liquidity and dividend payout and negative association for firm size, investment opportunity
with the payment of dividends by the sample. The authors concluded that the average target
payout ratio of the total sample was 30% which was very low payout. This implied instability
of dividend policies of sample firms that had higher retention of earnings.
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SECTION - V: RETENTION POLICY AND REINVESTMENT

The empirical work concerning the retention policy and reinvestment of earnings by firms are
reviewed and reported here to understand the models of reinvestment developed by
researchers and scholars around the world. This research study has explored retention and
reinvestment related issues on the basis of published empirical work.
Johnson, McMillan and Woodruff (2002) investigated the association of secure property
rights and the investments done by the entrepreneurs. They also analyzed prevailing
conditions of property rights and access to external finance by these entrepreneurs. They
selected 300 private small manufacturing firms that belonged to Russia, Ukraine, Poland,
Slovakia and Romania and conducted a survey research in 1997. The countries selected by
authors were known for weak property rights. They developed reinvestment demand model
and applied probit regression on the data. They found that secured property rights facilitated
government of the sample countries to increase the level of reinvestment rate. Whereas weak
property rights negatively affected the reinvestment rate. Respondents from Russia and
Ukraine agreed that they had paid illegal payment in their countries. Sample firms from
Poland and Romania reinvested more than 50% of their profits in their countries whereas
30% of the profits were reinvested by the sample firms in Ukraine. The basic cause behind
this higher level of retention of profits by firms in Russia and Ukraine was unsecured
property rights. So, Romania, Poland and Slovakia were the countries that had experienced
greater amounts of reinvestments of profits. Sample firms from Poland took the highest
amount of loan from banks whereas sample firms from Russian and Ukrainian took the least.
Sample firms from Russia and Ukraine reinvested 12% profits of their sales. So, lower level
of reinvestment was observed in the case of Russia and Ukraine and highest in the case of
Poland. The authors concluded that entrepreneurs in Poland and Romania reinvested the
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highest amounts of profits due to secured property rights. This implied that secured property
rights were an important factor that is necessary for the reinvestment activities by a firm.
Baum and Turner (2004) analyzed different corporate retention rate policies of multiple
European office markets to understand the interaction of lease structures and depreciation
rates with the retention policies. They evaluated performance of European corporate property.
The authors collected sample data from 186 owners that owned single buildings and 205
owned multiple buildings in London, 73 owners from Frankfurt, 150 from Paris, 215 from
Stockholm and 100 from Amsterdam, during 1998 to 2000. The authors formulated and
modified market rental growth model and tested it by using ownership data. The rental
growth was related to special property that means office space. They found that the retention
rates relating standard investment office portfolios across sample were reported different
for each and every subject of the sample. London office market showed lowest retention rates
as compared to other European office markets due to long-term lease agreements in UK
office markets. The decline in rental value was greater and depreciation was higher in
London office markets. The authors reported highest retention rates in Paris and Frankfurt
office markets. Results of the study confirmed that retention rates and depreciation were
inversely related. The authors suggested that ownership of property and related lease
structure can generate returns when management of a firm reinvests earnings in positive NPV
projects. UK owners of multiple office buildings were better-off due to continuous inflow of
returns in the form of rent from the occupation of office buildings. In UK retention rate of
office space was at lowest level as compared to other nations in Europe. The authors
concluded that property investment and reinvestment was a difficult task which was entirely
different from equity based investments done in capital markets. So, property related
investments should included lease structure and depreciation factors which could be
88
considered as restrictions when returns in the form of rents were realized. Owners of office
buildings in Europe were found active in the reinvestment of returns (rental income) that
were generated as a result of property lease agreements.
Cull and Xu (2005) examined the level of expropriation risk and contract enforcement,
involvement of the sample firms. They also examined property rights of privately owned
property in China. The sample of this survey research was 2400 firms that belonged to 5
regions and 18 cities of China and the study was conducted during 2000 and 2002. They used
reinvestment model of Johnson, McMillan and Woodruff (2002). The authors found that the
correlation association between property rights and external finance were low. The authors
also tested regression model of reinvestment and found that the average reinvestment rate in
China by privately owner sample firms was 27%. The expropriation risk and contract
enforcement were found significant in determining the reinvestment levels of the sample
firms. Ownership structure and external finance showed positive and significant association
with the reinvestment. So, reinvestment rate was higher for small and startup young Chinese
sample firms. They attributed higher development of firms in China due to effective and
helpful nature of Court (justice) System as well as government facilitation provided to the
growing firms. The authors concluded that secured property rights, access to external finance,
risk of expropriation and contract enforcement by courts were the important factors that
determined the maximization or minimization of firms profits reinvestment in China.
Lundan (2006) investigated enhanced reinvestment activity of a transnational corporation in

its home country. She constructed a conceptual model of reinvestment and identified factors
that affected the reinvestment activities of the sample firms. She also evaluated intra-firm
dividends with respect to tax effect and reinvestment. She used data relating reinvestment of
89
FDIs and compared balance of payments data of USA with the data of Europe and Japan. She
reported shrinking of reinvestments by the major European countries in USA. She found that
increase in taxation in a host country negatively affected the FDIs as well as reinvestment by
a transnational corporation. So, management of a multinational or transnational corporation
must understand that higher taxed countries usually experience lower levels of reinvestments
by foreign firms. In the case of repatriation, higher taxation resulted into higher levels of
dividend payment to the shareholders by the affiliate in the host country. So, taxation system
must be supportive for the reinvestment activity by a transnational corporation. The author
concluded that profits reinvestment was an important element of FDI. Reinvestment of profits
in a country was essential for the growth of a firm and for the economy of a country.
90
AFTER REVIEW OF LITERATURE THE PROPOSED PLAN OF ACTION

After review of literature, the current author intends to focus on the distribution of equity
capital. The distribution of equity capital (earnings) is divided into two conditions; one, in
which firm pays dividend and second, when firm retains all of its earnings for investment
purposes. The process of reinvestment of retained earnings will be explored by means of
structured instrument. The mechanism of use of retained earnings by the Pakistani sample
firms will be explored in detail and it will be done by comparing retained earning and
dividend payout models based on maximization of the firm value and the shareholders
wealth. Also, the affect of capital budgeting process and decisions will be analyzed.
The report of International Trade Centre (ITC) (2007) indicated that in Pakistan there are 3.2
million economic establishments and among these 93% of the entities fall into the category of
SMEs. Moreover, Mehar (2007) states that, in Pakistan SMEs are in regular practice of
retaining their earnings because these firms do not have surplus funds to be paid out as
dividends. Therefore, most of these firms use retained earnings to invest in expansion related
investment projects. So, low dividend or no dividend is the consequence of this high earnings
retention in Pakistan. In Pakistan only 23% of incremental profits are transformed into
dividends. The current author has reported similar situation in multiple countries around the
world. There is a need to explore the flow and use of retained earnings by the firms. The
current author has identified this as a knowledge gap in the corporate financial literature and
explored it in the business environment of Pakistan.
In this study, based on cited literature, the current author has formulated and empirically
tested a new theory named as Hybrid Theory of Firm Valuation. The Hybrid Theory of
Firm Valuation states that; the increase/ decrease in the value of the firm is attributed by the
combined effect of dividend payout and retained earnings which are the bifurcations of firms
net earnings generated in result of business processes and activities during a certain period of
91
time. The Hybrid Theory of Firm Valuation is developed based on common financial formula
which divides net earnings of the firm into payout and retention ratios (Brigham and
Ehrhardt, 2001; Brealey and Myers, 2003) as follows:
1 = Payout ratio + Plowback ratio
The financial formula stated above explains that out of 100% net earnings of the firm, some
percentage of earnings is retained and some is paid out to the shareholders (investors). This
division of net earnings is dependent on a vast number of factors including; the firms
profitability, cash flows, liquidity, leverage, capital structure, firms life cycle, growth, macro
and micro economic factors, investment opportunities, informational asymmetries, ownership
structure, governance and other related factors already being identified by the corporate
finance community. The current author has considered these factors as vector (X) as being
done by Deshmukh (2003) and Ho (2003). In this study main concern is plowback ratio (the
retained earnings) but an equal importance is given to dividend payout.
In-order to test the Hybrid Theory of Firm Valuation the current author has devised two
models, one with retained earnings as independent variable (value of firm and wealth of
shareholders as dependent variable) and other with dividend payout as independent variable
(value of firm and wealth of shareholders as dependent variable). Capital budgeting process
and decisions has been incorporated as moderating variable in the two models. The current
author has formulated hypotheses based on review of corporate finance literature and
empirically tested them. For this study the firm valuation equation (A) derived by Sethi and
Taksar (2002) has been extended into two conditions in-order to test the formulated theory.
These conditions are as follows:
Condition 1: (When there is continuous payout of dividends)
In this condition the equation derived by Sethi and Taksar (2002) will remain the same and it
is written as follows:
92
1 ( x)
r (x )
xx
The above is the linear value function, where, ( x - x *) represents payout of dividend to the
firms shareholders and
x represents Firms assets / capital at threshold level or it
represents the mean value of the firm assets.
Condition 2: (When earnings are retained and no dividend is paid)

In this condition firm is below the threshold level of its earnings and decides not to pay any
dividend and retain all of its earnings to be reinvested in the profitable projects at hand. The
equation then takes the form:
1 ( x )
r (x )
x
The above equation represents value function, where the symbols have the following
interpretations:
1 ( x) = It represents total value of the firm
r (x )
= It is the present value of the total earnings stream or capitalized value of the
earnings stream and is the shareholders required rate of return or the cost of capital
93
CHAPTER 3: THEORETICAL FRAMEWORK
This chapter explains the research model development and its components. It also explains
the components (variables) of the model and deduction of hypotheses based on the literature
review to show the existing form of evidence relating the association of variables considered
in the research model. Also, variables of the study have been defined and operationalized.
3.1.
OVERVIEW OF THEORETICAL FRAMEWORK OF THE STUDY

The theoretical framework of this thesis is presented in (figure 3.1). The research
model presented in Figure (3.1), developed by the current author, is an extension of
the equations derived by Sethi and Taksar (2002). They solved optimal financing
problem of infinite horizon corporation and derived few equations that best described
the optimal value of a corporation. The study of Sethi and Taksar explained the value
function ( x ) in terms of optimal financing where they considered retained
earnings and external equity for maximizing the value of the corporation in a
stochastic environment. Sethi and Taksar used diffusion process to prove their
equations.
Sethi and Taksar derived the value function for the total value of the firm under the
case of transactional cost as follows:
c (x )
r (x ) x x
c
c
[Equation 5.5][Sethi and Taksar (2002)]
The equation (5.5) is a linear function where, c (x ) represents the optimal return
function and c shows an explicit dependence of the value function on the brokerage
commission (1-c). Sethi and Taksar derived equation (5.5) from the Hamilton Jacobi
Bellmans equation of the value function, which is as follows:
94
2
1
d (x )
1
2 d (x )
Max ( ( x ))
r (x )
( x), 1 ( x ), ( x) 0
2
dx
c
2
dx
The derivation of the Hamilton Jacobi Bellmans equation includes which

represents the field of earnings generated by the process X(t), where X(t) denotes
firms assets at time t for which X(0-) = x > 0 and it represents firms assets at the
starting time zero and it is not equal to zero. Sethi and Taksar supposed that once
the firm is incorporated, it has non-zero assets at the beginning of the operations.
They further solved the above Hamilton Jacobi Bellmans equation under the case
of zero transactional cost by putting value of c = 1, and the new expression took
the following form:
r (x )
1 ( x )
xx
[Equation A ]
The equation A may be explained in the following words:

Total value of the firm = Capitalized value of the total earnings stream + Firms
assets at a particular time firm assets / capital at threshold level or mean value of
the firms assets. According to Sethi and Taksar, The optimal policy for the firm
value maximization is to keep the assets at level x . Any excess over x should
be paid out as dividends and any shortfall from x should cause the firm to retain
earnings and issue external equity immediately to reach x . Thus, in the case when
x x , the firm pays immediately a lump sum dividend of ( x x ) .
Subsequently, the firm earns a stream r ( x ) of income over a period of time. The
95
capitalized value of this earned stream is
[ (x x )
r (x )
. Thus, the total value of the firm
r (x )
] is the same or equal to ( x ) , the equation A.
On the other hand it is mentioned by Sethi and Taksar that, when x x , the firm
can immediately raise sufficient funds to bring the firms capital level back to x .
r (x )
The present value of the total earnings stream, r ( x ) is equal to
. Now,
according to Sethi and Taksar, when the new stockholders of the firm provide the
external financing equal to the amount of ( x x ) to the firm, stockholders will get
back the amount equal to ( x x ) , which is actually the firms payout of dividends to
the stockholders when discounted at the stockholder's required rate of return. Thus,
the value of the firm for the initial firms stockholder according to the interpretations
r (x )
(x x )] , which is also
and derivations of Sethi and Taksar is eqaual to [
equal to ( x ) , the equation A.

From these derived equations by Sethi and Taksar current author has only selected the
value function that represents total value of the firm in terms of retention of earnings
as well as payout of dividends on the equity generated by the firms from the capital
market. In this way two conditions have been developed and discussed at the end of
chapter two of this thesis. These two conditions represent model 1 and model 2.
The diagrammatical form of these two conditions in terms of research model of our
thesis is represented in figure 3.1 below:
96
Figure 3.1
Thesis Research Model
INDEPENDENT VARIABLES
DEPENDENT VARIABLES
MODEL 1
r (x*) + (x - x*)
_______
Value
Maximization
of the Firm
MODEL 2
Contribution
towards the
enhancement
of
Shareholders
Wealth
r (x*)
+ x
______
Capital
Budgeting
Process and
Decisions
(Moderating Variable)
In figure 3.1, a moderating variable has been introduced that is capital budgeting
process and decisions. The basic reason to introduce this moderating variable is the
importance of capital budgeting in the corporate finance. Many researchers while
conducting research on dividend policy and retention policy tend to ignore capital
budgeting process and decision making process of the firm. A number of researchers
have conducted researches on capital budgeting process and decisions in isolation.
Seitz and Ellison (1998) identified in their book the role of capital budgeting process
as a catalyst that acts within the firm to generate wealth for the firm and for the
shareholders. Similarly, Horne, Wachowicz and Bhaduri (2008) linked future benefits
of the firm with long-term decisions as a part of capital budgeting, related to the
selection of viable investment projects that had greater rate of return as compared to
97
the required rate of return for the investors, the shareholders. So, these authors
emphasized on the use of capital budgeting process and decisions as process enhancer
positive exercise within the firm. Toit and Pienaar (2005) studied capital budgeting
practices of South African firms and criticized them for not using all the essential
tools of capital budgeting that became the basic reason of lower value addition.
However, Bilici and Benli (2005) and Elumilade, Asaolu and Ologunde (2006)
indicated effective implementation of capital budgeting process as facilitator that
modified as well as equipped firm to achieve competitive advantage as a result of
enhanced value. Hence, based on these facts current author has included capital
budgeting process and decisions as an integral part of his research model.
3.2.
MODIFIED RESEARCH MODEL

The modifications in the research model presented in (figure 3.1) have been done to
simplify it for further empirical testing and analysis. Sethi and Taksar (2002) derived
equation A from Hamitton Jacobi Bellmans equation under the case of zero
transactional cost. The current author has further simplified the same equation under
two conditions which are x x and x x . The solution to these two
conditions has been incorporated in the figure (3.1) to represent a testable research
model with qualitative form of variables. The mathematical simplification process
under these two conditions is as follows:
Solving for Condition 1:
The equation A derived by Sethi and Taksar is as follows:
r (x )
1 ( x )
x x [Equation A ]
Taking right hand side of the equation A, we get
98

r ( x )
r (x )
x x
xx
Where the following conditions apply and hold true;
r (x )
0 [for r ( x ) I1 , I 2 , I 3 , I 4 , , I n ]
And,
rg [g growth rate of return for total earnings stream of the firm ]
Where;
I = Investment of the firm in a project
r = Return function for the current level of firms assets x
= Cost of capital or the required rate of investor return

As,
r (x )
0 Considered as a continuous return function, whereas rest is constant
Now, taking the rest of the right hand side of the equation A, we get
x x DIVpayout
Where, [ DIVpayout ] is the dividend paid by the firm to its shareholders under the
application of the condition x x .
So, under the condition x x , firm will pay a continuous stream of dividends to
its shareholders. And, here we have also taken a continuous outflow of dividends to
shareholders by the firm. Therefore, the solution to the equation A can be written as
follows:
99
1 ( x ) Continuous Stream of Total Earnings DIVpayout
Here, total value of the firm is only affected by the change in the level of dividends
payout to the shareholders and the total stream of earnings of the firm is considered
greater than zero or it is non-zero value. So, equation A can take the following form:
1 ( x ) CSTE DIVpayout X
Or ,
1 ( x ) DIVpayout
[ Equation representing Solution to Condition 1]
Where, ( X ) represents vector of all the financial variables affecting the total value of
the firm and here we have taken it as control vector which creates no impact on the
equation. And, (CSTE) represents Continuous Stream of Total Earnings of the firm
taken as fixed variable creating no impact on the equation.
Thus, the total value of the firm under the application of the condition 1, that is,
x x is equal to the continuous outflow of dividends by the firm to its
shareholders.
Solving for Condition 2:

The reduced form of equation A is given below which represents condition 2. In
this condition firm is at the threshold level of its earnings and retains all of its
earnings in the form of retained earnings. The reduced form of equation A is as
follows:
r (x )
1 ( x )
x [Equation S]
Now, solving the right hand side of the equation S, we get
100

r (x )
r (x )
x
x
Where, the following conditions are also applicable and holds true in the case of
second condition, which is;
r (x )
0 [for r ( x ) I1 , I 2 , I 3 , I 4 , , I n ]
And,
rg [g growth rate of return for total earnings stream of the firm ]
Here, the meanings of the above mentioned symbols are similar as these are given in
r (x )
is same as it is solved for
the solution of condition 1. Therefore, result of

the condition 1.
Now, the right hand side of the equation S can be written as follows:
r (x )
x [Continuous Stream of Total Earnings] [Firms funds / capital

below the Threshold Level]
Where, x x holds true and in this situation firm has no extra funds that can be
paid out as dividends to the shareholders. Thus, firm retains all of its earnings and
also stretch-out for external financing from the financial institution or capital market
to get back to the threshold level of firms assets x . Now, equation S takes the
following form:
1 ( x) = [Continuous Stream of Total Earnings] + [Retention of Current Funds]

Or,
1 ( x) = [CSTE] + [Retained Earnings] + X
101
Or,
1 ( x ) [Retained Earnings] [Equation representing solution to condition 2]
Where, ( X ) represents vector of all the financial variables affecting the total value of
the firm and here we have taken it as control vector which creates no impact on the
equation. And, (CSTE) represents Continuous Stream of Total Earnings of the firm
taken as fixed variable creating no impact on the equation.
Thus, the total value of the firm under the application of the condition 2, that is,
x x is equal to the retained earnings of the firm.
Now, the modified form of the research model used by current author for further
empirical testing and analysis is as follows:
Figure 3.2
Modified Research Model
INDEPENDENT VARIABLES
DEPENDENT VARIABLES
Condition - 1
Value
Maximization
of the Firm
Dividend
Payout by
the firm
Contribution
towards the
enhancement
of
Shareholders
Wealth
Condition - 2
Retained
Earnings of
the firm
Capital
Budgeting
Process and
Decisions
102
The simplified form of the modified research model of the thesis is as follows:
Figure 3.3
Simplified Interaction of variables in Modified Research Model
INDEPENDENT VARIABLE
DEPENDENT VARIABLES
Condition - 1
Value
Maximization
of the Firm
Dividend
Payout by
the firm
Capital
Budgeting
Process and
Decisions
Contribution
towards the
enhancement
of
Shareholders
Wealth
MODEL 1
INDEPENDENT VARIABLE
DEPENDENT VARIABLES
Condition - 2
Value
Maximization
of the Firm
Retained
Earnings of
the firm
Capital
Budgeting
Process and
Decisions
MODEL 2
103
Contribution
towards the
enhancement
of
Shareholders
Wealth
3.3.
DEFINITION OF THE VARIABLES

The research model constructed consists of two models which create impact on the
value of firm and shareholders wealth along with the moderating affect of the
moderator variable that is, capital budgeting process and decisions. These two models
are basically two conditions representing retention policy and dividend payout policy
of the firm and their respective impacts. So, the variables considered are
operationalized and tested in the business environment of Pakistan.
Dependent Variables
1. Firm Value
2. Shareholders Wealth
Independent Variables
3. Retained Earnings of the firm
4. Dividend Payout by the firm
Moderating Variable
5. Capital Budgeting Process and Decisions
3.3.1. Firm Value

Firm value is the first dependent variable in the models and it is defined by Booth and
Cleary (2006) as, present value of firms all the investments. Gentry, Reilly and
Sandretto (2003) defined it as, Market value of the firm is equal to the market value
of firms stocks plus market value of long-term debt held by the firm. And, Sethi and
Taksar (2002) defined it as, total value of the firm is equal to the capitalized value of
the total earnings stream plus firms assets at a particular time minus capital of the
firm at threshold level or mean value of the firms assets.
104
3.3.2. Shareholders Wealth

Shareholders Wealth is second dependent variable in the models and it is defined by
Seitz and Ellison (1998) as, The increase in shareholders wealth is attributed to the
difference in the current and purchased share prices of the stocks held by the
shareholders. And, Botha, Bosch and Van Zyl (1987) defined it as, the product of
the number of shares owned by the shareholders multiplied by the current share price
in the capital market plus the dividends received in the following year.
3.3.3. Retained Earnings (Retention Policy)

Retained Earnings is the independent variable in the second model and it is defined by
Copeland, Weston and Shastri (2007) as internally available capital to the firm,
Mahapatra and Mahapatra (2004) define as residual of firms profits, Chiu and Liaw
(2009) define as reserves of a firm, Upneja and Dalbor (2001) define as internally
available cash flows, Brien (2003) define as financial slack and Karadeniz, Kandir,
Balcilar and Onal (2009) define as Free Cash Flows (FCF).
3.3.4. Dividend Payout (Dividend Policy of the firm)

Dividends Payout is the independent variable in the first model. Dividends are called
shareholders wages [Graham and Dodd in (1951)], portion of earnings that is paid to
shareholders [Mahapatra and Mahapatra (2004)], dividend payout is the part of the
total earnings of the firm [Demirguc-Kunt and Maksimovic (1996)], wealth
distribution by the firms to its shareholders [Weigand and Baker (2009)], the payout
ratio of the firm [Emery et al. (1997)].
105
Seitz and Ellison (1998) mentioned three pure dividend policies which when
combined generate mixed dividend policy. These are residual dividend policy,
constant dollar dividend policy and constant payout ratio dividend policy.
3.3.5. Capital Budgeting Process and Decisions

Capital Budgeting Process and Decisions is the moderating variable in the models. It
is defined by Horne et al. (2008) as, The process of identifying, analyzing and
selecting investment projects whose returns (cash flows) are expected to extend
beyond one year.
3.4.
OPERATIONALIZATION OF THE VARIABLES

Variables of the study have been operationalized with the help of adopted questions
that are generated from the elements of the concepts of the study. These concepts are
basically the variables included by the current author in his modified model. The
detail regarding operationalized form of these elements representing the variables of
the study is as follows:
3.4.1. Operationalized form of Dividend Payout, Firm Value and Shareholders

Wealth variables under Condition 1 representing Model 1 of the study
The operationalized elements of Dividend Payout, Firm Value and

Shareholders Wealth variables have been adopted from Baker, Saadi, Dutta
and Gandhi (2007). These operationalized elements have been scaled from 1
to 5 (Likert type), where 1 represents strongly disagree and 5 represents
106
strongly agree. The operationalized elements representing these variables are

stated below:
Operationalized elements of dividend payout (Model 1)
(i) Firm should change dividends based on sustainable shifts in earnings, (ii)
The market places greater value on stable dividends than stable payout ratios,
(iii) Firm should have a target payout ratio, (iv) Firm should set a target
dividend payout ratio and periodically adjust its current payout towards the
target, (v) The payment of dividends forces firm to seek more external (debt or
equity) financing, subjecting the firm to additional investor scrutiny, (vi)
Firms dividend policy generally affects its cost of capital, (vii) The pattern of
cash dividends generally changes over firms lifecycle, (viii) Firm should view
cash dividends as a residual after funding desired investments from earnings,
(ix) Firms expenditures on new capital investments generally affect its
dividend pattern (x) Firms investment, financing, and dividend decisions are
interrelated.
Operationalized elements of firm value (Model 1)

(i) A change in firms cash dividends affects its value, (ii) An optimal
dividend policy strikes a balance between current dividends and future growth
that maximizes stock price, (iii) Growth oriented firms generally have lower
dividend payout ratios than non-growth oriented firms, (iv) Firms stock price
generally rises when the firm unexpectedly increases its dividend, (v) Firms
stock price generally falls when the firm unexpectedly decreases its dividend.
107
Operationalized elements of shareholders wealth (Model 1)

(i) Firm should formulate its dividend policy to produce maximum value for
its shareholders, (ii) The payment of dividends encourages firms managers to
act in the interest of the firms outside shareholders, (iii) Investors generally
regard dividend changes as signals about firms future prospects.
3.4.2. Operationalized form of Retained Earnings, Firm Value and Shareholders

Wealth variables under Condition 2 representing Model 2 of the study
The operationalized elements of Retained Earnings, Firm Value and

Shareholders Wealth variables have been adopted and modified based on
the questions relating dividend payout, firm value and shareholders
wealth variables. These variables have been adopted from Baker, Saadi, Dutta
and Gandhi (2007). These operationalized elements have been scaled from 1
to 5 (Likert type), where 1 represents strongly disagree and 5 represents
strongly agree. We have modified operationalized elements for condition 2
which have been retrieved from the work of Baker, Saadi, Dutta and Gandhi
and this modification is justified on the basis of the following formula taken
from the book of Brigham & Ehrhardt (2001).
Plowback ratio = 1 payout ratio
According to Brigham & Ehrhardt this formula includes plowback (retention)
ratio that represents percentage of earnings retained by the firm and payout
ratio represents percentage of earnings that a firm has paid-out as dividends to
its shareholders (stockholders). These two ratios are sides of a single coin,
which means that the earnings distribution mechanism of a firm divides into
108
two parts, one is retention and other is payout of earnings. So, on the basis of
this explanation of Brigham & Ehrhardt, the current author has adopted and
modified the operationalized elements of dividend payout, firm value and
shareholders wealth variables.
The operationalized elements representing Retained Earnings, Firm Value
and Shareholders Wealth variables are stated below:
Operationalized elements retained earnings (Model 2)

(i) Firm should change its level of cash holdings based on sustainable shifts in
earnings, (ii) These days market places greater value on stockpiling of
earnings as a form of financial buffer (cushion), (iii) Firm should have a target
earnings retention ratio, (iv) Firm should set a target earnings retention ratio
and periodically adjust its current level of retained earnings towards the target,
(v) Retained earnings are the least risky source of financing investment
projects, (vi) Firms earnings retention policy generally affects its cost of
capital, (vii) The pattern of earnings retention generally changes over firms
lifecycle, (viii) Firm should view retained earnings as a residual after payment
of dividends to its shareholders, (ix) Firms expenditures on new capital
investments are generally affected by its level of retained earnings, (x) Firms
investment, financing, and earnings retention decisions are interrelated.
Operationalized elements firm value (Model 2)

(i) A change in firms level of retained earnings affects its value, (ii) An
optimal earnings retention policy strikes a balance between current holdings
and future growth that maximizes stock price, (iii) Growth oriented firms
109
generally accumulate more earnings as compared to non-growth firms, (iv)

Firms stock price generally rises when the firm unexpectedly increases its
retained earnings, (v) Firms stock price generally falls when the firm
unexpectedly decreases its retained earnings, (vi) Growth oriented firms
having greater conflict of interests between managers and shareholders
generally accumulate more cash to meet their investment needs, (vii) Mature
firms generally stockpile earnings higher than younger firms, (viii) Firms
greater amount of retained earnings facilitates management by achieving their
goals in a better way even in the times of market turbulence, (ix) Reinvestment
of retained earnings in business expansion activities is a prominent signal of
firms exponential growth in terms of income.
Operationalized elements shareholders wealth (Model 2)

(i) Firm should formulate its earnings retention policy to maximize value for
its shareholders, (ii) The accumulation of earnings (retained earnings)
encourages firms managers to pursue their private benefits against the
interest of the firms inside shareholders, (iii) The accumulation of earnings
(retained earnings) encourages firms managers to pursue their private
benefits against the interest of the firms outside shareholders, (iv) Investors
generally regard firms earnings reserves as signals about its future prospects,
(v) Investors prefer that a firm retains funds over paying dividends because of
the way capital gains are taxed as compared with dividends.
110
3.4.3. Operationalized form of Capital Budgeting Process and Decisions under

Condition 2 representing Model 2 of the study
The operationalized elements of Capital Budgeting Process and Decisions

variable has been adopted from work of Graham and Harvey (2002). The
operationalized elements relating this variable have been divided into four
main areas:
I. Capital budgeting Techniques for project selection
II. Utilization of discount rates for new project evaluation
III. Adjustment of discount rate or cash flows to cater risk
IV. Effectiveness of capital budgeting process and decisions and the use
of budget control system
I. Capital budgeting Techniques for project selection

The operationalized elements adopted here have been scaled from 1
to 5 (Likert type), where 1 represents never, 2 represents
rarely, 3 represents sometimes, 4 represents often and 5
represents always. Capital budgeting techniques included in the
research instrument are; Net Present Value (NPV), Internal Rate of
Return (IRR), Hurdle Rate, Earnings Multiple Approach, Adjusted
Present Value (APV), Payback Period (PBP), Discounted Payback
Period, Profitability Index (PI), Accounting Rate of Return (or Book
Rate of Return on Assets), Sensitivity Analysis (e.g., good vs.
fair vs. bad), Value at Risk or other simulation analysis and Real
options.
111
II. Utilization of discount rates for new project evaluation

The operationalized elements adopted have been scaled from 1 to
5 (Likert type scale), where 1 represents never, 2 represents
rarely, 3 represents sometimes, 4 represents often and 5
represents always. Operationalized elements included under
captioned topic in the research instrument are; (i) The discount rate
for our entire firm, (ii) The discount rate of the Pakistani market, (iii)
A risk-matched discount rate for the project by considering both
industry and country (Pakistan), (iv) A different discount rate for
each component cash flow that has a different risk characteristic
(e.g., depreciation vs. operating cash flows)
III. Adjustment of discount rate or cash flows to cater risk

The operationalized elements adopted have been scaled from 1 to
4, where 1 represents discount rate, 2 represents cash flow,
3 represents both, and 4 represents none (Itemized rating
scale). Operationalized elements included under captioned topic in
the research instrument are; (i) Risk of unexpected inflation, (ii)
Interest rate risk (change in general level of interest rates), (iii) Term
structure risk (i.e., change in the long-term vs. short-term interest
rate), (iv) Gross Domestic Product (GDP) or business cycle risk, (v)
Commodity price risk (CPI), (vi) Distress risk (probability of
bankruptcy), (vii) Size (e.g., small firms being riskier), (viii) Market
to Book ratio (ratio of market value of firm to book value of assets),
112
(ix) Momentum (i.e., recent stock price performance), (x) Exchange

rate risk (generally or in case of exports)
IV. Effectiveness of capital budgeting process and decisions and the use
of budget control system
The operationalized elements i, ii and iii have been developed by the
current author and iv, v and vi have been adopted from Tsamenyi and
Tauringana (2004). The questions included here have been scaled
from 1 to 5 (Likert type), where 1 represents strongly disagree,
2 represents disagree, 3 represents no opinion, 4 represents
agree and 5 represents strongly agree. Operationalized elements
have been included under captioned topic in the research instrument
are; (i) Capital Budgeting process and decisions generally facilitate
management to utilize retained earnings (capital) effectively in
reinvestment activities, which leads to maximized market value of
the firm, (ii) Capital Budgeting process and decisions generally
facilitate management in distribution and allocation of income
(capital) effectively, which leads to maximized market value of the
firm, (iii) Capital Budgeting process and decisions generally
facilitate management of the firm to maximize its market value, (iv)
Do you think budget control procedure or system is an effective tool,
(v) Do you think budget control procedure or system helps
management to identify additional risks of the project, (vi) Do you
think analysis of projects with budget control procedure or system
helps management to identify large unfavorable budget variances.
113
3.5.
INTERACTIONS OF THE VARIABLES

In the current thesis the author has tested and evaluated the following level of
interactions between the variables in the modified model
i. Impact of dividend payout on firm value under condition 1 of model 1
ii. Impact of dividend payout on shareholders wealth under condition 1 of
model 1
iii. Moderating affect of capital budgeting process and decisions on the
interaction of dividend payout on firm value as well as dividend payout
on shareholders wealth under condition 1 of model 1
iv. Impact of retained earnings on firm value under condition 2 of model
2
v. Impact of retained earnings on shareholders wealth under condition 2
of model 2
vi. Moderating affect of capital budgeting process and decisions on the
interaction of
retained earnings on firm value variable as well as
retained earnings on shareholders wealth under condition 2, model 2

vii. Comparison of model 1 and 2 are based on their strengths of impact of
independent variables on the dependent variables along with the moderating
affect of the moderating variable.
3.6.
HYPOTHESES OF THE STUDY

The following hypotheses concerning the variables of the study have been deduced
from the empirical work documented in this work (see appendix D). The statements
of the hypotheses are drawn from cited literature representing interaction of variables
114
considered in this study. These hypotheses have been arrived at and tested by the
authors whose names are written immediately below the hypotheses.
3.6.1. Hypotheses concerning retained earnings impact on Firm Value
Hypothesis 1: Retained earnings are positively associated with firms
performance [Chiu and Liaw (2009)].
Hypothesis 2: Free Cash Flows (FCF) in the shape of Retained earnings as
the primary source of financing investments enhance value of the firm
[Karadeniz, Kandir, Balcilar and Onal (2009)].
Hypothesis 3: Retained earnings are the potential source of long-term
finance utilized to exploit growth related investments available to the firm to
enhance long-term value [Ezeoha (2008)].
Hypothesis 4: Corporate retained earnings which when coupled with best
strategic choice positively impact the performance of the firm [Brien (2003)].
3.6.2. Hypotheses concerning retained earnings impact on shareholders wealth
Hypothesis 5: If retention of earnings increases along with the increase of
reinvestment of retained earnings, return on equity increases and increase in
return on equity automatically enhances the value of the firm and thus
shareholders objective of wealth maximization is achieved [Baum and Turner
(2004)].
Hypothesis 6: Retaining excess cash in the form of retained earnings
maximizes the wealth of firms shareholders in the case when greater
investment opportunities are available to the firm [Chen (2008)].
Hypothesis 7: Firm which follows shareholders value maximization policy
accumulates funds to be invested in profitable projects [Ghosh and Woolridge
(1989)].
115
3.6.3. Hypotheses concerning dividend payout impact on Firm Value

Hypothesis 8: Dividend payments in the forms non-cash as well as cash
payments facilitate management of the firms to maximize firm value [Seitz
and Ellison (1998)].
Hypothesis 9: Dividend payout is positively associated with the market
value of the firm [Chung and Wright (1998)].
Hypothesis 10: Dividend payout is positively related to the market value of
the firm [Weigand and Baker (2009)].
Hypothesis 11: Higher payout of dividends by the firm is linked with higher
profitability as well as firms market value [Amidu and Abor (2006)].
Hypothesis 12: Firms payout of dividends positively affects the value of the
firm [Fama and French (1998)].
Hypothesis 13: Firms dividend payout has a positive impact on the
corporate value [Hughes (2008)].
3.6.4. Hypotheses concerning dividend payout impact on shareholders wealth
Hypothesis 14: Higher dividend payout increases firms value and in result
investors (the shareholders) become well-off [Graham and Dodd in (1951)].
Hypothesis 15: Dividend policy is relevant and contributes toward value
creation of the firm as well as maximization of shareholders wealth [Baker,
Saadi, Dutta and Gandhi (2007)].
Hypothesis 16: Dividend policy of the firm affects and enhances the value of
the shareholders [Dhanani (2005)].
Hypothesis 17: Dividend policy is relevant and contributes toward value
creation of the firm as well as maximization of shareholders wealth [Baker,
Saadi, Dutta and Gandhi (2007)].
116
Hypothesis 18: Dividend payout positively impact shareholders wealth

[Azhagaiah and Priya (2008)].
3.6.5. Hypotheses concerning interaction of firm value and shareholders wealth
Hypothesis 19: Higher value creating strategies successfully generate greater
shareholders wealth [Kilroy (1999)].
Hypothesis 20: An optimal selection of portfolio of investment projects
generally maximizes the firm value and facilitates management in achieving
shareholders wealth maximization goal of the firm [Lin and Ji (2007)].
Hypothesis 21: If a firm strives to maximize the wealth of its shareholders
then in result firm will move on the path of prosperity and profitability
[Copeland et al. (2007)].
3.6.6. Hypotheses concerning moderating affect of capital budgeting process and
decisions on the interactions of variables of model 1 & 2
Hypothesis 22: Capital budgeting process is a positive exercise within the
firm that acts as catalyst to generate wealth for the firm as well as for its
shareholders [Seitz and Ellison (1998)].
Hypothesis 23: Capital budgeting practices of the firms must employ capital
investments evaluation methods which add value to the firm and in return
wealth of the shareholders increases [Toit and Pienaar (2005)].
Hypothesis 24: Capital budgeting process is critical for every firm to
enhance its value [Elumilade, Asaolu and Ologunde (2006)].
Hypothesis 25: Capital budgeting process and decisions help management of
the firm to improve its performance [Horne et al. (2008)].
117
CHAPTER 4: RESEARCH DESIGN
This chapter explains the research design of the study. It also explains the universe and
sample selection mechanism in detail. Moreover, this chapter elaborates the process of
sample selection and reasons behind the selection criteria of the universe.
4.1.
RESEARCH DESIGN OF THE STUDY

The research design of this dissertation is as follows:
4.1.1. Purpose of the study
This is an exploratory study because the modified research models tested in
the business environment of Pakistan have never been tested in the past.
Bhattacharyya (2007) stated that despite the fact that a large number of studies
over a period of more than forty years have explored the issues concerning
dividend policy in an international context, but no one has yet solved the
dividend puzzle. So, it is justified that research in the area of dividend policy
is still at exploration stage.
Also, the current author has not seen any study that was conducted based on
the impact of dividend payout as well as retained earnings on the firm value
and shareholders wealth along with the moderating affect of capital budgeting
process and decisions in two separate research models. In this study the
current author has deduced and tested hypotheses which have been developed
based on an extensive literature review. This exploratory study has extended
the existing knowledge base of corporate finance by testing hypotheses in the
business environment of Pakistan. In this study he has also analyzed with the
help of a research instrument the reinvestment pattern of the retained earnings
118
as well as the trend in firms growth due to reinvestment / investment

activities. The current author has also tested Pecking Order Theory,
managerial ownership, firm performance and financing of the firms by
considering Pakistani listed firms. This research study tries to answer the
following questions:
What is the level of significance and application of model of reinvestment of
corporate retained earnings in Pakistan and how it affects the value of the firm
and shareholders wealth?
What is the level of significance and application of corporate dividend payout
model in Pakistan and how it affects the value of the firm and shareholders
wealth?
How the retained earnings are used in the reinvestment activities of the
selected sample firms listed at Karachi Stock Exchange?
How retained earnings work in the selected sample of firms?
In the case of dividend payout and in its absence how companies select best
projects to maximize the value of the firm and enhance the wealth of its
shareholders?
What are the capital budgeting strategies, process and decisions of the sample
firms and how they affect the research models 1 and 2 of the study?
What is the level of difference between condition 1 and 2 relating firms
selected for the study based on the parameters of value maximization and
wealth generation?
How much and at what level the reinvestment of retained earnings are useful
in enhancing the well being of the firm and its shareholders?
119
4.1.2. Type of investigation

The type of investigation in this study is testing and analyzing the correlation
among the variables of the study where impacts of models are established. The
current author intend to examine the correlation of retained earnings,
dividend payout firm value and shareholders wealth in two separate
settings in-order to test the formulated theory. The comparison of the
correlation of these variables along with the moderating affect of capital
budgeting process and decisions variables establish the strength of the
research models and the degree of variance created by the independent
variables on the dependent variables of the study. The comparison of the
strengths of correlations before and after the introduction of the moderating
variables that is capital budgeting process and decisions are analyzed and
reported in the study.
4.1.3. Extent of researcher interference
In this study the current author has used a research instrument which is
designed to extract data from non-contrived working environment where
interference of researcher is minimal and no attempt is made to alter or modify
the normal processes of business entities. The current author thus collected
data by means of a research instrument (questionnaire) and analyzed data to
test the modified research model of the study.
4.1.4. Study setting
This study is conducted in a non-contrived working environment (Natural
working environment). This study falls in the category of a field study and
reports new evidences in the field of finance in general and corporate finance
in particular. The current author has extracted required data from the sample
120
taken from KSE listed manufacturing firms of Pakistan belonging to various

industries.
4.1.5. Unit of analysis
In this research study the unit of analysis are the Pakistani manufacturing
firms listed at Karachi Stock Exchange. This study has targeted senior level
managers (like; Chief Executive Officer, Chief Finance Officer, Managing
Director Finance, etc.) to get the questionnaires filled. Listed manufacturing
firms were selected by Chung and Wright (1998), Pandey and Bhat (2007),
Baker and Powell (1999), Ugurlu and Aksoy (2006), Mizuno (2007), Chen
(2008), Garcia-Teruel and Martinez-Solano (2008), Marsat and Williams
(2008), Cleary (2005), Tsamenyi and Tauringana (2004), Jiang, Chen and
Huang (2006) and Johnson, McMillan and Woodruff (2002).
4.1.6. Sampling design
The current study employed probability sampling methodology and
accordingly simple random sampling technique was used to retrieve data from
the sample. This allowed every listed Pakistani manufacturing firm full chance
to be selected as subject of the sample.
4.1.7. Sample size (n)
The size of the sample of this study is 102 manufacturing firms out of 189
listed at Karachi Stock Exchange (KSE) that belong to eight industries of
Pakistan. (Appendix C)
4.1.8. Time horizon
This is a one-shot cross sectional study. The current author approached sample
firms by means of postal and electronic mails and got the questionnaires filled
by the concerned executive being authorized by the management of the
121
concerned firm. This process took four months from August to November
2010.
4.1.9. Data collection Method
Data was collected by means of an instrument questionnaire developed on
the basis of research studies done around the world. This instrument contained
closed questions. The detail of the questions and their sequencing in the
research instrument is discussed in the next chapter.
4.2.
UNIVERSE AND THE SAMPLING

The detail regarding the selection of the universe and the sample of this thesis is
stated below:
The universe of this study is 189 manufacturing firms representing eight industrial
manufacturing sectors of Pakistan and listed at Karachi Stock Exchange (KSE),
largest stock exchange operating in Pakistan. The sample of this study comprises of
102 firms belonging to; Chemicals, Pharma and Bio Tech, Electronic and Electrical
Equipment, Food Producers, Construction and Materials, Automobile and Parts,
Industrial Engineering and Industrial Metals and Mining.
The process of sampling comprised of random selection of manufacturing firms and
the random sample was generated with the help of an online random sample generator
known as randomizer (see appendix C). This random sample generator generated
a set of 102 unique numbers representing subjects of the sample. The current author
checked the accuracy of the sample size with the help of an online sample size
calculator and analyzer known as Raosoft and found that the sample size of 102
firms is appropriate for 95% confidence level at 5% margin of error (see appendix C
for detail).
122
The sample of 102 Pakistani manufacturing listed firms has been divided in eight
industrial sectors according to the generated set which is shown in the table below:
Table 4.1
Randomly selected firms industry-wise distribution
S.
No
Industry
Range of sample
of firms
Number of firms
1
2
Chemicals
Pharma and Bio Tech
1 20
21 24
20
4
Electronic and Electrical Equipment
25
4
5
6
7
Food Producers
Automobile and Parts
Construction and Materials
Industrial Engineering
26 60
61 71
72 95
96 99
36
11
23
4
Industrial metals and Mining
100 102
102
102
TOTAL
Source: http://www.kse.com.pk
The final sample analyzed by the current author was 85 (see appendix E). The 85
sample firms represent parent firms and all the subsidiaries of these parent firms taken
as sample have been eliminated. This has been done because in previous corporate
finance studies authors only considered and analyzed parent firms and took all
subsidiaries as part of parent firms. The current author also eliminated sample firms
that have closed their operations in Pakistan or liquidated their assets due to financial
problems (Appendix F). Descriptive analysis of the collected data in chapter 6
explains the characteristics of the sample.
4.3.
RATIONALE OF THE SELECTION OF THE UNIVERSE

The current author has seen in multiple finance researches discussed in chapter 2 of
this thesis research that finance researchers have selected listed firms as their universe
123
and focus of analysis and examination. Among these finance researcher, [Kouki
(2009), Eije and Megginson (2007), Renneboog and Trojanowski (2007), Upneja and
Dalbor (2001), Al-Twaijry (2007), Pandey and Bhat (2007), Baker and Powell (1999),
Jones and Sharma (2001), Chen and Steiner (1999), Brien (2003), Amidu and Abor
(2006), Pindado and Torre (2008), Fargher and Weigand (2009), Isshaq and Bokpin
(2009), Ugurlu and Aksoy (2006), Sloan (1996), Jokipii and Vahamaa (2006), Fuller
and Blau (2010), Grinstein and Michaely (2005), Mizuno (2007), Partington (1984),
Botha, Bosch and Van Zyl (1987), Dhanani (2005), Chen (2008), Opler, Pinkowitz,
Stulz and Williamson (2001), Marsat and Williams (2008), Nappi-Choulet,
Missonier-Piera and Cancel (2009), Baker, Saadi, Dutta and Gandhi (2007), Negakis
(2006), Dasilas, Lyroudi and Ginoglou (2009), Azhagaiah and Priya (2008), Toit and
Pienaar (2005), Corria and Cramer (2008), Grinstein and Tolkowsky (2004), Jiang,
Chen and Huang (2006), Mehar (2007), Ahmed and Javid (2009), Naeem and Nasr
(2007) and Kanwer (2003)] have selected listed firms as their universe of study. This
is the basic and compelling reason so the current author has done the same.
124
CHAPTER 5: DATA COLLECTION
This chapter explains the data collection methodology used in this thesis.
5.1.
RATIONALE AND SELECTION OF TOOL

The tool used in this research thesis is Questionnaire (see appendix A). The
questionnaire used comprised of ten parts. Each part contains series of questions
representing operationalized form of variables of the study. Almost all the questions
included in the ten parts of the tool have been adopted from past studies reviewed in
chapter 2. However, few questions have been added to justify this research work.
These questions represent variables derived from an econometric modeled equation
representing total value of a firm taken from the study of Sethi and Taksar (2002).
This equation has been bifurcated in two conditions representing two models of the
study (see chapter 3 for detail).
5.2.
TOOL DEVELOPMENT
The current author has collected data by means of a research tool that has ten parts.
The first page of the tool starts with a covering letter that briefly explained the
purpose of the study. The second page of the tool includes questions relating
categorization of firms based on dividend payer or non-payer and personal
information of respondents. The third page of the tool includes questions regarding
firms demographics. The rest of the tool consists of part 1, 2, 3, 4, 5, 6, 7, 8, 9 and
10, that are comprised of questions regarding performance based on ten factors of the
sample firms during 2000 to 2009, dividend policy, firm value and shareholders
wealth for model 1, retention policy, firm value and shareholders wealth for model 2,
125
sources of financing projects, firms after tax and interests profits as percentage of
total sales during 2000 to 2009, firms percentage of net income reinvestment during
2000 to 2009, selection of projects for reinvestment of net income during 2000 to
2009, outcomes of recent projects investments, percentage of managerial ownership,
financial values of firms financial statements, capital budgeting process and
decisions including project evaluation techniques, budget control system and use of
and adjustment of discount rates, cash flows and risk, firms growth trends during
2000 to 2009, expected turnover in terms of growth and conditions of sources of
financing in next 3 years (see appendix A).
5.3.
DETAILS OF THE TOOL

The current author has used questionnaire as a tool and distributed 102 questionnaires
by means of post mail, electronic mail and in person. Table 5.1 shows the distribution
of questionnaires in random sample consisting of 12 cities of Pakistan.
Table 5.1
Detail of the distribution of questionnaires in the sample
S.
No
1
Distribution of Questionnaires
in Different Cities
Lahore
Number of
Questionnaires
30
2
3
Rawalpindi and Islamabad

Karachi
10
48
4
5
Hub
Quetta
5
2
6
7
Swabi
Mardan
2
1
8
9
Hattar
Kohat
1
1
10
11
Faisalabad
Thatta
TOTAL
126
1
1
102
Out of 102 questionnaires only 12 completely filled questionnaires were received (see
appendix H). The industrial distribution of the responded sample firms is shown in
table 5.2 below.
Table 5.2
Industrial sector wise distribution of responded sample firms
Industrial sector
Questionnaires received
Chemicals
Automobile and Parts
Food Producers
Construction and Materials
Total
12
The response rate of this study is 14.12%. This response rate seems satisfactory when
compared with various other studies including Graham and Harvey (2002) and Toit
and Pienaar (2005) as may be seen in table 5.3.
Table 5.3
Empirical evidence regarding response rate of research studies
United States
Response
Rate
9%
Graham and Harvey
Publication
Year
2002
South Africa
South Africa
13 %
15 %
Toit and Pienaar

Correia and Cramer
2005
2008
United States
Australia
20.5 %
24.4 %
Ryan and Ryan

Truong, Partington and Peat
2002
2006
Country
Authors
Sweden
Uzbekistan
29 %
40 %
Holmen and Pramborg

Tsamenyi and Tauringana
2006
2004
Nigeria
51 %
Elumilade, Asaolu and Ologunde
2006
127
5.4.
VALIDITY AND RELIABILITY OF THE TOOL

The validity of the tool was checked by applying factor analysis on the data collected,
that is, factor loadings of the variables of the model 1 and 2. The factor loading
showed strengths of inter-association of variables and in the case of both models
factor loadings showed significant results greater than 0.50 cutoff value, which
approved the validity of the instrument used in the study (see appendix I for details
of extraction of commonality values of the variables of modified research model of
the study).
The reliability of the tool has been accessed by applying Cronbachs Alpha on the
data collected related to the variables of the study. The total score of complete
instrument is 0.763 for a total number of 226 items of the research instrument which
means the tool used is strongly reliable. The score of Cronbachs Alpha for each
variable included in the study for model 1 and 2 is listed in table 5.4 below:
Table 5.4
Cronbachs Alpha score of the variables of Model 1 & 2
Variables
MODEL 1
Dividend payout
Firm value
Shareholders wealth
MODEL 2
Retained earnings
Firm value
Shareholders wealth
Capital budgeting
process and decisions
Cronbachs Alpha score
No. of Items
0.909
0.895
0.797
0.593
0.881
0.819
0.539
0.639
25
10
5
3
31
10
9
5
0.724
128
CHAPTER 6: DATA ANALYSIS AND INTERPRETATION

This chapter describes the data analysis including descriptive and regression analyses and
interprets the results by comparing them with the existing empirical literature. The current
author has also analyzed sources of financing, profitability, reinvestment activities, outcome
of recent projects, managerial ownership, capital budgeting techniques, discount rates for
investment projects, adjustment of risk factors, average growth, expected growth and
conditions of financing of the sample.
6.1.
DATA ANALYSIS PLAN

The data analysis plan includes the analysis of research model 1 and 2. Using
SPSS-15, models have been analyzed by applying descriptive and regression analyses.
The analyses of the models have been done with and without the influence of the
moderating variable.
6.2.
DESCRIPTIVE ANALYSIS OF COLLECTED DATA

Table 6.1 below shows the status of dividend payout by the firms included in the
sample. It shows that 83.3% of the firms regularly paid dividend against 16.7% firms
which did not pay the dividend.
Table 6.1
Dividend payer and non-payer categories of the sample
Status of Dividend payout by
the firm (Categories)
My firm pays dividend
(Category - 1)
My firm has never paid
dividends
(Category - 2)
Frequency
Percent
Cumulative
Percent
10
83.3
83.3
16.7
100
129
6.2.1. Respondents data

The data collected regarding personal information of respondents below shows
that 50% of the respondents are Chief Financial Officers of their firms, 25% of
the respondents are finance managers, 8.3% of respondents are holding other
designations (Table 6.2).
Table 6.2
Frequency of respondents designation
Designation
Frequency
Percent
Cumulative
Percent
CFO
50
50
GM Finance
8.3
58.3
8.3
66.7
25
91.7
8.3
100
Director Finance
Finance Manager
Other
Table 6.3
Frequency of respondents gender
Gender
Frequency
Percent
Cumulative
Percent
Female
Male
12
100
100
The table 6.3 shows that all the respondents are male with no female
participation.
130
Table 6.4
Frequency of gender of the respondents
Age (Years)
Frequency
Percent
Cumulative
Percent
30 to 39
50
50
40 to 49
16.7
66.7
50 to 59
25
91.7
65 Plus
8.3
100
The table 6.4 shows that, 50% of the respondents belong to the age group that
ranges between 30 to 39 years, 25% belong to the age group 50 to 59 years,
16.7% belong to the age group 40 to 49 years and 8.3% belong to the age of
65 and above.
Table 6.5
Frequency of education level of the respondents
Education Level
Frequency
Percent
Cumulative
Percent
Bachelors Degree
8.3
8.3
Master's Degree
8.3
16.7
ACCA
16.7
33.3
CA
58.3
91.7
Other
8.3
100
131
The table 6.5 shows that majority of the respondents (58.3%) are Chartered
Accountants, 16.7% hold ACCA degree and 8.3% hold Bachelors, Masters
and other degrees.
6.2.2. Firm demographic data

The data collected regarding firms demographics includes; firm ownership,
number of employees, age of the firm, industrial classification, total sales
revenue of the firm, type of dividend payout, retention policy of the firm and
dividend policy of the firm. The analysis of the data collected is presented in
tabular form below:
Table 6.6
Frequency of ownership of the sample firms
Firm Ownership
Frequency
Percent
Cumulative
Percent
Public Firm
41.7
41.7
Private Firm
58.3
100
The table 6.6 shows that 58.3% of the firms belong to private owners and
41.7% belong to public sector.
132
Table 6.7
Frequency of employees of the sample firms
Number of
Employees
Frequency
Percent
Cumulative
Percent
Greater than 250

employees
12
100
100
Table 6.7 shows that all the firms have more than 250 employees working in
their factories, mills, offices and it shows that all of these firms are large firms
[SMEDA (2007)].
Table 6.8
Frequency of age of the sample firms
Age of Firm
Frequency
Percent
Cumulative
Percent
5 - 10 years
8.3
8.3
10 - 15 years
8.3
16.7
15 - 20 years
8.3
25
20 - 25 years
33.3
58.3
25 - 30 years
8.3
66.7
More than 40 years
33.3
100
The table 6.8 shows that 33.3% of the firms are in business for 20 to 25 years
as well as more than 40 years. Whereas, 8.3% of firms are in business for 5 to
10, 10 to 15, 15 to 20 and 25 to 30 years respectively.
133
Table 6.9
Frequency of the industrial classification of the sample firms
Industrial
Classification
Frequency
Percent
Cumulative
Percent
Chemicals
16.7
16.7
Food Producers
41.7
58.3
Construction and
Materials
25
83.3
Automobile and
Parts
16.7
100
Table 6.9 shows that, 41.7% firms belong to Food Producers industry, 25%
belong to Construction and Materials and 16.7% belong to Chemicals and
Automobile and Parts industries respectively.
Table 6.10
Frequency of the total sales revenue of the sample firms
Total Sales Revenue
Frequency
Percent
Cumulative
Percent
Greater than Rs. 250

million
12
100
100
Table 6.10 shows that all of the desponded firms have total sales revenue
greater than Rupees 250 million. Thus, all the firms that responded to our
research questionnaire were large firms.
134
Table 6.11
Frequency of the type of dividend payment by the sample firms
Type of dividend
payment
Frequency
Percent
Cumulative
Percent
Cash dividends
50
50
None
16.7
66.7
Cash and Stock

dividends both
33.3
100
Table 6.11 shows that 50% of firms pay cash dividends, 33.3% pay both cash
and stock dividends, and 16.7% of firms have not yet paid any type of
dividends to their shareholders and thus are known as non-dividend paying
firms. These non-dividend paying firms belong to Food Producer and
Construction and Materials industries.
Table 6.12
Frequency of retention of earnings by the sample firms
Retention Policy
Frequency
Percent
Cumulative
Percent
Yes
12
100
100
Table 6.12 shows that, all the responded firms have earnings retention policy
and earnings are stock-piled for the purpose of firms future and current
growth related investment projects.
135
Table 6.13
Frequency of maintaining dividend policy by the sample firms
Dividend Policy
Frequency
Percent
Cumulative
Percent
Yes
75
75
No
25
100
The table 6.13 shows that, 75% of firms have well maintained dividend
policies as compared to 25% firms that have not yet formulated their dividend
policies for the fair distribution of wealth generated in result of their business
operations.
6.3.
REGRESSION ANALYSIS OF MODEL 1

The results of linear regression analysis applied on the variables of research model 1
are presented in tabular form below:
6.3.1. Impact of Dividend Payout on Firm Value

In order to find out the impact of dividend payout on the Firm Value, the
linear regression is used on the collected data. The results of the regression
analysis are presented in table 6.14 below:
136
Table 6.14
Impact of dividend payout on firm value
Unstandardized
Coefficients
B
Std. Error
Model
1
(Constant)
1.751
.671
Dividend Payout
.625
.187
R
R Square
F
Sig
Standardized
Coefficients
Beta
t
Sig
2.607
.026
3.339
.008
.726
.726
.527
11.148
.008
1 Dependent variable: FIRM VALUE
Table 6.14 lists one independent variable that is entered into the regression
model. The table shows the value of Beta equal to .726 for dividend payout,
which is significant at 0.05 level. This is confirmed by high value of R (=.726)
between independent and dependent variable. The value of R square (=.527),
which shows value of variance in dependent variable being explained by
independent variable is also pretty high, again, confirming the above results.
The F value of 11.148 which shows overall significance of the model is
significant at the 0.05 level. The positive sign of Beta indicates that if firm
value is to be enhanced, it is necessary to increase the dividend payout by the
firm.
What the results mean is that 52.7% of the variance in firm value has been
significantly explained by the independent variable. Thus, hypotheses 8, 9, 10,
11, 12 and 13 are substantiated.
137
6.3.2. Impact of Dividend Payout on Shareholders Wealth

In order to find out the impact of dividend payout on the shareholders
wealth, the linear regression is used on the collected data. The results of the
regression analysis are presented in table 6.15 below:
Table 6.15
Impact of dividend payout on shareholders wealth
Unstandardized
Coefficients
B
Std. Error
Model
1
(Constant)
1.334
.947
Dividend Payout
.719
.222
R
R Square
F
Sig
Standardized
Coefficients
Beta
t
Sig
1.679
.124
3.243
.009
.716
.716
.513
10.520
.009
1 Dependent Variable: SHAREHOLDERS WEALTH
model. The table shows the value of Beta equal to .716 for dividend payout,
significant at the 0.05 level. The positive sign of Beta indicates that if
shareholders wealth is to be enhanced, it is necessary to increase the dividend
payout by the firm.
138
What the results mean is that 51.3% of the variance in shareholders wealth
has been significantly explained by the independent variable. Thus,
hypotheses 14, 15, 16, 17 and 18 are substantiated.
6.3.3. Impact of Firm Value on Shareholders Wealth

In order to find out the impact of firm value on the shareholders wealth,
the linear regression is used on the collected data. The results of the regression
Table 6.16
Impact of firm value on shareholders wealth
Unstandardized
Coefficients
B
Std. Error
Model
1
(Constant)
.471
.996
Firm Value
.858
.249
R
R Square
F
Sig
Standardized
Coefficients
Beta
t
Sig
.473
.647
3.444
.006
.737
.737
.543
11.862
.006
model. The table shows the value of Beta equal to .737 for firm value, which
is significant at 0.05 level. This is confirmed by high value of R (=.737)
139
shareholders wealth is to be enhanced, it is necessary to increase the value of
the firm.
hypotheses 19, 20 and 21 are substantiated.
6.3.4. Impact of Dividend Payout and Capital Budgeting Process and Decisions on
Firm Value
In order to find out the impact of dividend payout and capital budgeting
process and decisions on the firm value, the linear regression is used on the
collected data. The results of the regression analysis are presented in table 6.17
below:
Table 6.17
Impact of dividend payout and moderating variable on firm value
Unstandardized
Coefficients
B
Std. Error
Model
1
(Constant)
2.597
.678
Dividend Payout
and Moderating
Variable
.093
.045
R
R Square
F
Sig
Standardized
Coefficients
Beta
t
Sig
3.829
.003
2.052
.067
.545
.545
.296
4.214
.067
1 Dependent Variable: FIRM VALUE

Moderating Variable: CAPITAL BUDGETING PROCESS AND DECISIONS
140
Table 6.17 lists one independent variable and one moderating variable that are
first computed and then entered into the regression model as one independent
variable. The table shows the value of Beta equal to .545 for dividend payout,
under the effect of moderating variable, which is not significant at 0.05 level
besides the high value of R (=.545) between independent and dependent
variable. The value of R square (=.296), which shows value of variance in
dependent variable being explained by independent variable under the effect
of moderating variable, is pretty low, again, confirming the above results. The
F value of 4.214 which shows overall significance of the model is not
value is to be enhanced, it is necessary to increase the dividend payout by the
firm under the moderating effect of capital budgeting process and decisions.
non-significantly explained by the independent variable under the effect of
moderating variable. Thus, hypotheses 22, 23, 24 and 25 are not substantiated.
6.3.5. Impact of Dividend Payout and Capital Budgeting Process and Decisions on
Shareholders Wealth
In order to find out the impact of dividend payout and capital budgeting
process and decisions on the shareholders wealth, the linear regression is
used on the collected data. The results of the regression analysis are presented
in table 6.18 below:
141
Table 6.18
Impact of dividend payout and moderating variable on shareholders wealth
Unstandardized
Coefficients
B
Std. Error
Model
1
(Constant)
2.191
.770
Dividend Payout
and Moderating
Variable
.114
.051
R
R Square
F
Sig
Standardized
Coefficients
Beta
t
Sig
2.846
.017
2.233
.050
.577
.577
.333
4.984
.050

variable. The table shows the value of Beta equal to .577 for dividend payout,
under the effect of moderating variable, which is significant at 0.05 level. This
is confirmed by high value of R (=.577) between independent and dependent
of moderating variable, is satisfactory, again, confirming the above results.
shareholders wealth is to be enhanced, it is necessary to increase the dividend
payout by the firm under the moderating effect of capital budgeting process
and decisions.
142
has been significantly explained by the independent variable under the effect
of moderating variable. Thus, hypotheses 22 and 23 are substantiated.
6.4.
REGRESSION ANALYSIS OF MODEL 2

The results of linear regression analysis applied on the variables of research model 2
are presented in tabular form below:
6.4.1. Impact of Retained Earnings on Firm Value

In order to find out the impact of retained earnings on the firm value, the
linear regression is used on the collected data. The results of the regression
Table 6.19
Impact of retained earnings on firm value
Unstandardized
Coefficients
B
Std. Error
Model
1
(Constant)
.927
.626
Retained Earnings
.672
.152
R
R Square
F
Sig
Standardized
Coefficients
Beta
T
Sig
1.482
.169
4.365
.001
.810
.810
.656
19.054
.001
model. The table shows the value of Beta equal to .810 for retained earnings,
143

value is to be enhanced, it is necessary to increase the retained earnings of the
firm.
hypotheses 1, 2, 3 and 4 are substantiated.
6.4.2. Impact of Retained Earnings on Shareholders Wealth

In order to find out the impact of retained earnings on the shareholders
wealth, the linear regression is used on the collected data. The results of the
regression analysis are presented in table 6.20 below:
Table 6.20
Impact of retained earnings on shareholders wealth
Model
1
(Constant)
Retained Earnings
R
.726
R Square .527
F
11.148
Sig
.008
Unstandardized
Coefficients
B
Std. Error
1.751
.671
.625
.187
144
Standardized
Coefficients
Beta
T
Sig
2.607
.026
3.339
.008
.726
model. The table shows the value of Beta equal to .726 for retained earnings,
shareholders wealth is to be enhanced, it is necessary to increase the retained
earnings of the firm.
6.4.3. Impact of Firm Value on Shareholders Wealth

In order to find out the impact of firm value on the shareholders wealth,
the linear regression is used on the collected data. The results of the regression
145
Table 6.21
Impact of firm value on shareholders wealth
Unstandardized
Coefficients
B
Std. Error
Model
1
(Constant)
.340
.925
Firm Value
.836
.253
R
R Square
F
Sig
Standardized
Coefficients
Beta
T
Sig
.367
.721
3.308
.008
.723
.723
.523
10.945
.008
model. The table shows the value of Beta equal to .723 for firm value, which
is significant at 0.05 level. This is confirmed by high value of R (=.723)
shareholders wealth is to be enhanced, it is necessary to increase the value of
the firm.
146
6.4.4. Impact of Retained Earnings and Capital Budgeting Process and Decisions
on Firm Value
In order to find out the impact of retained earnings and capital budgeting
process and decisions on the firm value, the linear regression is used on the
collected data. The results of the regression analysis are presented in table 6.22
below:
Table 6.22
Impact of retained earnings and moderating variable on firm value
Model
1
(Constant)
Retained Earnings
and Moderating
Variable
R
.897
R Square .805
F
41.221
Sig
.000
Unstandardized
Coefficients
B
Std. Error
1.655
.314
.118
.018
Standardized
Coefficients
Beta
T
Sig
5.273
.000
6.420
.000
.897

variable. The table shows the value of Beta equal to .897 for retained earnings,
147
of moderating variable, is pretty high, again, confirming the above results. The
F value of 41.221 which shows overall significance of the model is significant
at the 0.05 level. The positive sign of Beta indicates that if firm value is to be
enhanced, it is necessary to increase the retained earnings of the firm under the
moderating effect of capital budgeting process and decisions.
significantly explained by the independent variable under the effect of
moderating variable. Thus, hypotheses 22, 23, 24 and 25 are substantiated.
148
6.4.5. Impact of Retained Earnings and Capital Budgeting Process and Decisions
on Shareholders Wealth
In order to find out the impact of retained earnings and capital budgeting
process and decisions on the shareholders wealth, the linear regression is
used on the collected data. The results of the regression analysis are presented
in table 6.23 below:
Table 6.23
Impact of retained earnings and moderating variable on shareholders wealth
Unstandardized
Coefficients
B
Std. Error
Model
1
(Constant)
1.632
.599
Retained Earnings
and Moderating
Variable
.105
.035
R
R Square
F
Sig
Standardized
Coefficients
Beta
t
Sig
2.723
.021
2.968
.014
.684
.684
.468
8.809
.014

variable. The table shows the value of Beta equal to .684 for retained earnings,
149
of moderating variable, is pretty high, again, confirming the above results. The
F value of 8.809 which shows overall significance of the model is significant
at the 0.05 level. The positive sign of Beta indicates that if shareholders
wealth is to be enhanced, it is necessary to increase the retained earnings of
the firm under the moderating effect of capital budgeting process and
decisions.
has been significantly explained by the independent variable under the effect
of moderating variable. Thus, hypotheses 22 and 23 are substantiated.
150
6.5.
COMPARISON OF MODEL 1 AND 2

Tables 6.24 and 6.25 below show the results of regression analysis of model 1 and
2 used by the current author to differentiate model 1 from model 2.
Table 6.24
Regression results of model 1
Interaction of variables
Impact of Dividend
Payout on Firm Value
under Moderator Affect
Impact of Dividend
Payout on Shareholders
Wealth under Moderator
Affect
R square
.545
.296
.577
.333
Moderator: CAPITAL BUDGETING PROCESS AND DECISIONS
Table 6.25
Regression results of model 2
Interaction of variables
Impact of Retained
Earnings on Firm Value
under Moderator Affect
Impact of Retained
Earnings on Shareholders
Wealth under Moderator
Affect
R square
.897
.805
.684
.468
Moderator: CAPITAL BUDGETING PROCESS AND DECISIONS
151
The table 6.24 and 6.25 lists the values of R and R square. These values explain the
correlation and variance of independent and dependent variables in model 1 and 2.
The value of R (=.545) and R square (=.296) generated in result of the impact of
dividend payout on firm value under moderator affect is lower than the value of R
(=.897) and R square (=.805) generated in result of the impact of retained earnings on
firm value under moderator affect. This shows higher correlation and variance
explained by retained earnings in the firm value under moderator affect.
Moreover, the value of R (=.577) and R square (=.333) generated in result of the
impact of dividend payout on shareholders wealth under moderator affect is also
lower than the value of R (=.684) and R square (=.468) generated in result of the
impact of retained earnings on shareholders wealth under moderator affect. This
shows higher correlation and variance explained by retained earnings in the
shareholders wealth under moderator affect.
What the results mean is that, retained earnings under the affect of moderating
variable are correlated with the firm value and shareholders wealth more than
dividend payout. Similarly, retained earnings, has explained greater variance in the
dependent variables as compared to dividend payout.
152
Table 6.26
Regression results of model 1 without moderator affect
Model 1
WITHOUT MODERATOR AFFECT
Regression
Results
Dividend payout
impact on Firm
Value
Dividend payout
impact on
Shareholders
Wealth
72.6%
71.6%
R square
52.7%
51.3%
Table 6.27
Regression results of model 2 without moderator affect
Model 2
Regression
Results
WITHOUT MODERATING AFFECT

Retained Earnings
impact on Firm
Value
Retained Earnings
impact on
Shareholders
Wealth
81 %
41.5 %
R square
65.6 %
17.2 %
Tables 6.26 and 6.27 lists the values of R and R square of model 1 and 2 without
the affect of the moderating variable. The value of R (=72.6%) and R square
(=52.7%) generated in result of the impact of dividend payout on firm value is lower
than the value of R (=81%) and R square (=65.6%) generated in result of the impact
of retained earnings on firm value. This shows higher correlation and variance
153
explained by retained earnings in the firm value without the affect of moderating
variable.
Moreover, the value of R (=71.6%) and R square (=51.3%) generated in result of the
impact of dividend payout on shareholders wealth is higher than the value of R
(=41.5%) and R square (=17.2%) generated in result of the impact of retained
earnings on shareholders wealth without the affect of moderating variable. This
shows higher correlation and variance explained by dividend payout in the
shareholders wealth without the affect of moderating variable.
What the results mean is that, retained earnings are correlated with the firm value
more than dividend payout without the affect of moderating variable. But, dividend
payout is correlated with the shareholders wealth more than retained earnings
without the affect of moderating variable. Similarly, retained earnings, has explained
greater variance in firm value and dividend payout has explained greater variance in
shareholders wealth in the absence of moderating variable.
Table 6.28
Regression results of model 1 with moderator affect
Model 1
Regression
Results
WITH MODERATING AFFECT

Dividend payout
impact on Firm
Value
Dividend payout
impact on
Shareholders
Wealth
54.5 %
57.7 %
R square
29.6 %
33.3 %
154
Table 6.29
Regression results of model 2 with moderator affect
Model 2
Regression
Results
WITH MODERATOR AFFECT

Retained Earnings
impact on Firm
Value
Retained Earnings
impact on
Shareholders
Wealth
89.7 %
68.4 %
R square
80.5 %
46.8 %
Tables 6.28 and 6.29 lists the values of R and R square of model 1 and 2 with the
affect of the moderating variable. The value of R (=54.5%) and R square (=29.6%)
generated in result of the impact of dividend payout on firm value is lower than the
value of R (=89.7%) and R square (=80.5%) generated in result of the impact of
retained earnings on firm value. This shows higher correlation and variance explained
by retained earnings in the firm value under the affect of moderating variable.
Moreover, the value of R (=57.7%) and R square (=33.3%) generated in result of the
impact of dividend payout on shareholders wealth is also lower than the value of R
(=68.4%) and R square (=46.8%) generated in result of the impact of retained
earnings on shareholders wealth under the affect of moderating variable. This shows
higher correlation and variance explained by retained earnings in the firm value and
shareholders wealth under the affect of moderating variable.
What the results mean is that, retained earnings are correlated with the firm value and
shareholders wealth more than dividend payout under the affect of moderating
variable. Similarly, retained earnings, has explained greater variance in firm value and
shareholders wealth as compared to dividend payout.
155
Table 6.30
Change in the values of R and R square for model 1 & 2
MODEL 1
DIFFERENCE IN VALUES
AFTER THE INTRODUCION OF MODERATING
VARIABLE
Impact of
Impact of
Impact of
Impact of
dividend
retained
dividend
retained
payout on
earnings on
payout on
earnings on
shareholders
shareholders
firm value
firm value
wealth
wealth
Calculated
results
Change in R
Change in R
MODEL 2
(-) 18.1 %
(-) 13.9 %
(+) 8.7 %
(+) 26.9 %
(-) 23.1 %
(-) 18 %
(+)14.9 %
(+) 29.6 %
Table 6.30 compares the model 1 and 2 with respect to the change in the values of
R and R square. The change in the values of R and R square for model 1 shows
negative value as compared to model 2. This shows that after the introduction of
capital budgeting process and decisions as moderating variable strength of model 2
increased substantially as compared to model 1.
156
6.6.
ANALYSIS AT INDUSTRIAL LEVEL

In this research thesis the current author has analyzed collected data with respect to
the industrial sectors and has drawn results to understand the changes in the variables
that influence the performance of the sample firms. The industrial level analysis of the
collected data is explained as follows:
6.6.1. Performance of the sample

The performance indicators analyzed by considering mean values of the
sample firms at industrial level are depicted in the table 6.31 below:
Table 6.31
Indicators of sample performance at industrial level
INDUSTRY
Performance
Indicators
[Mean scale values for the period (2000 to 2009)]

Construction
Food
Automobile
Chemical
and
Producers
and Parts
Materials
Sales Revenue
1.2
1.5
Development
Expenditure
1.5
1.66
1.5
1.5
1.4
1.75
1.6
1.33
1.5
1.5
Net Income
1.8
1.66
1.5
Capital
Investment
1.6
1.33
1.5
Productivity
1.4
1.5
1.66
1.35
1.57
1.62
1.55
Borrowings
Dividend
Payments
Retained
Earnings
Number of
Employees
Total Cost of
Capital
Overall Mean for
Industries
157
Table 6.31 lists the performance indicators representing part 1 of the

questionnaire of the study. Here, 1 shows increased, 2 shows decreased and 3
shows no change. The current author has calculated mean values against the
scale used in part 1 of the instrument. The overall mean values of various
industries show large variations in the mean values of Food Producers and
Construction and Materials industries performance indicators. However, the
best performer is Chemical industry with overall mean score of 1.35 which
shows that this industry is growing faster than other three industries because
the total mean value for this industry is near to 1 which indicates increase in
the performance indicators (see appendix A).
The overall mean scores for the four industries mentioned in the table 6.31
show that excluding chemical industry rest are growth oriented industries but
they are facing problems in achieving sustainable and smooth growth in their
respective markets in Pakistan.
158
6.7.
SOURCES OF FINANCING
The analysis of the collected data relating the sources of financing employed by the
sample firms to generate funds for investment in available investment projects, is
depicted in the tables 6.32 and 6.33 below:
Table 6.32
Analysis results of the sources of financing of the sample
Source of financing the project
Loan from
stateowned
banks
Loan from
non-state
banks/
financial
institutions
Loan from
special
institutions
providing
funds
12
12
12
12
1.50
2.17
1.83
2.75
Best
66.66 %
0%
25 %
0%
Moderate
16.66 %
83.33 %
66.66 %
25 %
Least
16.66 %
16.66 %
8.33 %
75 %
Statistics
Retained
Earnings
N
Mean
Percent
(%)
Table 6.33
Analysis results of the sources of financing of the sample
Source of financing the project
Trade
credits
with
existing
business
partners
12
Statistics
N
Mean
Best
Percent
(%)
Moderate
Least
Private
equity
from
investors
Equity
Bond issue capital
to investors from stock
market
12
12
12
2.33
2.67
2.83
2.67
8.33 %
8.33 %
0%
8.33 %
50 %
16.66 %
16.66 %
16.66 %
41.66 %
75 %
83.33 %
75 %
159
Tables 6.32 and 6.33 lists the values of N that represent number of responded firms,
Mean represents average of scale values, Best, Moderate and Least represent
percentage of scale values with respect to the choices of the scale selected by the
respondents (see appendix A).
The table 6.32 shows that 66.66% of the respondents use retained earnings as the best
source of financing their firms investment projects. 83.33% indicate that they
moderately use loan from state owned banks as the source of financing projects.
66.66% indicate that they moderately use loan from non-state banks/ financial
institutions. 75% indicate the least use of loan from special institutions providing
funds, as their source of financing projects.
The table 6.33 shows that 50% of the respondents moderately use trade credits from
existing business partners. 75% indicate the moderate use of private equity from
investors. Bond issue to investors and equity capital from stock market, are identified
as the least source of financing investment projects by the respondents.
The values of table 6.32 and 6.33 indicate that in the best category the use of retained
earnings is the first choice of the respondents as the source of financing investment
projects; second choice is the loan from non-state banks/ financial institutions and
third choice is trade credits with existing business partners, private equity from
investors and equity capital from stock market. These results of the research thesis
satisfy assumptions of the Pecking Order Theory.
160
6.8.
PROFITABILITY
The analysis of the collected data relating the profitability of the sample firms
representing profits (after tax and interest) as percentage of total sales during the
period 2000 to 2009, is depicted in the tables 6.34 and 6.35 below:
Table 6.34
Analysis results of the profitability of the sample
Firm's profit (after tax and interest) as percentage of total
sales in the following year of operations
Statistics
2000
2001
2002
2003
2004
12
12
12
12
12
2.33
2.08
2.50
2.75
2.67
41.66 %
50 %
41.66 %
25 %
25 %
0%
0%
0%
0%
0%
1 % to 10 %
41.66 %
41.66 %
50 %
58.33 %
58.33 %
10 % to 20 %
16.66 %
8.33 %
0%
8.33 %
16.66 %
20 % to 30 %
0%
0%
0%
8.33 %
0%
30 % to 40 %
0%
0%
0%
0%
0%
More than
40 %
0%
0%
8.33 %
0%
0%
N
Mean
Negative
0%
Percent
(%)
Total mean (2000 - 2009) = 2.566
161
Table 6.35
Analysis results of the profitability of the sample
Statistics
Firm's profit (after tax and interest) as percentage of total

sales in the following year of operations
2005
2006
2007
2008
2009
12
12
12
12
12
2.67
2.83
2.83
2.58
2.42
Negative
25 %
25 %
25 %
25 %
33.33 %
0%
0%
0%
0%
0%
0%
1 % to 10 %
58.33 %
50 %
58.33 %
66.66 %
58.33 %
10 % to 20 %
16.66 %
16.66 %
0%
8.33 %
8.33 %
20 % to 30 %
0%
8.33 %
16.66 %
0%
0%
30 % to 40 %
0%
0%
0%
0%
0%
More than
40 %
0%
0%
0%
0%
0%
N
Mean
Percent
(%)
Total mean (2000 - 2009) = 2.566
Mean represents average of scale values, Negative, 0%, 1% to 10%, 10% to 20%,
20% to 30%, 30% to 40% and more than 40% represent percentage of scale values
with respect to the choices of the scale selected by the respondents (see appendix A).
The tables 6.34 and 6.35 show the results of the analysis of the collected data relating
the sample firms profit (after tax and interest) as percentage of total sales for the
period 2000 to 2009. 41.66% respondents indicate that in 2000 the net profit as
percentage of total sales of their firms was negative as well as ranged between, 1 to
10%. In 2001 respondents indicate that 50% of the net profit as percentage of total
162
sales of their firms was negative. In 2002, 50 % of respondents indicate that the net
profit as percentage of total sales of their firms ranged between, 1 to 10%.
In 2003, 2004, 2005, 2007 and 2009, 58.33% of the respondents indicate that their
firms net profit as percentage of total sales was ranged between 1 to 10%. In 2006
50% and in 2008 66.66% of the respondents indicate that their firms net profit as
percentage of total sales was ranged between, 1 to 10%. The total mean of the net
profit as percentage of total sales of the sample firms during the period 2000 to 2009
is 2.566 which indicates profitability as percentage of total sales of the sample firms
range between 0% to 10%.
Graph 6.1
Net profit as percentage of sales of the sample firms at industrial level
Mean
7
6
Chemical
Food Producers
Construction and
Materials
Automobile and
Parts
Sample Mean
1
0
2000 2001 2002 2003 2004 2005 2006 2007 2008 2009
Years
The graph 6.1 shows the movement of net profits as percentage of sales of the sample
firms at industrial level in the period 2000 to 2009. The sample firms of chemical
industry show higher net profits as percentage of total sales as compared to other
163
sample firms of food producers, construction and materials, and automobile and parts
industries. The total mean plot of the sample shows net profits as percentage of total
sales range between 1 to 10 %.
6.9.
REINVESTMENT ACTIVITIES
The analysis of the collected data relating the reinvestment activities of the sample
firms by using their reserves of net income during the period 2000 to 2009, is depicted
in the tables 6.36 and 6.37 below:
Table 6.36
Analysis results of the reinvestment activities of the sample
Reinvestment of net income (after tax and interests)
of the firm during the following years of operations
Statistics
2000
2001
2002
2003
2004
11
11
11
11
11
2.82
3.09
3.00
3.00
3.00
0 25 %
45.45 %
36.36 %
36.36 %
36.36 %
36.36 %
25 50 %
0%
0%
0%
0%
0%
50 75 %
9.09 %
9.09 %
18.18 %
18.18 %
18.18 %
75 100 %
18.18 %
27.27 %
18.18 %
18.18 %
18.18 %
No reinvestment
27.27 %
27.27 %
27.27 %
27.27 %
27.27 %
N
Mean
Percent
(%)
Total mean (2000 - 2009) = 2.802
164
Table 6.37
Analysis results of the reinvestment activities of the sample
Statistics
2005
2006
2007
2008
2009
11
11
11
11
11
2.73
2.64
2.64
2.55
2.55
0 25 %
36.36 %
45.45 %
45.45 %
45.45 %
45.45 %
25 50 %
9.09 %
0%
0%
9.09 %
9.09 %
50 75 %
18.18 %
9.09 %
9.09 %
0%
0%
75 100 %
18.18 %
36.36 %
36.36 %
36.36 %
36.36 %
No reinvestment
18.18 %
9.09 %
9.09 %
9.09 %
9.09 %
N
Mean
Percent
(%)
Reinvestment of net income (after tax and interests)

of the firm during the following years of operations
Total mean (2000 - 2009) = 2.802
Mean represents average of scale values, 0% to 25%, 25% to 50%, 50% to 75%, 75%
to 100% and no reinvestment represent percentage of scale values with respect to the
choices of the scale selected by the respondents (see appendix A).
The tables 6.36 and 6.37 shows that in 2000, 2006, 2007, 2008 and 2009 majority of
the respondents (45.45%) reinvested up to 25% of their firms net income in value
enhancing projects. In 2001, 2002, 2003, 2004 and 2005 majority of the respondents
(36.36%) invested up to 25% of their firms net income as compared to 27.27% of
respondents who reinvested net income of their firm between 75 to 100%. A decrease
in no reinvestment activity from 27.27% respondents to 18.18% respondents in the
year 2005 indicates increase in reinvestments by the sample firms. The no
165
reinvestment response is also reduced from 2006 when only 9.09% of the net income
was retained by the sample firms and rest was used for reinvestments.
Graph 6.2
Mean
Reinvestment activities of the sample firms at industrial level

5
4.5
4
3.5
3
2.5
2
1.5
1
0.5
0
Chemical
Food Producers
Construction and
Materials
Automobile and
Parts
Sample Mean
Years
The graph 6.2 shows the reinvestment activity by the sample firms with respect to
their industries. The graph shows that sample firms of chemical industry reinvested up
to 25% of their firms net income (after tax and interest). The reinvestment activity of
sample firm of food producers industry also increased after 2004 and up to 100 % of
net income of the food producers industry was reinvestment in 2001 and 2002 which
is visible from the line graph 6.2. The reinvestment activity of sample firms of
construction and materials industry has decreased as the line graph decline beyond
2004. Sample firms of automobile and parts industry also experienced increase in
reinvestment activity as the line graph of this industry shows increase during 2000 to
2003 and beyond this period sample firms in this industry reinvested more than 50%
166
of their net income in value enhancing investment projects. Most of the respondents
indicated that they have selected the following investment projects to reinvest net
income in the ten year period (2000 to 2009):
i.
Business expansion activities within the firm
ii.
New investments in long-lived assets
iii.
Investment in real estate
6.10. OUTCOME OF RECENT PROJECTS

The analysis of the collected data relating the outcome of the recent investment
projects undertaken by the sample firms is depicted in the table 6.38 below:
Table 6.38
Analysis results of the outcome of recent projects of the sample
Outcome of the most recent projects
the firm undertook in Pakistan
Statistics
N
11
Mean
Percent
(%)
2.45
More profitable than expected
0%
As profitable as was predicted
72.72 %
Less profitable than expected
18.18 %
Break-even
0%
Not profitable at all
9.09 %
Table 6.38 lists the values of N that represent number of responded firms, Mean
represents average of scale values, more profitable than expected, as profitable as was
167
predicted, less profitable than expected, break-even and not profitable at all represent
percentage of scale values with respect to the choices of the scale selected by the
respondents (see appendix A).
The table 6.38 shows that 72.72% respondents find their firms investment in recent
projects as according to their predictions. 18.18% of respondents find their firms
investments less profitable than their expectations. 9.09% respondents indicate that
their firms recent investment activity is not profitable enough to be considered as
valuable. The mean value of 2.45 indicates that profitability is gained by the sample
firms from their recent investment activities.
6.11. MANAGERIAL OWNERSHIP

The analysis of the collected data relating the managerial ownership situation of the
sample firms is depicted in the table 6.39 below:
Table 6.39
Analysis results of the managerial ownership in the sample firms
Percentage of shares owned by the firm's
senior managers (e.g., CEO, CFO, etc)
Statistics
N
12
3.50
Mean
Less than 5 %
Percent
(%)
33.33 %
5 % - 10 %
0%
10% - 20 %
0%
Greater than 20 %
16.66 %
None
50 %
168
represents average of scale values, less than 5%, 5% to 10%, 10% to 20%, greater
than 20% and none represent percentage of scale values with respect to the choices of
the scale selected by the respondents (see appendix A).
The table 6.39 shows that majority (50%) of the senior level managers of the
responded sample firms hold not a single share of their respective firms. 33.33%
respondents hold less than 5% shares of their respective firms and 16.66% hold
greater than 20% shares of their firms. This higher amount of share ownership is seen
in the case when the senior level manager, that is; chief executive officer, or director
is also a partner in the business and mostly private sector firms in Pakistan have this
type of managerial ownership. Thus, lower level of managerial ownership that is less
than 5% is also a contributing factor that increases value of the firm.
169
6.12.
CAPITAL BUDGETING TECHNIQUES

The analysis of the collected data relating the use of capital budgeting techniques by
the respondents of the sample firms is depicted in the tables 6.40 and 6.41 below:
Table 6.40
Analysis results of the use of capital budgeting techniques by the sample
Use of Capital Budgeting Techniques by the sample firms for

project selection or acquisition of asset
Statistics
N
Mean
Percent
(%)
Net
Present
Value
Internal
Rate of
Return
Hurdle
Rate
Earnings
Multiple
Approach
Adjusted
Present
Value
Payback
Period
12
12
12
12
12
12
4.00
4.17
1.67
1.50
1.50
4.50
66.66 %
58.33 %
0%
Never
0%
Rarely
16.16 %
0%
16.16 %
16.66 %
33.33 %
0%
Sometimes
0%
0%
8.33 %
16.16 %
8.33 %
8.33 %
50 %
16.16 %
0%
0%
0%
33.33 %
0%
0%
58.33 %
Often
Always
16.16 % 66.66 %
33.33 % 66.66 % 8.33 %
170
Table 6.41
Analysis results of the use of capital budgeting techniques by the sample
Use of Capital Budgeting Techniques by the sample firms for

project selection or acquisition of asset
Statistics
Discounted
Payback
Period
Value at
Sensitivi Risk or
-ty
other
Analysis Simulation
Analysis
Real
Options
of a
project
12
12
12
12
12
12
3.33
2.50
1.92
3.75
1.42
2.42
Never
16.66 %
33.33 %
66.66 %
25 %
Rarely
16.66 %
25 %
0%
0%
25 %
16.66 %
Sometimes
0%
16.66 %
16.66 %
0%
8.33 %
33.33 %
50 %
8.33 %
8.33 %
25 %
0%
8.33 %
16.66 %
16.66 %
8.33 %
50 %
0%
8.33 %
Mean
Percent
(%)
Accounting
Rate of
Profitability Return or
Index
Book Rate
of Return
on Assets
Often
Always
66.66 % 33.33 %
Mean represents average of scale values, never, rarely, sometimes, often and always
represent percentage of scale values with respect to the choices of the scale selected
by the respondents (see appendix A).
The table 6.40 shows that 33.33% respondents always and 16.16% respondents rarely
used Net Present Value (NPV) as capital budgeting technique for the selection of an
investment project. Internal Rate of Return (IRR) is being used by 66.66%
respondents as compared to 16.66% respondents that often used this capital budgeting
technique. Most of the respondents (66.66%) have never used hurdle rate and earnings
multiple approach as capital budgeting techniques to evaluate investment projects.
171
58.33% never and 33.33% rarely used adjusted present value as capital budgeting
technique to evaluate investment projects. In the case of pay back period, 58.33% of
the respondents indicate that they always use it and 33.33% of the respondents
indicate that they often use this technique in the selection of investment projects.
The table 6.41 shows that in the case of discounted payback period as capital
budgeting technique, 50% of the respondents often and 16.66% of the respondents
always used this technique for the evaluation of the investment projects. Majority of
respondents (33.33%) indicate that they have never used profitability index as
compared to 25% that have indicated that they have rarely used this technique.
66.66% respondents never used accounting rate of return or book rate of return as
capital budgeting technique. Sensitivity analysis is also used by firms and 50%
respondents indicate that they always and 25% indicate that they often use it to select
projects. Simulation analysis and real options are not commonly used by the
respondents as capital budgeting technique for the selection and evaluation of
investment projects.
In this research the current author has not analyzed the required items of the financial
statements (part 8 of the questionnaire) of the responded sample firms due to larger
amounts of missing information related to net income, retained earnings, dividend
payout and total cash holdings, for the period 2000 to 2009.
172
6.13. DISCOUNT RATE FOR INVESTMENT PROJECTS

The analysis of the collected data relating the use of discount rate for investment
projects by the respondents of the sample firms is depicted in the tables 6.42 below:
Table 6.42
Analysis results of use of discount rate for investment projects by sample
Use of the discount rate by the sample firms to evaluate
new project in the market place
The discount
The discount
rate of the
rate for the
Pakistani
entire firm
market
Statistics
A different
discount rate
for each
component
cash flow
12
12
12
12
4.00
1.92
2.08
1.75
Never
0%
50 %
41.66 %
41.66 %
Rarely
8.33 %
25 %
33.33 %
41.66 %
Sometimes
25 %
8.33 %
8.33 %
16.66 %
Often
25 %
16.66 %
8.33 %
0%
41.66 %
0%
8.33 %
0%
Mean
Percent
(%)
A riskmatched
discount rate
for the
project by
considering
both industry
and country
(Pakistan)
Always
represents average of scale values, never, rarely, sometimes, often and always
173
The table 6.42 shows that 41.66% respondents always, 25% often as well as rarely
used discount rate of their entire firms to evaluate a new project in the market. In the
case of discount rate of the Pakistani market 50% never and 25% rarely used it to
evaluate new investments projects. 41.66% never used a risk-matched discount rate
for the project by considering both industry and country (Pakistan) and a different
discount rate for each component cash flow to evaluate a new investment project in
the Pakistani market place. The mean value of 4 for the discount rate for the entire
firm is the most popular means of evaluation of new project adopted by the
respondents of the sample firms.
6.14. ADJUSTMENT OF RISK FACTORS

The analysis of the collected data relating the adjustment of risk factors for
investment projects by the respondents is depicted in the tables 6.43 and 6.44 below:
Table 6.43
Analysis results of the adjustment of risk factors by the sample
Adjustment of either the discount rate or cash flow for

the risk factors affecting the project valuation
Gross
Domestic
Risk of
Interest
Term
Product
Commod
Unexpect
Rate
Structure or
ity Price
ed
Risk
Risk
Business Risk
Inflation
Cycle
Risk
12
12
12
12
12
Mean
2.83
3.25
3.67
3.92
3.67
Discount Rate
0%
0%
0%
0%
0%
Cash Flow
33.33 %
25 %
16.66 %
0%
16.66 %
Both
50 %
25 %
0%
8.33 %
0%
None
16.66 %
50 %
83.33 %
91.66 %
83.33 %
Statistics
Percent
(%)
174
Table 6.44
Analysis results of the adjustment of risk factors by the sample
When valuing a project firm adjust either the discount
rate or cash flow for the following risk factors
Distress
Risk
(Probabil
ity of
bankrupt
cy)
Statistics
Market
to Book
Ratio
Moment
um (i.e.,
recent
Exchang
stock
e Rate
price
Risk
performa
nce)
12
12
12
12
12
3.83
3.67
3.50
3.00
2.58
0%
8.33 %
8.33 %
25 %
8.33 %
8.33 %
0%
8.33 %
8.33 %
50 %
Both
0%
8.33 %
8.33 %
8.33 %
16.66 %
None
91.66 %
83.33 %
75 %
58.33 %
25 %
Mean
Discount Rate
Percent
(%)
Size
(e.g.,
small
firms
being
riskier)
Cash Flow
Mean represents average of scale values, discount rate, cash flow, both and none
The table 6.43 shows that 50% of the respondents have adjusted cash flows and
discount rate for the unexpected inflation in the Pakistani market. 25% of respondents
have adjusted cash flow and 25% have adjusted both the cash flow and discount rate
for interest rate risk. Term structure risk, gross domestic product or business cycle
risk and commodity price risk are not adjusted by the majority of the respondents.
The table 6.44 shows that majority of the respondents have ignored the adjustment of
their firms projects cash flows and discount rates for; distress risk (probability of
bankruptcy), size (e.g., small firms being riskier), market to book ratio and
175
momentum (i.e., recent stock price performance). In the case of exchange rate risk,
50% of the respondents indicate that they have adjusted cash flow and 16.66%
indicate that they have adjusted both the cash flows as well as discount rates during
the process of valuation of the investment project. Thus, inflation and exchange rate
risks are mostly adjusted by the respondents of the sample firms.
6.15. AVERAGE GROWTH
Table 6.45
Analysis results of the average growth of the sample during (2000 - 2009)
On average growth of firm per year (from
2000 to 2009)
Statistics
N
12
Mean
Percent (%)
2.17
Less than 10 % per year
33.33 %
10 20 % per year
33.33 %
Over 20 % per year
16.66 %
No growth
16.66 %
Got smaller
0%
Not applicable, the firm

is too recent
Dont know/Not
available
0%
0%
represents average of scale values, less than 10% per year, 10% to 20% per year, over
20% per year, no growth, got smaller, not applicable/ the firm is too recent and dont
176
know/not available represent percentage of scale values with respect to the choices of
the scale selected by the respondents (see appendix A).
The table 6.45 shows the average growth of the sample firm over the period 2000 to
2009. 33.33% respondents indicate that their firms grew less than 10% and 10% to
20% per year. Whereas, 16.16% respondents indicate that their firms grew more than
20% per year during 2000 to 2009. However, 16.16% respondents indicate that their
firms showed no growth during 2000 to 2009. So, overall sample firms showed
growth during 2000 to 2009.
6.16. EXPECTED GROWTH
Table 6.46
Analysis results of the expected growth of the sample in 2 to 3 years
Turnover of the firm over
the next 2 to 3 years (expected growth)
Statistics
N
12
Mean
Percent
(%)
2.08
Slow growth below 10 % per
year
Grow moderately between 10
to 20 % per year
Grow substantially over 20 %
per year
33.33 %
25 %
41.66 %
Stay the same size
0%
Become smaller
0%
Dont know/ Not available
0%
represents average of scale values, slow growth (below 10% per year), Grow
177
moderately (between 10% to 20% per year), grow substantially (over 20% per year),
stay the same, become smaller and dont know/ not available represent percentage of
scale values with respect to the choices of the scale selected by the respondents (see
appendix A).
The table 6.46 shows that in view of 41.66% respondents, their respective firms will
expect to grow substantially (over 20%) per years over the next 2 to 3 years.
However, 33.33% of the respondents indicate that their respective firms will
experience slow growth (below 10%) over the period of next 2 to 3 years. But, 25% of
respondents indicate moderate growth (10% to 20%) per year over the next 2 to 3
years. Hence, majority of the respondents are hopeful that their firms will continue to
grow at a faster pace in the future.
178
6.17. FINANCING CONDITIONS
Table 6.47
Analysis results of the expected growth of the sample in 2 to 3 years
Condition of financing over the period of next 1 to 3 years of
the sample firms
Internal
funds,
for
Bank
example
loan
from
retained
earnings
Statistics
N
Mean
Will
improve
Percent
(%)
Equity
investm
ent in
the firm
Trade
credit
Debt
securityes issue
Other*
12
12
12
12
12
12
1.58
2.25
3.25
2.42
4.00
3.50
75 %
33.33 %
0%
8.33 %
0%
16.66 %
33.33 % 41.66 % 66.66 %
0%
0%
Will remain
Unchanged
8.33 %
Will
Deteriorate
0%
8.33 %
8.33 %
0%
0%
0%
Not
applicable
to my firm
16.66 %
25 %
33.33 %
25 %
100 %
83.33 %
Dont know
0%
0%
16.66 %
0%
0%
0%
* For example, loan from a related company or shareholders, excluding trade credit,
loan from family and friends, leasing & factoring
represents average of scale values, will improve, will remain unchanged, will
deteriorate, not applicable to my firm and dont know represent percentage of scale
values with respect to the choices of the scale selected by the respondents (see
appendix A).
179
The table 6.47 shows the condition of the financing available to the sample firms over
the period of next 1 to 3 years. 75% of the respondents indicate that retained earnings
(internal funds) as a primary source of financing will improve in 2 to 3 years time.
33.33% of the respondents indicate that bank loan as the source of financing will
improve and the same number of respondents indicated that this form of financing
will remain un-change for their firm in 2 to 3 years time. Equity investment in the
firm and trade credit as the sources of financing will remain un-change for 41.66%
and 66.66% respondents. Respondents have not used debt securities issue and other
sources of financing because in Pakistan bond market does not exist.
6.18. INTERPRETATION OF DATA

The regression analysis of the data shows that dividend payout and firm value are
significantly and positively related to each other. Similar was reported by Graham and
Dodd (1951); Fama and French (1998); Seitz and Ellison (1998); Chung and Wright
(1998); Amidu and Abor (2006); Mizuno (2007); Baker, Saadi, Dutta and Ghandhi
(2007); DeAngelo and DeAngelo (2007); Hughes (2008); Weigand and Baker (2009);
Fargher and Weigand (2009); Fuller and Blau (2010).
The regression analysis of the data shows that dividend payout and shareholders
wealth are significantly and positively related to each other. Similar was reported by
Graham and Dodd (1951); Botha, Bosch and Van Zyl (1987); Dhanani (2005);
DeAngelo and DeAngelo (2007); Baker, Saadi, Dutta and Ghandhi (2007); Azhagaiah
and Priya (2008); Dasilas, Lyroudi and Ginoglou (2009).
The regression analysis of the data shows that firm value and shareholders wealth are
significantly and positively related to each other. Similar was reported by Kilroy
(1999); Lin and Ji (2007); Copeland, Weston and Shastri (2007, p. 667).
180
The regression analysis of the data shows that capital budgeting process and decisions
as moderating variable has reduced the affect of dividend payout on firm value. And,
the combined affect of dividend payout and capital budgeting process and decisions is
insignificantly but positively related to firm value. However, Brookfield (1995); Seitz
and Ellison (1998); Toit and Pienaar (2005); Elumilade, Asaolu and Ologunde (2006);
Horne et al. (2008) reported significant and positive affect of capital budgeting
process and decisions on the value of the firm when firm focuses on investment of
funds over and above payout of dividends to the shareholders. Capital budgeting
process and decisions are only beneficial for a firm when funds are allocated for
investment and reinvestment activity. In this study the main reason of negative affect
of dividend payout and capital budgeting process on the firm value is the higher
reinvestment activity by the sample firms. So, higher reinvestment activity is
facilitated by capital budgeting process and decisions of the sample firms and as a
consequence payout of dividends is decreased.
as moderating variable has significantly and positively modified the affect of dividend
payout on shareholders wealth. Similarly, Brookfield (1995); Seitz and Ellison
(1998); Toit and Pienaar (2005); Elumilade, Asaolu and Ologunde (2006); Horne et
al. (2008) reported significant and positive affect of capital budgeting process and
decisions on the wealth of the shareholders.
The regression analysis of the data shows that retained earnings and firm value are
significantly and positively related to each other. Similar was reported by Brien
(2003); Gentry, Reilly and Sandretto (2003); Baum and Turner (2004); Chen (2008);
Ezeoha (2008); Chiu and Liaw (2009); Karadeniz, Kandir, Balcilar and Onal (2009).
181
The regression analysis of the data shows that retained earnings and shareholders
wealth are significantly and positively related to each other. Similar was reported by
Ghosh and Woolridge (1989); Baum and Turner (2004); Chen (2008).
as moderating variable has significantly and positively modified the affect of retained
earnings on firm value. Similarly, Brookfield (1995); Seitz and Ellison (1998); Toit
and Pienaar (2005); Elumilade, Asaolu and Ologunde (2006); Horne et al. (2008)
reported significant and positive affect of capital budgeting process and decisions on
the investment and reinvestment of retained earnings (internal finds) of the firm in
value enhancing investment projects.
as moderating variable has significantly and positively modified the affect of retained
earnings on shareholders wealth. Similarly, Brookfield (1995); Seitz and Ellison
(1998); Toit and Pienaar (2005); Elumilade, Asaolu and Ologunde (2006); Horne et
al. (2008) reported significant and positive affect of capital budgeting process and
decisions on the investment and reinvestment of retained earnings (internal finds) of
the firm in value enhancing investment projects that ultimately maximize the wealth
of the shareholders.
182
CHAPTER 7: FINDINGS AND DISCUSSION
This chapter discusses the findings of the study. The discussion of results is done in two
sections. Section one discuss the findings of the data analyzed in the case of modified
research models of the study and section two discuss the findings of the analyses of the
supporting data.
The analysis and interpretation of the data supports the fact that under current state of
knowledge available to the manager in the corporate world one can not devise a dividend
policy that can completely maximize the value of the firm [Seitz and Ellison (1998)] but, with
certain set rules and regulations capital of a firm can be utilized optimally for the
maximization of the firm value. It can be done when the distribution mechanism of capital is
fair and based on facts and market information. According to the formula of capital
distribution stated below, manager can effectively manage capital to curtail wastage or
misuse of capital (Brealey and Mayer, 2003).
Plowback ratio = 1 payout ratio
The ratio stated above is the golden principle. Plowback and payout are two sides of a single
coin. It means that if 1 is the net income of a firm then there must be a plowback as well as
payout ratio of a listed firm. If we analyze financial statement of a listed firm we can see that
net income earned in the previous year is settled in the owners equity after deducting
dividends paid, and the final year end balance is written after treating these accounts by the
management. This implies that when net income is 1 and from this a fraction of earnings is
paid to the shareholders of the firm and rest is transferred to next business year as opening
balance. Thus, maintenance of corporate dividend and retention policies is critical for the
survival and growth of a corporation.
183
Lintner (1956) advocated that dividend policy is the center of gravity of each and every
decision that involves financial matters of a firm. So, dividend payout and retention of
earnings compliment each other and are integral part of firms investment and financing
policy.
These policies once devised and implemented need a monitoring system that identify and
correct flaws of the outcomes (management of project cycle). The budget control procedure
or system is the best tool that regulates the project development and implementation process.
The subject that deals with the management of firm capital (tangible or intangible) is known
as capital budgeting which has been defined well earlier by Horne et al. (2008). Horne et al.
indicated that future benefits of a firm rest on the selection of viable investment projects that
optimally enhance the value of the firm and in return wealth of the firms shareholders can be
maximized.
SECTION 1
7.1.
DISCUSSION AND FINDINGS RELATING RESEARCH MODELS

The results of regression analysis of model 1 and 2 without the influence of the
moderating variable establishes that dividend payout and retained earnings are
positively and significantly associated with the firm value and shareholders wealth
variables. Also, firm value is positively and significantly associated with the
shareholders wealth. This implies that in Pakistan top level managers of the listed
firms have recognized the importance of dividend and retention policies and are fully
aware of the pros and cons of the likely impact of these policies on the value of the
firm and wealth of the shareholders.
The analysis of results show that 50% respondents are chief financial officers of the
sample firms holding Chartered Accounting degrees. So, respondents know the
184
importance of devising policies relating to dividend payout and earnings retention.

The firms that responded are larger in size and majority of them pay cash dividends to
their shareholders.
The regression analysis of models shows that without the influence of moderating
variable retained earnings has created greater variance in the firm value as compared
to dividend payout. This implies that in Pakistan greater tendency of retention of
firms earnings is established and less emphasis by sample firms on payout of
dividends is evident. These results also indicate that retention of earnings is currently
good for the sample firms because the expected growth forecast by respondents is
66.66% and the growth is dependent on the investment and reinvestment of internal
funds (retained earnings).
The regression analyses of the impact of dividend payout and retained earnings on
shareholders wealth without the influence of moderating variable in model 1 and 2
show that greater variance is being created by dividend payout as compared to the
retained earnings. It implies that dividend payout is closely associated with the
maximization of the wealth of the shareholders of the sample firms. The results of
dividend payout show that 83.3% of respondents indicated that their firms pay
dividends.
The results of regression analysis of the impact of dividend payout and retained
earnings on the firm value under the influence of a moderating variable in model 1
and 2 shows that the variance created by retained earnings on firm value is enhanced
with the introduction of moderating variable. Whereas, variance created by dividend
payout on the firm value is reduced. This implies that retained earnings have better
explained the firm value as compared to dividend payout. It implies that listed sample
firms in Pakistan must use retained earnings under strict capital budgeting system that
185
maximizes firm value by devising proper capital budgeting guidelines. These

guidelines must incorporate procedures that control and regulate flow of cash and
minimize costs.
The result of regression analysis of the impact of dividend payout and retained
earnings on the shareholders wealth under the influence of the moderating variable in
model 1 and 2 show greater variance is being created by the retained earnings. This
implies that retained earnings are closely associated with the shareholders wealth.
The variance created by firm value on the shareholders wealth variable is 54.3% in
model 1 and 52.3% in model 2. This implies that if value of the firm is enhanced
the wealth of its shareholders will increase accordingly. Thus, retention of retained
earnings and its investment and reinvestment is better option that can maximize the
value of the firms as well as the shareholders of the listed Pakistani firms. So, in
Pakistan listed sample firms must focus on the proper allocation and use of retained
earnings because higher net present valued investment projects can optimally
maximize the wealth of the shareholders if guidelines of capital budgeting system are
followed without any exception or delay.
The current author has noticed that respondents of the study have used consistently
the capital budgeting techniques to evaluate investment projects in-order to cater
growth opportunities. This fact shows that reinvestment of retained earnings is higher
and dividends payout is lower in Pakistan.
SECTION 2
7.2.
DISCUSSION AND FINDINGS RELATING SUPPORTING DATA

The analysis of data at industrial level reveals that chemical industry is growing faster
than automobile and parts, food producers and construction and materials industries.
186
The use of sources of financing indicates that sample firms use retained earnings first
and than seek external financing that are; loan from state owned and non-owned
banks and financial institutions and trade credit from existing business partners, in
case internal financing is not sufficient to finance available investment projects. This
pattern of selection of sources of financing satisfies the assumptions of Pecking Order
Theory.
The graph (6.1) shows profitability of the sample firms that ranged from 1% to 10%
during 2000 to 2009. The reason of this lower percentage is the higher amounts of
reinvestments done by the sample firms in value enhancing projects that includes;
business expansion activities within the firm, new investments in long-lived assets
and investment in real estate that includes acquisition of land for the new office
building or factory.
The outcome of most recent investment projects of the responded sample firms was
according to their predictions. This means that majority of the sample firms have
experienced good profitability from the investment projects executed in Pakistan. The
managerial ownership of firms shares is less than 5% for 33.33% of the respondents.
This low amount of ownership of shares by senior level managers of the sample firms
facilitated sample firms in the achievement of goals and objectives because when
managerial ownership increases from (0 to 5%) value of the firm increases and when
managerial ownership increases from (5 to 25%) value of the firm decreases Dutta (p.
2, 1999).
The regression results regarding the use of capital budgeting techniques reveal that
majority of the respondents always use internal rate of return, second technique used
is payback period and third is net present value method. The current author has noted
that discount rate for the entire firm is being used by the majority (66.66%) of the
187
respondents to evaluate new projects in the market place. Also, during evaluation of
investment projects inflation, interest rate risk and exchange rate risks are mostly
adjusted by the respondents of the sample firms. This implies that short term projects
of less than 5 years are normally being executed by the responded firms in Pakistan.
The average growth of the sample firms during 2000 to 2009 was beyond 20%. And,
the expected growth for the next 2 to 3 years for the sample firms will vary between
10% to 20% per year. The regression results shows that retained earnings (internal
funds) are the primary source of financing investments and it will improve with bank
loans in 1 to 3 years ahead.
This study has answered all the questions asked in the study. The current author has
noticed that reinvestments of retained earnings (cash as well as equity balances) done
by Pakistani listed sample firms in business expansion activities have facilitated them
to grow beyond 20% per annum. This higher growth was achieved due to the
commitment of resources of the sample in expansion related activities during 2000 to
2009, and this was the reason lower payout ratio in Pakistan was reported by Mehar
(2007). The corporate dividend payout model tested in this study is significant but has
not proved itself as the main contributor of value for the firm as well as the
shareholders. The current author has seen that dividend payout model is
comparatively weak in explaining the firm value and shareholders wealth. So,
dividend payout model is currently not suitable for manufacturing listed sample firms
operating in Pakistan.
The use of retained earnings in reinvestment activities by the sample firms resulted in
higher sales. This signifies the authenticity of the retained earnings model in Pakistan.
The current author has identified model 2 of the study best for the sample firms
operating under prevailing market conditions of Pakistan.
188
The empirical tests of the devised models of the study have supported the Hybrid
Theory of Firm Valuation formulated by the current author. The current author has
identified the following circumstances that have provided the framework for the
application of the theory in normal business environment; (i) Firm follow the goal of
shareholders wealth maximization and believe in payout of earnings in the form of
dividends to the shareholders, (ii) Informational asymmetries and agency costs are
minimal, (iii) Firm is larger in size with ascending/ descending order of sales revenue,
(iv) Firm is growing or is at the stage of maturity (firm lifecycle), (v) Firm rely less on
debt and external equity capital, (vi) Firm is taxed based on National Taxation System
of the country.
189
CHAPTER 8: CONCLUSION AND RECOMMENDATIONS
This chapter concludes the thesis and presents recommendations based on the analysis of the
collected data.
8.1.
CONCLUSION
In this study on the basis of review of literature Hybrid Theory of Firm Valuation
has been developed. This theory is tested empirically by using two models that
represent distribution of capital by a firm. Using market based data, the models have
been tested and it has been found that earnings retention model is currently more
suitable for the sample firms operating in Pakistan because higher growth
opportunities are available to the sample firms. The sample firms of construction and
materials industry have increased their production capacities to matchup demand with
supply in the areas of construction of all types of infrastructure within Pakistan and
abroad. The sample firms of chemical industry have experienced higher demand of
chemicals like; paint and emulsion products which were exported to Afghanistan and
central Asian states. On the other hand sample firms of food producers industry have
recently expanded in multiple product lines in Pakistan. In the case of sample firms of
automobile and parts industry, growth opportunities were reduced, but the firms
managed their markets well. Thus, higher growth opportunities signified the use of
retained earnings model in Pakistan and dividend payout model was minimally
employed by the sample firms. The findings of the study endorsed the Hybrid
Theory of Firm Valuation and the future direction of the research opens new avenues
for further tests of the Hybrid Theory of Firm Valuation in other parts of the world.
190
Initially, the hypothesis of the study were developed to test formulated models based
on market based data for the entire population, but due to very small response rate
(14.12 %) of the study, conclusions were drawn for sample firms. So, due to this
undeniable fact the word sample firms is used by current author to draw
conclusions based on the results of statistical analyses. This fact is supported by the
study of Radhakrishna and Doamekpor (2008). Radhakrishna et al. (2008) stated that,
do a comparison between early and late, early and non-respondents, and late and
non-respondents. If the comparison indicates no differences between these three
groups of respondents, then you can generalize the findings to the population. On the
other hand, if you find significant differences, you cannot generalize the findings to
the population.
In this study out of 85 final sample of manufacturing listed firms, 4 responded early, 8
responded late and 73 have not responded at all. Non-respondents have been
requested twice by the current author to respond even after deadline dates but no one
responded. Hence, there is significant difference between early, late and nonrespondents. This is the basic reason which compelled current author not to generalize
findings to the population of the study.
191
8.2.
RECOMMENDATIONS
The recommendations presented here can be useful for the Government of Pakistan,
financial research communities, independent scholars as well as international
organizations that want to understand the functioning of the listed firms in Pakistan
regarding the significance and applicability of the models devised and tested in this
thesis.
In particular it is recommended that;
1. Retention models may be used by the firms until and unless they are available
with growth opportunities in the market. The retained earnings should be used in
positive net present valued investments because it is the basic strategy that
generate wealth for the shareholders and boost the economic activity in the
country.
2. Firms can adopt share repurchase strategy as a means of distribution of capital to
the shareholders because firms in USA, Europe and Australia have successfully
deployed this strategy to replace cash dividend payout.
3. Long-term investments and reinvestments by the firms in Pakistan may be
increased by controlling risk factors influencing cash flows of investment projects.
The enhanced investment activities are achievable if capital budgeting process and
decisions are effectively aligned with the dividend and retention policies of the
firms. So, the capital generated in result of business activities executed under
effective capital budgeting mechanism can optimally contribute towards the
enhancement of firm value and maximization of shareholders wealth.
192
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http://www.uakron.edu/colleges/cba/docs/Uzbekistan_formatted.pdf
Tseng, Chung-Li., Lin, Kyle. Y., & Sundararajan. (2005). Managing Cost Overrun Risk in
Project Funding Allocation. Annals of Operations Research, 135, 127-153. Retrieved
Ugurlu, Mine., & Aksoy, Hakan. (2006). Prediction of Corporate Financial Distress in an
Emerging Market: The Case of Turkey. Cross Cultural Management: An
International Journal, 13(4), 277-295. Retrieved January 10, 2010, from
Upneja, Arun., & Dalbor, Michael. C. (2001). An Examination of Capital Structure in the
Restaurant Industry. International Journal of Contemporary Hospitality Management,
13(2), 54-59. Retrieved December 29, 2009, from http://www.emerald-librsry.com/ft
Vanacker, Tom. R., & Manigart, Sopie. (2008). Pecking Order and Debt Capacity
Considerations for High-growth Companies Seeking Financing. Journal of Small
Business Economics. Retrieved January 06, 2009, from Springer Science Plus
Business Media, LLC website (online).
Watson, R. & Wilson. N. (2002). Small and Medium Sized Enterprise Financing: A Note on
some of the Empirical Implications of a Pecking Order. Journal of Business Finance
& Accounting, 29(3/4), 557-578.
Weigand, Robert. A., & Baker, H. Kent. (2009). Changing Perspectives on Distribution
Policy, The Evolution from Dividends to Share Repurchase. Managerial Finance,
35(6),
479-492.
Retrieved
January
10,
2010,
from
Wu, Xueping., & Yeung, Chau. Kin. Au. (2009). A Growth Type Explanation for Capital
Structure Persistence. Social Science Research Network Electronic Publishing Inc.
213
LIST OF PUBLICATIONS OF THE CANDIDATE

JOURNAL RESEARCH PAPER PUBLICATIONS
Tirmizi, M. Ali., Rehman, K., & Saif, M. I. (2009). An Empirical Study of Consumer
Impulse Buying Behavior in Local Markets, European Journal of Scientific Research,
Vol. 28, No. 4, pp. 522-532.
Tirmizi, M. Ali., & Shah, S. M. H. (2009). Is IT Industry Productive: A Performance Based
Investigation of IT Sector Firms Operating in Pakistan, International Journal of
Business and Management, Vol. 4, No. 5, pp. 207-221.
RESEARCH PAPERS ACCEPTED FOR PUBLICATION IN IMPACT FACTOR
INTERNATIONAL JOURNALS
Tirmizi, M. Ali., & Ahmad, Mehboob. (2012). A Test of Retained Earnings Based Firm
Valuation Model, Archives Des Sciences (ADS) Journal. Geneva, Switzerland. (ISI
Index with Impact Factor = 0.474)
Tirmizi, M. Ali., & Ahmad, Mehboob. (2012). Dividend Payout Based Firm Valuation
Model: Evidence from Pakistan, Archives Des Sciences (ADS) Journal. Geneva,
Switzerland. (ISI Index with Impact Factor = 0.474)
INTERNATIONAL CONFERENCE PRESENTATIONS
Tirmizi, M. Ali., Malik, M. I., & Hasan, M. (2007). Measuring satisfaction: An investigation
regarding age, tenure and job satisfaction of white collar employees, Proceedings of
the International Colloquium on Business and Management (ICBM), 19-22
November, Bangkok Palace Hotel, Bangkok, Thailand.
Mailk, M. I., Tirmizi, M. Ali., & Chaudhary, Beenish. (2008). Job Satisfaction among
university teachers within Pakistan, Proceedings of the 1st International Conference
on Business and Technology (ICBT), 5-6 April, Margalla Hotel, Islamabad, Pakistan.
NATIONAL CONFERENCE PRESENTATIONS
Ali, Tajwar., Malik, M. I., & Tirmizi, M. Ali. (2007). Assessment of the organizational
success in private sector of Telecom Industry (Rawalpindi/Islamabad) (Mobilink,
Telenor and Warid). Proceedings of the 5th National Research Conference, 24 th May,
Shaheed Zulfiqar Ali Bhutto Institute of Science & Technology (SZABIST),
Islamabad, Pakistan.
Malik, M. I., Tirmizi, M. Ali., Ali, Tajwar., & Shaikh, R. L. (2007). The fresh avenues for
investment in Pakistan, Proceedings of the 5 th National Research Conference, 24 th
May, Shaheed Zulfiqar Ali Bhutto Institute of Science & Technology (SZABIST),
Islamabad, Pakistan.
214
APPENDIX A: RESEARCH INSTRUMENT
Industry:
Serial #:
FOUNDATION UNIVERSITY
INSTITUTE OF ENGINEERING AND MANAGEMENT SCIENCES
RESEARCH WORK FOR PH.D DISSERTATION
Research Topic:
Impact of retained earnings on the maximization of firm value and

shareholders wealth.
Study Description: This study is initiated with an aim to analyze devised models of
retained earnings (retention policy) and dividend payout (dividend
policy) and their impact on the maximization of firm value and
shareholders wealth (with special emphasis on reinvestment of
retained earnings) along with the moderating affect of capital
budgeting process and decisions taken by management of
manufacturing firms listed at Karachi Stock Exchange (KSE) in
Pakistan.
Dear respondent / informant
The purpose of this questionnaire is to collect data regarding captioned
topic in-order to understand and study the process of earnings distribution and utilization by
manufacturing firms listed at Karachi Stock Exchange (KSE). According to a research paper
Corporate governance and dividend policy published by Ayub Mehar in 2007, it is
mentioned that, in Pakistan 23 percent of firms listed at KSE convert their accumulated
profits into dividends. This percentage of dividend payment to shareholders in Pakistan is a
deteriorating phenomenon against the primary goal of a firm inception, that is, Shareholders
Wealth Maximization. The retention policy of listed firms in Pakistan is reported highest as
compared to business practices in other emerging nations of the world. This stockpiling of
profits and its reinvestment by the listed firms poses a big question. An attempt is being made
to explore this comprehensively in this study. All the information collected by means of this
questionnaire will strictly be kept confidential and only be used to facilitate this research
study. Sir, your frank, free and friendly response will be highly appreciated.
Note: A strict confidentiality will be maintained and no information, under all circumstances,
will be passed on to any individual(s) or organization(s).
Supervisor: Prof. Dr. Mehboob Ahmad

FUIEMS, Rawalpindi.
Researcher: Muhammad Ali Tirmizi

Ph.D Scholar, FUIEMS,
Rawalpindi.
216
217
218
219
220
221
222
223
224
225
DESCRIPTION OF THE TOOL

The details of the tool used for the dissertation is as follows:
1. Introduction of the tool
The introduction of the tool consists of a covering letter that briefly explains the purpose
of the study. On the second page two questions are included that asked respondents about
226
their understanding relating their firms payout policy and asked them to categorize their
firm as dividend payer firm or non-dividend payer firm. The introduction part also
contains four questions relating to the personal information of the respondents. In
personal information of respondents, they are asked about their designation, gender,
age and education and to answer these questions researcher has provided options
below these questions. He also asked respondents about the demographics of their firms
comprising of eight questions that included; firm ownership (adopted from the study of
Graham and Harvey (2002)), number of employees (developed based on the policy work
of SMEDA (2007)), firm age (developed personally), industrial classification (modified
based on the work of Graham and Harvey (2002) and the data included was acquired
from the website of the Karachi Stock Exchange), sales revenue (developed based on the
work of SMEDA (2007)), types of dividends (developed personally), retention policy
(developed personally) and dividend policy (developed based on the work of Graham and
Harvey (2002)). These questions have also been provided with suitable options, from
which respondents can select the best possible answer.
2. Part 1 of the tool

This part of the tool is comprised of ten questions. These questions have been included to
tap responses of the respondents regarding their firms performance from 2000 to 2009.
The questions in this part of the tool have been used to tap responses of the respondents
regarding their firms; sales revenue (modified based on the work of Graham and Harvey
(2002)), development expenditure (modified based on the work of Graham and Harvey
(2002)), borrowings (modified based on the work of Graham and Harvey (2002)),
dividend payments (modified based on the work of Graham and Harvey (2002)), retained
earnings as internal funds (developed personally), number of employees (modified based
227
on the work of Graham and Harvey (2002)), net income (modified based on the work of
Graham and Harvey (2002)), capital investment (developed personally), productivity
(modified based on the work of Graham and Harvey (2002)) and total cost of capital
(developed personally). In these questions researcher has provided three options to the
respondents based on the itemized rating scale. The scale is based on three options
adopted from the study of Graham and Harvey (2002) where option 1 represents
increased, 2 represents decreased and 3 represents no change.

This part of the tool is comprised of eighteen questions. These questions have been
included to tap dividend payout, firm value and shareholders wealth related
responses of the respondent regarding their firm. These questions have been specifically
included to tap responses of the respondents to test model 1 of our study. Researcher
used five point likert scale for these questions which ranges from 1 to 5 where, 1
represents strongly disagree, 2 represents disagree, 3 represents no opinion, 4
represents agree and 5 represents strongly agree. He adopted question 1 to 16
from the work of Baker, Saddi, Dutta and Gandhi (2007). Question 17 was developed
based on the work of Jones and Sharma (2001) and question 18 has been developed and
added by him.

This part of the tool is comprised of twenty three questions. These questions have been
included to tap retained earnings, firm value and shareholders wealth related
responses of the respondent regarding their firm. These questions have been specifically
included and modified to tap responses of the respondents to test model 2 of our study.
228
Researcher used five point likert scale for these questions which ranges from 1 to 5
where, 1 represents strongly disagree, 2 represents disagree, 3 represents no
opinion, 4 represents agree and 5 represents strongly agree. He adopted and
modified question 1 to 13 and 19 based on the work of Baker, Saddi, Dutta and
Gandhi (2007). He modified and transformed the actual questions representing dividend
payout, firm value and shareholders wealth adopted from the work of Baker, Saddi,
Dutta and Gandhi (2007) to represent questions relating retained earnings, firm value
and shareholders wealth. It has been done based on the concept introduced in the book
of Brigham & Ehrhardt (2001), which is already being discussed in chapter 3 of this
research thesis. Researcher included question 14 and 15 which have been developed
based on the study of Chen (2008), question 16 has been developed based on the study
of Eije and Megginson (2007), question 17 has been developed based on the study of
[Jones and Sharma (2001), and Wu and Yeung (2009)], question 18 has been developed
based on the study of [Garcia-Teruel and Martinez-Solano (2008), Chen (2008)], question
20 has been developed based on the study of Cheremushkin (2008), question 21 has
been developed based on the study of [Chiu and Liaw (2009), Abor, SarpongKumankoma, Fiawoyife and Osei (2009)], and question 22 and 23 have been
developed based on the study of Baker and Powell (1999).

This part of the tool is comprised of one question that has eight options. Researcher used
three point itemized rating scale for this question that ranges from 1 to 3 where, 1
represents best, 2 represents moderate and 3 represents least. This part of the tool
is adopted from a survey of Indias private sector Questionnaire (2006).
229

This part of the tool is comprised of one question that asked respondents about their
firms profits (after tax and interests) in terms of percentage of their firms total sales for
the period that ranges from the year 2000 to 2009. The options provided in this question
are; (negative, 0%, 1% to 10%, 10% to 20%, 20% to 30%, 30% to 40% and more than
40%). This question has been developed and modified based on the study of Johnson,
Mcmillan and Woodruff (2002).

This part of the tool is comprised of three questions. Question one asked respondents
about their firms reinvestment of net income (after tax and interest) during the period
that ranges from the year 2000 to 2009. The options provided in this question are; (0% to
25%, 25% to 50%, 50% to 75%, 70% to 100% and no reinvestment). This question has
been developed and modified based on the study of Johnson, Mcmillan and Woodruff
(2002). Question two included in this part asked respondents about the selection of
projects by their respective firms in which the management of their respective firms have
reinvested net income after tax and interests in the period that ranges from the year 2000
to 2009. Researcher included five options in this question where 1 represents new
investment in long-lived assets, 2 represents business expansion activities within the
firm, 3 represents investment in real estate, 4 represents investment in intangible
assets (like; marketable securities or financial assets) and 5 represents other in case of
investments not mentioned in the four options provided in this question. This question
demanded respondents to select all that apply to their respective firms. He developed and
modified this question based on the study of Cheremushkin (2008). Question three
included in this part of the tool asked respondents about the outcome of their most recent
230
projects that their respective firms undertook in Pakistan. The options included in this
question ranges from 1 to 5, where 1 represents more profitable than expected, 2
represents as profitable as was expected, 3 represents less profitable than expected,
4 represents break-even and 5 represents not profitable at all. We developed and
modified this question on the basis of the study of Tsamenyi and Tauringana (2004).

This part of the tool is comprised of one question that asked respondents about the
percentage of their firms shares owned by the senior managers that are; chief executive
officer, chief financial officer, etc. The options provided in this question are; (less than
5%, 5% to 10%, 10% to 20%, greater than 20% and none). In this question Researcher
intended to find-out the impact of managerial ownership on the value of the firm and
according to the study of Dutta (1999) value of the firm increases as managerial
ownership increases from 0% to 5% and when managerial ownership increases from 5%
to 25% value of the firm decreases. He developed and modified this question based on
the study of Dutta (1999).

This part of the tool is comprised of one question that asked respondents about their
firms following items of financial statements in rupee amounts for the years of
operations that ranges from the year 2000 to 2009; net income (after tax and interests),
retained earnings, dividends paid and total cash holdings of the firm. Researcher
developed and modified this question on the basis of a survey questionnaire (1999)
designed for the national survey of small business finances by the board of governors of
231
the Federal Reserve and United States. Small Business Administration, United States of
America.

This part of the tool is comprised of four questions. These questions have been included
to tap capital budgeting process and decisions related to responses of the respondent
regarding their firm. These questions have been specifically included and modified to tap
responses of the respondents to test model 1 and 2 of our study based on the
moderating affect of capital budgeting process and decisions on the interaction of
variable of these models. Researcher used five point likert scale for question 1 and 2
that ranges from 1 to 5 where, 1 represents never, 2 represents rarely, 3
represents sometimes, 4 represents often and 5 represents always. He used four
point itemized rating scale for the question 3 that ranges from 1 to 4 where, 1
represents discount rate, 2 represents cash flow, 3 represents both and 4
represents none. The scale used for fourth question is five point likert scale that ranges
from 1 to 5 where 1 represents strongly disagree, 2 represents disagree, 3
represents no opinion, 4 represents agree and 5 represents strongly agree. We
adopted question 1 to 30 from the study of Graham and Harvey (2002). Question 31,
32, 33 and 34 have been developed by him and question 35, 36 and 37 have
been developed and modified based on the study of Tsamenyi and Tauringana (2004).

This part of the tool is comprised of three questions. These questions have been included
to tap responses of the respondents regarding their firms growth trends and conditions of
their firms sources of available finances. This question has been developed and modified
232
based on the study of Johnson, Mcmillan and Woodruff (2002). Question one included in
this part asked respondents about the average growth of their respective firms in the past
ten years that ranges from the year 2000 to 2009. The options provided in this question
are; (less than 10% per year, 10% to 200% per year, over 20% per year, got smaller, not
applicable, the firm is too recent and dont know). Question two included in this part
asked respondents about their firms expected growth in the next 2 to 3 year in terms of
turnover. The options provided in this question are; [slow growth (below 10% per years
in terms of turnover), grow moderately (between 10% to 20% per year in terms of
turnover), grow substantially (over 20% per year in terms of turnover), stay the same size,
become smaller and dont know]. Question three included in this part of the tool asked
respondents about the conditions of the available finances to their respective firms over
the period of one to three years. Researcher has provided six suitable and appropriate
options in this question scales on five point likert scale that ranges from 1 to 5 where
1 represents will improve, 2 represents will remain unchanged, 3 represents will
deteriorate, 4 represents not applicable to my firm and 5 represents dont know.
He adopted question 1, 2 and 3 included in this part of the tool from the European
Central Bank (2009), survey questionnaire named as European Commission and
European Central Bank Survey on the access to finance of SMEs.
233
APPENDIX B: STUDY POPULATION
234
235
236
237
238
APPENDIX C: RESEARCH SAMPLE
239
240
241
242
243
CALCULATIONS OF SAMPLE SIZE
244
APPENDIX D: EMPIRICAL EVIDENCE

OF INTERACTION OF VARIABLES OF THE STUDY
Table 1: Interaction of Retained Earnings and Firm Value
S.
No
Author(s)
Year of
Publication
Positive
Negative
Chung and Wright
1998
(for low q
firms)
Chung and Wright
1998
(for high
q firms
with R&D
investments)
Chiu and Liaw
2009
Karadeniz, Kandir,
Balcilar and Onal
2009
Ezeoha
2008
Brien
2003
Chen
2008
Gentry, Reilly and

Sandretto
2003
Baum and Turner
2004
245
Table 2: Interaction of Dividend Payout and Firm Value

S.
No
Author(s)
Year of
Publication
Positive
Negative
Graham and Dodd
1951
Seitz and Ellison
1998
Chung and Wright
1998
Weigand and Baker
2009
Amidu and Abor
2006
Fargher and Weigand
2009
Fuller and Blau
2010
Fama and French
1998
Mizuno
2007
10
DeAngelo and DeAngelo
2007
11
Hughes (2008)
2008
12
Baker, Saadi, Dutta and

Gandhi
2007
246
Table 3: Impact of Retained Earnings on Shareholders Wealth

S.
No
Author(s)
Year of
Publication
Positive
Negative
Groves and Samuels
1976
Chen
2008
Baum and Turner
2004
Ghosh and Woolridge
1989
Table 4: Impact of Dividends Payout on Shareholders Wealth

S.
No
Author(s)
Year of
Publication
Positive
Negative
Graham and Dodd
1951
DeAngelo and DeAngelo
2007
Botha, Bosch and Van Zyl
1987
Dhanani
2005
Baker, Saadi, Dutta and

Gandhi
2007
Dasilas, Lyroudi and

Ginoglou
2009
Azhagaiah and Priya
2008
247
Table 5: Impact of firm value on Shareholders Wealth

S.
No
Author(s)
Year of
Publication
Positive
Negative
Copeland et al.
2007
Kilroy
1999
Lin and Ji
2007
Table 6: Moderating affect of Capital Budgeting Process and Decisions the Interactions of
variables of Model 1 & 2
S.
No
Author(s)
Year of
Publication
Positive
Negative
Horne et al.
2008
Seitz and Ellison
1998
Toit and Pienaar
2005
Elumilade, Asaolu and

Ologunde
2006
Brookfield
1995
248
APPENDIX E: FIRMS LEFT AFTER DATA COLLECTION PROCESS

S.
No
RANDOMLY SELECTED MANUFACTURING

FIRMS OF PAKISTAN (SAMPLE)
Agritech Limited
Bawany Air Products Limited
Clariant Pakistan Limited
Dewan Farooque Motors Limited
Dynea Pakistan Limited
Engro Corporation Limited
Fauji Fert Bin Qasim Limited
Gatron Industries Limited
Ittehad Chemicals Limited
10
Leiner Pak Gelatine Limited
11
Mandviwala Mauser Plastic Industries Limited
12
Nimir Industrial Chemicals Limited
13
Polyron Limited
14
Shaffi Chemical Industries Limited
15
Sitara Chemical Industries Limited
16
Wah-Noble Chemicals Limited
17
Abbott Laboratories (Pakistan) Limited
18
Ferozsons Laboratories Limited
19
Highnoon Laboratories Limited
20
IBL HealthCare Ltd
21
Johnson & Phillips (Pakistan) Limited
22
AL-Abbas Sugar Mills Limited
23
Adam Sugar Mills Limited
249
24
AL-Noor Sugar Mills Limited
25
Chashma Sugar Mills Limited
26
Colony Sugar Mills Limited
27
Data Agro Limited
28
Goodluck Industries Limited
29
Habib-ADM Limited
30
Husein Sugar Mills Limited
31
Haseeb Waqas Sugar Mills Limited
32
Ismail Industries Limited
33
Kohinoor Sugar Mills Limited
34
Khairpur Sugar Mills Limited
35
Mirpurkhas Sugar Mills Limited
36
Morafco Industries Limited
37
Punjab Oil Mills Limited
38
Quice Food Industries Limited
39
Rafhan Maize Products Company Limited
40
Sanghar Sugar Mills Limited
41
Sind Abadgar's Sugar Mills Limited
42
Shakarganj Mills Limited
43
Shakarganj Foods Limited
44
Shahtaj Sugar Mills Limited
45
Sakrand Sugar Mills Limited
46
Salim (O)
47
S.S.Oil Mills Limited
48
Tandlianwala Sugar Mills Limited
49
UniLever Pak Pakistan Limited
250
50
Wazir Ali Industries Limited
51
Atlas Honda Limited
52
Bela Automotives Limited
53
Exide Pakistan Limited
54
Ghani Automobile Industries Limited
55
General Tyre
56
Pak Suzuki Motor Company Limited
57
Transmission Engineering Industries Limited
58
Berger Paints Pakistan Limited
59
Balochistan Glass Limited
60
Cherat Cement Company Limited
61
Dadex Eternit Limited
62
Dadabhoy Cement Industries Limited
63
D. G. Khan Cement Company Limited
64
Dandot Cement Company Limited
65
EMCO Industries Limited
66
Gammon Pakistan Limited
67
Gharibwal Cement Limited
68
Haydari Construction Company Limited
69
Javedan Cement Limited
70
Kausar Paints Limited
71
Karam Ceramics Limited
72
Kohat Cement Company Limited
73
Lafarge Pakistan Cement Limited
74
Mustehkam Cement Limited
75
Pioneer Cement Limited
251
76
Safe Mix Concrete Products Limited
77
Zeal Pak. Cement Factory Limited
78
Bolan Castings Limited
79
Ghandhara Industries Limited
80
Hinopak Motors Limited
81
Crescent Steel & Allied Products Limited
82
Huffaz Pipe Seamless Pipe Industries Limited
83
Siddiqsons Tin Plate Limited
84
Nestle Pakistan Limited
85
Mitchell's Fruit Farms Limited
252
APPENDIX F: FIRMS DEFAULTED DURING DATA COLLECTION

(Reason: Offices Closed or Firms Liquidated)
S.
No
Firm Information
Postal Mail Return Information
Extraction (Pakistan) Limited (Faisalabad)
Sind Alkalis Limited (Karachi)
Uqab Breeding Farms Limited (Thatta)
Mubarik Dairies Limited (Lahore)
Taxila Engineering Limited (Lahore)
Suraj Ghee Industries Limited (Lahore)
Adil Polypropylene Products Limited (Lahore)
Pak Fibre Industries Limited (Hub Baluchistan)
253
Questionnaire
Dispatched
August 25, 2010
Questionnaire
Returned
August 31, 2010
Questionnaire
Dispatched
August 25, 2010
Questionnaire
Returned
August 31, 2010
Questionnaire
Dispatched
August 25, 2010
Questionnaire
Returned
September 16, 2010
Questionnaire
Dispatched
September 15, 2010
Questionnaire
Returned
September 20, 2010
Questionnaire
Dispatched
September 15, 2010
Questionnaire
Returned
September 21, 2010
Questionnaire
Dispatched
September 15, 2010
Questionnaire
Returned
September 22, 2010
Questionnaire
Dispatched
September 28, 2010
Questionnaire
Returned
October 01, 2010
Questionnaire
Dispatched
August 25, 2010
Questionnaire
Returned
October 12, 2010
APPENDIX G: DISTRIBUTION OF RESEARCH QUESTIONNAIRES

Table 1: Distribution by means of postal mail
S.
No
1
QUESTIONNAIRES DISTRIBUTION
THROUGH POSTAL MAIL
CLARIANT PAKISTAN LIMITED
2
3
SENT DATE
STATUS
August 20, 2010
Responded
PAK FIBRE INDUSTRIES LIMITED
August 20, 2010
No response
August 20, 2010
No response
August 20, 2010
No response
SHAFFI CHEMICAL INDUSTRIES LIMITED

ABBOTT LABORATORIES (PAKISTAN)
LIMITED
AL-NOOR SUGAR MILLS LIMITED
August 20, 2010
No response
EXTRACTION (PAKISTAN) LIMITED
August 20, 2010
Defaulted
UNILEVER PAKISTAN LIMITED
August 20, 2010
No response
UQAB BREEDING FARMS LIMITED
August 20, 2010
Defaulted
August 20, 2010
Defaulted
August 20, 2010
No response
August 20, 2010
No response
August 20, 2010
No response
August 20, 2010
No response
14
CENTRAL FOREST PRODUCTS LIMITED

DADABHOY CONSTRUCTION TECHNOLOGY
LIMITED
DADABHOY CEMENT INDUSTRIES LIMITED
HAYDARI CONSTRUCTION COMPANY
LIMITED
HUFFAZ SEAMLESS PIPE INDUSTRIES
LIMITED
SIND ALKALIS LIMITED
August 20, 2010
Defaulted
15
IBL HEALTHCARE LIMITED
August 20, 2010
No response
16
AL-ABBAS SUGAR MILLS LIMITED
August 20, 2010
No response
17
JAVEDAN CEMENT LIMITED
August 20, 2010
No response
18
TAXILA ENGINEERING LIMITED
September 14, 2010
Defaulted
19
SURAJ GHEE INDUSTRIES LIMITED
September 14, 2010
Defaulted
20
MUBARIK DAIRIES LIMITED
September 14, 2010
Defaulted
21
MORAFCO INDUSTRIES LIMITED
September 14, 2010
No response
22
GHANDHARA INDUSTRIES LIMITED
September 14, 2010
No response
23
AGRITECH LIMITED
September 14, 2010
No response
24
BAWANY AIR PRODUCTS LIMITED
September 17, 2010
No response
25
ENGRO CORPORATION LIMITED
September 17, 2010
No response
26
MIRPURKHAS SUGAR MILLS LIMITED
September 17, 2010
No response
27
SHAHTAJ SUGAR MILLS LIMITED
September 17, 2010
No response
28
SINDH ABADGAR'S SUGAR MILLS LIMITED
September 17, 2010
Responded
29
HABIB-ADM LIMITED
September 17, 2010
No response
30
WAZIR ALI INDUSTRIES LIMITED
September 17, 2010
No response
31
LAFARGE PAKISTAN CEMENT LIMITED
September 17, 2010
Responded
10
11
12
13
254
32
DEWAN FAROOQUE MOTORS LIMITED
September 21, 2010
No response
33
GHANI AUTOMOBILE INDUSTRIES LIMITED
September 21, 2010
No response
34
SAFE MIX CONCRETE PRODUCTS LIMITED
September 21, 2010
No response
35
DANDOT CEMENT COMPANY LIMITED
September 21, 2010
No response
36
PIONEER CEMENT LIMITED
September 21, 2010
No response
37
CHERAT CEMENT COMPANY LIMITED
September 22, 2010
No response
38
GAMMON PAKISTAN LIMITED
September 22, 2010
Responded
39
SHAKARGANJ MILLS LIMITED
September 27, 2010
No response
40
TAXILA ENGINEERING LIMITED
September 27, 2010
Defaulted
41
PAK SUZUKI MOTOR COMPANY LIMITED
September 27, 2010
Responded
42
ADIL POLYPROPYLENE PRODUCTS LIMITED
September 27, 2010
Defaulted
43
TANDLIANWALA SUGAR MILLS LIMITED
September 27, 2010
No response
44
AGRIAUTO INDUSTRIES LIMITED
September 27, 2010
No response
45
September 27, 2010
Responded
September 27, 2010
No response
47
MITCHELL'S FRUIT FARMS LIMITED

CRESCENT STEEL & ALLIED PRODUCTS
LIMITED
NESTLE PAKISTAN LIMITED
September 27, 2010
Responded
48
IBL HEALTHCARE LIMITED
October 1, 2010
No response
SENT DATE
STATUS
August 22, 2010
No response
46
Table 2: Distribution by means of E-mail

S.
No
1
QUESTIONNAIRES DISTRIBUTION
THROUGH ELECTRONIC MAIL
ADAM SUGAR MILLS LIMITED
BALOCHISTAN GLASS LIMITED
August 22, 2010
No response
BAWANY AIR PRODUCTS LIMITED
August 22, 2010
No response
BELA AUTOMOTIVES LIMITED
August 22, 2010
No response
BOLAN CASTINGS LIMITED
August 22, 2010
No response
DYNEA PAKISTAN LIMITED
August 22, 2010
No response
ENGRO CORPORATION LIMITED
August 22, 2010
No response
EXIDE PAKISTAN LIMITED
August 22, 2010
No response
GATRON (INDUSTRIES) LIMITED
August 22, 2010
No response
10
GHANDHARA NISSAN LIMITED
August 22, 2010
No response
11
GOODLUCK INDUSTRIES LIMITED
August 22, 2010
No response
12
HABIB-ADM LIMITED
August 22, 2010
No response
13
ISMAIL INDUSTRIES LIMITED
August 22, 2010
No response
14
KAUSAR PAINTS LIMITED
August 22, 2010
No response
15
KHAIRPUR SUGAR MILLS LIMITED
August 22, 2010
Responded
255
August 22, 2010
No response
17
MANDVIWALA MAUSER PLASTIC

INDUSTRIES LIMITED
MIRPURKHAS SUGAR MILLS LIMITED
August 22, 2010
No response
18
POLYRON LIMITED
August 22, 2010
No response
19
August 22, 2010
No response
August 22, 2010
No response
21
QUICE FOOD INDUSTRIES LIMITED

RAFHAN MAIZE PRODUCTS COMPANY
LIMITED
SAKRAND SUGAR MILLS LIMITED
August 22, 2010
No response
22
SANGHAR SUGAR MILLS LIMITED
August 22, 2010
No response
23
SHAHTAJ SUGAR MILLS LIMITED
August 22, 2010
No response
24
SIDDIQSONS TIN PLATE LIMITED
August 22, 2010
No response
25
SINDH ABADGAR'S SUGAR MILLS LIMITED
August 22, 2010
Responded
26
August 22, 2010
No response
August 22, 2010
No response
28
SITARA CHEMICAL INDUSTRIES LIMITED

TRANSMISSION ENGINEERING INDUSTRIES
LIMITED
WAZIR ALI INDUSTRIES LIMITED
August 22, 2010
No response
29
ZEAL PAK CEMENT FACTORY LIMITED
August 22, 2010
No response
30
ADIL POLYPROPYLENE PRODUCTS LIMITED
September 18, 2010
Defaulted
31
AGRIAUTO INDUSTRIES LIMITED
September 18, 2010
No response
32
ATLAS HONDA LIMITED
September 18, 2010
Responded
33
BERGER PAINTS PAKISTAN LIMITED
September 18, 2010
No response
34
CHERAT CEMENT COMPANY LIMITED
September 18, 2010
No response
35
September 18, 2010
No response
September 18, 2010
No response
37
COLONY SUGAR MILLS LIMITED

CRESCENT STEEL & ALLIED PRODUCTS
LIMITED
D. G. KHAN CEMENT COMPANY LIMITED
September 18, 2010
No response
38
DADEX ETERNIT LIMITED
September 18, 2010
No response
39
DANDOT CEMENT COMPANY LIMITED
September 18, 2010
No response
40
DATA AGRO LIMITED
September 18, 2010
No response
41
DEWAN FAROOQUE MOTORS LIMITED
September 18, 2010
No response
42
EMCO INDUSTRIES LIMITED
September 18, 2010
No response
43
FAUJI CEMENT COMPANY LIMITED
September 18, 2010
No response
44
FAUJI FERTILIZER BIN QASIM LIMITED
September 18, 2010
Responded
45
FAUJI FERTILIZER COMPANY LIMITED
September 18, 2010
Responded
46
FEROZSONS LABORATORIES LIMITED
September 18, 2010
No response
47
September 18, 2010
Responded
48
GENERAL TYRE
September 18, 2010
No response
49
GHANI AUTOMOBILE INDUSTRIES LIMITED
September 18, 2010
No response
50
GHARIBWAL CEMENT LIMITED
September 18, 2010
No response
51
HASEEB WAQAS SUGAR MILLS LIMITED
September 18, 2010
No response
16
20
27
36
256
52
HIGHNOON LABORATORIES LIMITED
September 18, 2010
No response
53
HINOPAK MOTORS LIMITED
September 18, 2010
No response
54
HONDA ATLAS CARS (PAKISTAN) LIMITED
September 18, 2010
Responded
55
HUSEIN SUGAR MILLS LIMITED
September 18, 2010
No response
56
ITTEHAD CHEMICALS LIMITED
September 18, 2010
No response
57
JOHNSON & PHILLIPS (PAKISTAN) LIMITED
September 18, 2010
No response
58
KARAM CERAMICS LIMITED
September 18, 2010
No response
59
KOHAT CEMENT COMPANY LIMITED
September 18, 2010
No response
60
KOHINOOR SUGAR MILLS LIMITED
September 18, 2010
No response
61
LEINER PAK GELATINE LIMITED
September 18, 2010
No response
62
NIMIR INDUSTRIAL CHEMICALS LIMITED
September 18, 2010
No response
63
PAK SUZUKI MOTOR COMPANY LIMITED
September 18, 2010
Responded
64
PIONEER CEMENT LIMITED
September 18, 2010
No response
65
PUNJAB OIL MILLS LIMITED
September 18, 2010
No response
66
S.S.OIL MILLS LIMITED
September 18, 2010
No response
67
SAFE MIX CONCRETE PRODUCTS LIMITED
September 18, 2010
No response
68
SALIM INDUSTRIAL COMPANY (PVT) LTD.
September 18, 2010
No response
69
SHAKARGANJ FOODS LIMITED
September 18, 2010
No response
70
SHAKARGANJ MILLS LIMITED
September 18, 2010
No response
71
TANDLIANWALA SUGAR MILLS LIMITED
September 18, 2010
No response
72
WAH NOBLE CHEMICALS LIMITED
September 18, 2010
No response
SENT DATE
STATUS
September 6, 2010
Responded
September 6, 2010
Responded
Table 3: Distribution by hand

S.
No
1
QUESTIONNAIRES DISTRIBUTED
PERSONALLY
MUSTEHKAM CEMENT LIMITED
CHASHMA SUGAR MILLS LIMITED
257
APPENDIX H: FIRMS REPLIED

WITH COMPLETELY FILLED QUESTIONNAIRES
S.
No
MANUFACTURING SAMPLE FIRMS
RECEIVING DATE
QUESTIONNAIRE
RECEIVED
CLARIANT PAKISTAN LIMITED
September 2, 2010
ATLAS HONDA LIMITED
September 23, 2010
SINDH ABADGAR'S SUGAR MILLS

LIMITED
September 24, 2010
FAUJI FERTILIZER BIN QASIM

LIMITED
September 29, 2010
CHASHMA SUGAR MILLS LIMITED
October 8, 2010
MITCHELL'S FRUIT FARMS LIMITED
October 11, 2010
NESTLE PAKISTAN LIMITED
October 13, 2010
PAK SUZUKI MOTOR COMPANY

LIMITED
November 12, 2010
MUSTEHKAM CEMENT LIMITED
November 22, 2010
10
LAFARGE PAKISTAN CEMENT

LIMITED
November 27, 2010
11
KHAIRPUR SUGAR MILLS LIMITED
December 8, 2010
12
December 20, 2010
Total useable Questionnaires received
258
12
APPENDIX I: FACTOR ANALYSIS

(Factor Loadings)
Table 1: Communality values for Dividend Payout variable of Model 1

Initial
Extraction
Q - 1: Firm's investment, financing and dividend decisions

are interrelated (Dividend payout)
1.000
.737
Q - 5: Firm's dividend policy generally affects its cost of

capital (Dividend Payout)
1.000
.774
Q - 6: Firm should view cash dividends as a residual after

funding desired investments from earnings (Dividend
payout)
1.000
.745
Q - 7: Firm's expenditures on new capital investments

generally affect its dividend pattern (dividend payout)
1.000
.874
Q - 8: Firm should change dividends based on sustainable

shifts in earnings (Dividend payout)
1.000
.964
Q - 9: The market places greater value on stable dividends

than stable payout ratios (Dividend payout)
1.000
.964
Q - 10: Firm should set a target dividend payout ratio and

periodically adjust its current payout towards the target
(Dividend payout)
1.000
.895
Q - 15: The payment of dividends forces firm to seek more

external (debt or equity) financing, subjecting the firm to
additional investor scrutiny (Dividend payout)
1.000
.601
Q - 16: The pattern of cash dividends generally changes

over firm's lifecycle (Dividend payout)
1.000
.912
Q - 18: Firm should have a target payout ratio (Dividend

payout)
1.000
.669
Extraction Method: Principal Component Analysis.
259
Table 2: Communality values for Firm Value variable of Model 1

Initial
Extraction
Q - 2: An optimal dividend policy strikes a balance between

current dividends and future growth that maximizes stock
price (Firm value)
1.000
.884
Q - 4: A change in firm's cash dividends affects its value

(Firm value)
1.000
.915
Q - 11: Firm's stock price generally rises when the firm

unexpectedly increases its dividend (Firm value)
1.000
.979
Q - 12: Firm's stock price generally falls when the firm

unexpectedly decreases its dividend (Firm value)
1.000
.944
Q - 17: Growth oriented firms generally have lower

dividend payout ratios than non-growth oriented firms (Firm
value)
1.000
.896
Table 3: Communalities values for Shareholders wealth variable of Model 1

Initial
Extraction
Q - 3: Firm should formulate its dividend policy to produce

maximum value for its shareholders (Shareholder's wealth)
1.000
.763
Q - 13: Investors generally regard dividend changes as

signals about firm's future prospects (Shareholder's wealth)
1.000
.501
Q - 14: The payment of dividends encourages firm's

managers to act in the interest of the firm's outside
shareholders (Shareholder's wealth)
1.000
.646
260
Table 4: Communality values for Retained Earnings variable of Model 2

Initial
Extraction
Q - 1: Firm's reinvestment, financing and earnings retention

decisions are interrelated (Retained Earnings)
1.000
.940
Q - 5: Firm's earnings retention policy generally affects its

cost of capital (Retained Earnings)
1.000
.892
Q - 6: Firm should view retained earnings as a residual after

payment of dividends to its shareholders (Retained
Earnings)
1.000
.926
Q - 7: Firm's expenditures on new investments are generally

affected by its level of retained earnings (Retained
Earnings)
1.000
.836
Q - 8: Firm should change its level of cash holdings based

on sustainable shifts in earnings (Retained Earnings)
1.000
.908
Q - 9: These days market places greater value on stockpiling

of earnings as a form of financial buffer (cushion) (Retained
Earnings)
1.000
.920
Q - 10: Firm should set a target earnings retention ratio and

periodically adjust its current level of retained earnings
towards the target (Retained Earnings)
1.000
.961
Q - 19: The pattern of earnings retention generally changes

over firm's lifecycle (Retained Earnings)
1.000
.716
Q - 22: Firm should have a target earnings retention ratio

(Retained Earnings)
1.000
.823
Q - 24: Retained Earnings are the least risky source of

financing investment projects (Retained Earnings)
1.000
.895
261
Table 5: Communality values for Firm Value variable of Model 2

Initial
Extraction
Q - 2: An optimal earnings retention policy strikes a balance

between current holdings and future growth that maximizes
stock price (Firm value 2)
1.000
.549
Q - 4: A change in firm's level of retained earnings affects

its value (Firm value 2)
1.000
.633
Q - 11: Firm's stock price generally rises when the firm

unexpectedly increases its retained earnings (Firm value 2)
1.000
.947
Q - 12: Firm's stock price generally falls when the firm

unexpectedly decreases its retained earnings (Firm value 2)
1.000
.968
Q - 16: Mature firms generally stockpile earnings higher

than younger firms (Firm value 2)
1.000
.709
Q - 17: Growth oriented firms generally accumulate more

earnings as compared to non-growth firms (Firm value 2)
1.000
.661
Q - 18: Growth oriented firms having greater conflict of

interests between managers and shareholders generally
accumulate more cash to meet their investment needs (Firm
value 2)
1.000
.877
Q - 20: Reinvestment of retained earnings in business

expansion activities is a prominent signal of firm's
exponential growth in terms of income (Firm value 2)
1.000
.836
Q - 21: Firm's greater amount of retained earnings facilitates

management by achieving their goals in a better way even in
the times of market turbulence (Firm value 2)
1.000
.651
262
Table 6: Communality values for Shareholders Wealth variable of Model 2

Initial
Extraction
Q - 3: Firm should formulate its earnings retention policy to

maximize value for its shareholders (Shareholder's wealth 2)
1.000
.729
Q - 13: Investors generally regard firm's earnings reserves

as signals about its future prospects (Shareholder's wealth 2)
1.000
.572
Q - 14: The accumulation of earnings (retained earnings)

encourages firm's managers to pursue their private benefits
against the interest of the firm's inside shareholders
(Shareholder's wealth 2)
1.000
.933
Q - 15: The accumulation of earnings (retained earnings)

encourages firm's managers to pursue their private benefits
against the interest of the firm's outside shareholders
(Shareholder's wealth 2)
1.000
.952
Q - 23: Investors prefer that a firm retains funds over paying

dividends because of the way capital gains are taxed as
compared with dividends (Shareholder's wealth 2)
1.000
.643
263
Table 7: Communality values for Capital Budgeting Process and Decisions moderating
variable
Initial
Extraction
Q - 31: Capital Budgeting Process and Decisions generally

facilitate management to utilize retained earnings (capital)
effectively in reinvestment activities, which leads to
maximized value of the firm (Capital Budgeting Process
and Decision)
1.000
.616

facilitate management in distribution and allocation of
income (capital) effectively, which leads to maximized
value of the firm (Capital Budgeting Process and Decision)
1.000
.823

facilitate management of the firm to maximize its market
value (Capital Budgeting Process and Decision)
1.000
.603
Q - 35: According to respondent, Budget Control Procedure

or System is an effective tool (Capital Budgeting Process
and Decision)
1.000
.726
Q - 36: According to respondent, Budget Control Procedure

or System helps management to identify additional risks of
the project (Capital Budgeting Process and Decision)
1.000
.683
Q - 37: According to respondent, Analysis of projects with

Budget Control Procedure or System helps management to
identify large unfavorable budget variances (Capital
Budgeting Process and Decision)
1.000
.716
264
APPENDIX J: EXTENTION OF EQUATIONS

On the basis of study results and their analysis we can modify the equations
representing solutions to condition 1 and 2 derived in chapter 3:
Combining solutions of condition 1 and 2 based on analysis of the research model
1 and 2, we get;
1 Div payout
Re tained Earnings
Or,
1
Div
payout
CSTE X
Re tained Earnings CSTE X t
And,
1 SW1 Div payout CSTE X t
Re tained Earnings CSTE X t
where; 1 SW1 because SW1 is a linear function of 1

Or,
1 SW1 1
Div
payout
CSTE X
2 Re tained Earnings CSTE X t t

Now, rewriting the above mentioned equation to separate interactions of constructs,
we get;
(1, i) 1 Div payout CSTE 1 X 1 ( t, i )

2
Re tained Earnings CSTE
And,
265
[Equation I]
X 2 ( t , i) t
SW(1, i ) 1
Div
payout
CSTE
X 1 ( t , i)
[Equation II]
2 Re tained Earnings CSTE 2 X 2 ( t , i) t
Now, after the introduction of the moderating variable that is; Capital Budgeting
Process and Decisions (CBPD) in above mentioned modeled equations I and II,
the change in the level of interactions between the constructs based on the analysis of
the results of the collected data relating to research model 1 and 2, can be
expressed as follows;
The outcome of the affect of dividend payout and moderating variable is shown
below:
Div
payout
[CBPD]
Div payout (MA )
The outcome of the affect of retained earnings and moderating variable is shown
below:
Re tained Earnings [CBPD ]2
Re tained Earnings ( MA )
Now, incorporating the outcomes of the impact of moderating variable with the
dividend payout and retained earnings variables in equation I and II, we get;
(1, i) 1
Div
payout ( MA )
CSTE
X 1 ( t , i)
[Equation III]
2 Re tained Earnings ( MA ) CSTE 2 X 2 ( t , i) t
And,
266
SW(1, i ) 1
Div
payout ( MA )
CSTE
X 1 (t, i)
[Equation IV]
2 Re tained Earnings ( MA ) CSTE 2 X 2 ( t , i) t
Where, the symbolic expressions mentioned in equation I, II, III and IV above
have the following meanings;
1 = It represents value of the firm i in the time t

SW1 = It represents shareholders wealth for the firm i in the time t
1 and 2 = These are the constants for modeled equation I and II
[CSTE ]1 and [CSTE ]2 = These represent continuous stream of total earnings
for the model I and II
X1 and X 2 = These represent vector of all the financial variables affecting
model I and II interaction of constructs
[CBPD]1 and [CBPD ]2 = These represent capital budgeting process and

decisions variable and it acted as moderating variable in the modeled equation
III and modeled equation IV
Div
payout ( MA )
= It represents dividend payout variable under the
moderating affect of the moderator variable in model III and IV
Re tained earnings
(MA )
= It represents retained earnings variable under the
moderating affect of the moderator variable in model III and IV
t = Model error term
267
The equation III and IV shows that dividend payout under the influence of the
moderating variable reduces value of firm i in the time t as well as the wealth of
the shareholders of the firm i in the time t is reduced. The reduction affect of
dividend payout under the influence of moderating variable is represented with the
negative sign in the equations III and IV. Whereas, retained earnings have
enhanced the value of the firm i in the time t as well as wealth of the shareholders
of the firm i in the time t is also maximized.
268

Impact of Retained Earnings On The Maximization of Firm Value and Shareholders Wealth

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IMPACT OF RETAINED EARNINGS ON THE MAXIMIZATION

OF FIRM VALUE AND SHAREHOLDERS WEALTH

INSTITUTE OF ENGINEERING AND MANAGEMENT SCIENCES

IMPACT OF RETAINED EARNINGS ON THE MAXIMIZATION

A Dissertation submitted to the

Faculty of Management Sciences

DEGREE OF DOCTOR OF PHILOSOPHY

TEAM OF SUPERVISOR, EVALUATORS & EXAMINERS

Prof. Dr. Mehboob Ahmad

Prof. Dr. Amin Sarkar

Prof. Dr. Sajid Anwar

Prof. Dr. Khair-uz-Zaman

Dr. Syed Hassan Raza

Dr. Hummayoun Naeem

TEAM OF SUPERVISOR, EVALUATORS & EXAMINERS...

CHAPTER -1: INTRODUCTION......

CHAPTER -2: REVIEW OF THE LITERATURE......

REVIE OF RELEVANT THEORATICAL DEVELOPMENT..

2.1 Early Developments regarding Dividends and Retained Earnings (1950-60).

2.2 Dividend Policy and MM Theory (1960-80s).. 7

REVIEW OF THE EMPIRICAL WORK DONE...

SECTION - I: TREATING INDEPENDENT VARIABLES.

2.5 Studies conducted in United States of America... 14

2.7 Studies Conducted in United Kingdom 35

2.10 Studies conducted in Korea and Japan.

2.11 Studies conducted in China, Taiwan and India

2.12 Studies conducted in African Countries... 46

2.15 Critical Analysis...

SECTION - II: TREATING DEPENDENT VARIABLES 56

2.20 Studies conducted by considering multiple countries..

2.21 Critical Analysis...

SECTION - III: TREATING MODERATING VARIABLE. 70

2.23 Studies conducted in Australia and European Union Countries..

2.24 Studies conducted in China, Taiwan and Uzbekistan..

2.25 Studies conducted in African Countries... 80

SECTION - IV: STUDIES CONDUCTED IN PAKISTAN... 84

CHAPTER-3: THEORETICAL FRAMEWORK....

3.2 Modified Research Model

3.3 Definition of the Variables...

3.3.1 Firm Value. 104

3.3.3 Retained Earnings (Retention Policy of the firm).

3.3.4 Dividend Payout (Dividend Policy of the firm)

3.3.5 Capital Budgeting Process and Decisions.

3.4 Operationalization of the Variables.. 106

3.4.2 Operationalized form of Retained Earnings, Firm Value and

3.4.3 Operationalized form of Capital Budgeting Process and

3.6 Hypotheses of the Study... 114

3.6.6 Hypotheses concerning moderating affect of capital budgeting

4.1 Research Design of the Study..

4.1.1 Purpose of the study..

4.1.2 Type of investigation. 120

4.1.5 Unit of analysis.. 121

4.1.7 Sample size (n)..

4.1.8 Time horizon.

4.1.9 Data collection Method.

4.2 Universe and the Sampling..

4.3 Rationale of the Selection of the Universe... 123

5.1 Rationale and Selection of Tool...

5.2 Tool Development.... 125

CHAPTER - 6: DATA ANALYSIS AND INTERPRETATION......

6.2 Descriptive Analysis of Collected Data...

6.2.1 Respondents data... 130

6.3.3 Impact of Firm Value on Shareholders Wealth..