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Corporate dividends decisions:

evidence from Saudi Arabia

Corporate
dividends
decisions

Jasim Al-Ajmi and Hameeda Abo Hussain

Department of Economics and Finance, College of Business Administration,
University of Bahrain, Sakhir, Bahrain

41

Abstract
Purpose The paper aims to test the stability of dividend policy, test the effect of cash flow on the
companys dividend policy, identify the factors that determine a firms cash dividend payments, and
examine the characteristics of dividend-paying and non-paying firms.
Design/methodology/approach The hypotheses are tested using unbalance panel data for a
sample of 54 Saudi-listed firms during 1990-2006.
Findings Saudi firms pay out a lower proportion of their cash flows compared to the proportion of
dividends of reported earnings. Firms have more flexible dividend policies since they are willing to cut
or skip dividends when profit declines and pay no dividends when losses are reported. Lagged
dividend payments, profitability, cash flows, and life cycle are determinants of dividend payments.
Agency costs are not a critical driver of dividend policy of Saudi firms. Zakat is found to play a role in
explaining firms dividend decisions.
Originality/value This paper is the first to study the determinants of dividend policy in a country
where companies are required to pay Islamic zakat.
Keywords Saudi Arabia, Islam, Dividends, Cash flow, Business policy
Paper type Research paper

I. Introduction
The absence of an adequate theory to explain the observed effect of a firms dividend
policy on its value is cogently stated by Black (1976) and Brealey and Myers (2003), who
argue that the dividend controversy is of the ten unsolved problems in finance that are
ripe for productive research. DeAngelo and DeAngelo (2006) challenge Blacks
proposition and state that this puzzle is not a puzzle because it is rooted in the mistaken
idea that Miller and Modiglianis (1961) irrelevance theorem applies to payout/retention
decisions. Bhattacharyya (2007) was unconvinced by that argument, and concluded that
dividend policy remains a puzzle. These conclusions echo the view of Baker et al.
(2002, p. 255), who assert that despite a voluminous amount of research, we still do not
have all the answers to the dividend puzzle.
The objectives of the present study are:
(1) to test the stability of dividend policy using Lintners (1956) model;
(2) to test the effect of cash flow on the companys dividend policy;
(3) to examine the effect of government and institutional ownership on dividend
decisions; and
(4) to examine the characteristics that distinguish firms that do pay dividends from
those that do not.
This study, which focuses on firms listed on the Saudi Securities Market, contributes to
the ongoing discussion of factors that influence dividend payments. First, it investigates

The Journal of Risk Finance

Vol. 12 No. 1, 2011
pp. 41-56
q Emerald Group Publishing Limited
1526-5943
DOI 10.1108/15265941111100067

JRF
12,1

42

whether the basic Lintner (1956) model or modified versions explain the dividend
behavior of these firms. Second, it tests the applicability of agency theory in explaining
the variations of a firms dividend payments.
The present study extends the primarily US-based literature in at least in two ways.
First, the analysis is applied to Saudi Arabian firms, which differ in important institutional
ways from firms in the USA and other developed and emerging markets, especially in
terms of corporate governance requirements, ownership structure, and financial policy.
For example, Saudi companies pay zakat (an Islamic tax), which represents 2.5 percent
of a firms unused assets in hand[1] (i.e. zakat base). Thus, zakat can be seen as a penalty
for those assets. Therefore, companies are encouraged to distribute generated income
unless it is needed to finance expansion. Second, the analysis contributes to the ongoing
investigation of the individual effects of ownership structure on payout policy. The
relationship between institutional ownership and dividend policy has been extensively
explored in US and UK firms (Rozeff, 1982; Jensen et al., 1992; Eckbo and Verna, 1994,
among others). However, the potential link between dividend policy and institutional
ownership in other countries is largely ignored. Short et al. (2002) and Bhattacharyya and
Elston (2009) assert that given the fact that the institutional frameworks and ownership
tend to vary across countries, this area of research is largely neglected[2].
The remainder of the paper is organized as follows. Section II briefly reviews the
relevant literature. Section III presents a description of the data and empirical methods.
Section IV presents the results. Section V concludes with a summary and
recommendations for future research.
II. Development of hypotheses and methodology
The effect of previous dividends
Previous dividend payments have long been regarded as the primary indicator of a
firms capacity to pay dividends (Lintner, 1956), because it is assumed that the
management will maintain a stable dividend policy. Furthermore, the information
asymmetry hypothesis assumes that dividend policy is sticky or shows a tendency to
remain at the level of previous dividends (Baskin, 1989).
The effect of profitability and cash flow
Lintner (1956) hypothesizes that earnings can be used as one primary indicator of a firms
capacity to pay dividends. Since dividends are usually paid from annual profits, profitable
firms will logically pay more dividends. In order to examine whether the profitability of a
firm influences its dividend policy, earnings per share (EPS) are used as a proxy for
profitability. A positive relationship between dividends and profitability is expected.
Brittian (1966) argues that cash flow is more important than net earnings in
determining a firms ability to pay dividends. Cash flow is considered the relevant
measure of a companys disposable income. In order to test the effect of cash flow on a
firms dividend policy, a new variable, operating cash flow per share (CFPS), is used as a
proxy. This variable is expected to be positively related to dividend payments (Table I).
The effect of firm size
Firm size has the potential to influence a firms dividend policy. Larger firms have an
advantage in capital markets in raising external funds, and therefore depend less
on internal funds (Higgins, 1972). Furthermore, larger firms have lower likelihood of

Factor

Variable name

Definition

Previous dividends
Profitability
Cash flow
Size
Leverage
Controlling
shareholders

LDPS
EPS
CFPS
SIZE
DR
CS

Government
ownership

GOV

Life cycle

LC

Tangibility

TANG

Lagged dividends per share

Earnings per share
Cash flow per share
Log of total assets
Ratio of debt to total assets
Dummy variable 1 for firms where the
big shareholders own 10 percent or more
and 0 otherwise
Dummy variable 1 if the government
or its agencies owned 10 percent or more
of shares outstanding and 0 otherwise
Ratio between retained earnings to
common equity
Total assets minus current assets divided
by total assets

Expected sign

2
2

Corporate
dividends
decisions
43

bankruptcy and, therefore, should be more likely to pay dividends. This implies
an inverse relationship between the size of the firm and its dependence on internal
financing (Renneboog and Trojanowski, 2005). Thus, larger firms are expected to pay
more dividends.
Furthermore, the effect of firm size on dividends is seen as a proxy for agency
problems. The assumption is that the larger the firm, the more difficult (costly) monitoring
will be (i.e. the greater the agency problem). Thus, dividends could play a role in
alleviating the agency problem. In addition, the positive relationship between dividend
yield and size supports the generally accepted principle that larger firms have easier
access to capital markets (Aivazian et al., 2006). In this study, the natural logarithm of
assets is used as a proxy for firm size.
The effect of leverage
Agrawal and Narayanan (1994) found that payout ratios for all-equity firms are
significantly larger than those for levered firms. There are several reasons for this. First,
leverage may affect a firms capacity to pay dividends because firms that finance their
business activities through borrowing commit themselves to fixed financial charges that
include interest and principal payments. Failure to make these payments in the
designated time may subject the firm to risk of liquidation and bankruptcy. Higher
leverage is likely result in lower dividend payments. Second, some debt covenants have
restrictions on dividend distribution. Among other empirical studies, Gugler and
Yurtoglu (2003) and Aivazian et al. (2006) report a negative relationship between
dividend payments and leverage. Thus, a negative relationship between dividends and
leverage is anticipated. Debt ratio (liabilities divided by total assets, measured in book
value terms) is used as a proxy for leverage.
The effect of corporate governance
Agency models suggest that the payment of dividends helps alleviate agency problems
between corporate insiders and outside shareholders. Essentially, dividends reduce
the amount of discretionary cash flow, which could otherwise be wasted through

Table I.
Variable definitions and
expected relationship

JRF
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44

over-investment and/or projects that provide personal benefits to the managers

( Jensen, 1986). Dividends subject firms to the scrutiny and monitoring of external capital
markets by making it more likely that they have to seek external financing (Easterbrook,
1984; Rozeff, 1982; Jensen et al., 1992). An implicit assumption underlying these models
is that the payment of dividends is costly because there are transaction costs associated
with being in the market for new capital or because dividends are tax inefficient for
tax-paying investors.
Ownership structure, as a proxy for corporate governance, is seen as an important
factor that may influence a firms dividend policy. Similar findings have been
established in many different countries: Maury and Pajuste (2002) for Finland,
Gugler (2003) for Austria, Carvalhal-da-Silva and Leal (2004) for Brazil, Gugler and
Yurtoglu (2003) for Germany, Wei et al. (2003) for China, Khan (2006) for UK, and Nor and
Sulong (2007) for Malaysia. The expropriation of small investors by large controlling
shareholders is another form of the agency problem (Shleifer and Vishny, 1997) that may
affect dividend payment. Firms with a larger percentage of outside equity holdings are
subject to higher agency costs (Rozeff, 1982). The more widely ownership is distributed,
the more acute is the free-rider problem and the greater the need for outside monitoring.
Different types of owners have different preferences for dividends (Goergen et al.,
2005). For example, in family-controlled firms where managers are the owners,
dividends have less of a role in reducing agency conflicts. Such firms set their dividend
policy to produce a favorable tax status (Oreland, 2007). In contrast, firms with a large
proportion of government ownership may have greater agency problems because there
is a double principal agent problem (Gugler, 2003, p. 1301). Dividend payments can
alleviate the agency problem in these firms. This analysis implies a positive association
between dividends and government ownership. However, Nor and Sulong (2007) report
a negative relationship between government ownership and dividend payout in
Malaysian firms. This might be due to the role that large shareholders play in reducing
the agency problem, and hence a reduced need for other mechanisms to mitigate this
problem (Goergen et al., 2005).
In countries where minority shareholder protection is weak, firms are expected to pay
low dividends (La Porta et al., 2000). The evaluation of corporate governance in
Saudi Arabia by the Institute of International Finance (2006) indicates that the protection
of minority shareholders scores 3.5 out of a possible 5.0 points. Consequently, a negative
association between the ownership of controlling shareholders and cash dividends is
expected. A dummy variable is used that takes the value of 1 for firms in which large
shareholders own 10 percent or more of the outstanding shares and 0 otherwise.
In order to control for government ownership, a dummy variable is used that takes
the value of 1 for firms in which the government is the controlling shareholder and
0 otherwise. A 10 percent threshold level for ownership is used to identify the ultimate
owner of the firm. For instance, if the government owns 10 percent or more of a firms
shares, that firm is considered government owned. This approach has also been used by
La Porta et al. (2000) and Maury and Pajuste (2002).
The effect of life cycle
Life-cycle theory is used to explain the variation of dividend payments between firms
(Grullon and Michaely, 2002; DeAngelo and DeAngelo, 2006; DeAngelo et al., 2006;
Denis and Osobov, 2007). This explanation is based on the tradeoffs between the benefits

(e.g. savings in the cost of flotation) and costs (e.g. agency costs of free cash flow) of
paying dividends. These costs and benefits are not similar for all firms. Owing to
declining investment opportunities and the accumulation of undistributed income,
mature firms find paying dividends more desirable. In contrast, younger firms need to
build up reserves to finance growth opportunities, requiring that they retain their
earnings. Like DeAngelo et al. (2006), the present study uses the ratio of retained
earnings to common equity (LC) as a proxy for firm maturity. A positive association
between dividends and a firms LC is expected.
The effect of tangible assets (TANG)
Booth et al. (2001) assert that asset tangibility may have an effect on dividend policy
because firms with a high level of TANG can use assets as collateral for debt.
Consequently, these firms tend to rely less on retained earnings, implying that these
firms will have more cash that can be distributed in dividends. This suggests a positive
association between TANG and dividends.
There is an opposing view in the dividend literature. Aivazian et al. (2003) find that
firms operating in emerging markets with high levels of TANG tend to have lower
dividends. This is because firms in emerging markets face more financial constraints
when short-term bank financing is a major source of debt. Thus, firms with high levels of
TANG will have fewer short-term assets that can be used as collateral to obtain the
necessary financing. Regarding firms in Saudi Arabia, loans from commercial banks
play a pivotal role in financing because of the lack of an active debt market. In this case,
the analysis by Aivazian et al. (2003) implies that there should be a negative association
between dividends and tangibility. The ratio of total assets minus current assets divided
by the total assets is used as a proxy for tangibility.
Empirical methodology
Lintner (1956) model represents one of the first attempts to study the dividend behavior
of firms. The model stipulates that each firm has an unobserved target dividend level in
year t, D*t , which is a function of earnings in that year, Et, and its target payout rate, r:
D*t rE t

Lintner argues that for any given year, the firm will adjust dividends partially toward the
target level of dividend for the year. The annual adjustment process is represented by a
factor, c, which reflects the degree of acceptance of the new target. Accordingly, the actual
difference Dt 2 Dt2 1 in dividends between two consecutive periods, t 2 1 and t, is given by:
Dt 2 Dt21 a cD*t 2 Dt21 1t

In equation (2), the constant term, a, reflects the reluctance on the part of management to
curtail dividends and 1t is an error term. In order to make the model operational, equation (1)
is substituted into equation (2):
Dt 2 Dt21 a crE t 2 cDt21 1t

By rearranging equation (3), one obtains the following empirically testable equation:
Dt a bE t 2 1 2 cDt21 1t

Corporate
dividends
decisions
45

JRF
12,1

The present study examines four models separately, starting with the basic Lintner model
(model I):
DPS t a b0 DPS t21 b1 EPS t 1t

where:

46

DPSt

Dividends per share in year t.

DPSt2 1 Dividends per share in year t 2 1.

EPSt

Earnings per share in year t.

1t

Error term.

In order to test the role of cash on the dividend payment, EPS is replaced by CFPS in
equation (5).
The second model (model II) extends Lintners model (model I) through the inclusion
of more independent variables. The initial variables are lagged dividends (LDPS) and
current profitability (EPS) or cash flow (CFPS). To those variables are added total assets
(SIZE), debt ratio (DR), controlling shareholders (CS), government ownership (GOV),
firms life cycle (LC), and tangible assets (TANG).
The third model attempts to identify the factors that determine firms decisions to pay
dividends. The independent factors are similar to those in model II. In this model, the
dependent variable equals 1 if a firm paid dividends in a particular year and 0 if it did not.
Owing to the values of dependent variable, the logit model is an appropriate for
achieving the objective of this model (Aivazian et al., 2006; Al-Malkawi, 2008).
Dividend policy is most likely a firm-specific choice (Andres et al., 2009). This means
that the payout decision is influenced by firm-specific characteristics that are not
captured by current earnings, the previous years dividend, or other independent
variables. In this case, ordinary least square regression leads to inconsistent and biased
estimates (Andres et al., 2009). Therefore, in order to control for these unobserved
influences, a fixed effects panel regression is used. A number of studies, including of
Omet (2004) and Al-Malkawi (2008), have used panel data. Baltagi (2001, p. 6) contends
that panel data provide more informative data, more variability, less collinearity among
the variables, more degrees of freedom and more efficiency. Furthermore, because the
sample spans a long period of time and is drawn from five sectors, time and sector are
controlled for by including dummy variables representing years and sectors.
Sample proprieties
The sample consists of unbalanced panel data (54 firms for the period between 1990 and
2006) totaling 708 firm-year observations. The data were taken from company
directories and the Saudi Securities Market web site (www.tadawul.com.sa).
Table II provides descriptive statistics and a correlation matrix of dependent and
independent variables. The EPS accounts for 80.5 percent of the cash flow per share.
Therefore, the mean dividend payout ratio on an EPS basis is higher than the equivalent
ratio on a cash flow basis: 66.3 and 53.4 percent, respectively. This might suggest that
earnings figures are somewhat conservative. The coefficient of variation of the
dividends per share (1.58) is higher than the coefficient of variation of EPS (1.46) and cash
flow (1.52). The variance ratio of the dividends per share over the EPS is 0.51 (1.102/1.532)

DPS

LDPS

EPS

CFPS

SIZE

DR

GOV

CS

LC

Mean
0.69
0.69
1.05
1.30 13.47
0.29
0.37
0.49 0.189
SD
1.10
1.10
1.53
1.98
1.49
0.22
0.48
0.50 0.012
Skewness
2.68
2.73
1.15
1.65
0.79
1.21
0.54
0.03 0.77
Kurtosis
14.91
15.53
5.25
9.26
4.86
5.82
1.29
1.00 2.74
Jarque-Bera 4,966.49 5,030.24 303.30 1,457.31 171.05 386.83 120.48 118.00 68.58
Correlation matrix
DPS
1.00
LDPS
0.77
1.00
EPS
0.78
0.72
1.00
CFPS
0.66
0.60
0.79
1.00
SIZE
0.31
0.29
0.41
0.43
1.00
DR
20.20 20.22 2 0.17
2 0.11
0.41
1.00
GOV
0.47
0.46
0.42
0.46
0.48 20.16
1.00
CS
20.14 20.14 2 0.12
2 0.12 20.10 20.01
0.00
1.00
LC
0.50
0.48
0.52
0.42
0.20 20.15
0.33
0.21 1.00
TANG
20.13 20.11 2 0.16
2 0.07 20.20 20.31 20.06 20.02 20.11

AMIX
0.66
0.20
2 0.66
3.32
52.24

1.00

Corporate
dividends
decisions
47

Table II.
Descriptive statistics and
correlation coefficients

and of the dividends over cash flows is 0.31. This provides a rough estimate of the degree
of dividend smoothing. Cash flows have a slightly higher coefficient of variation than
does the EPS, but the variance ratio of EPS over cash flows equals 0.60, which provides
little evidence of earnings smoothing by Saudi firms.
Table III reports the frequency of dividend decreases, omissions, increases, and
dividends maintained by the loss-incurring group and the profit-making group. The
sample of firm-year observations were divided into three groups: loss-incurring firms,
firms reporting increases in profits, and firms reporting decreases in profits. All firms
that reported losses decreased dividend payments in the year of the reported loss. With
respect to profitable firms, 30.25 percent decline to pay dividends and 8.70 percent
reduce dividends. Therefore, annual performance is a key determinant of the decision to
pay a dividend. The results from the literature that stand in greatest contrast to these
findings are those of DeAngelo et al. (1992), who found that among New York Stock
Exchange firms only 15 percent of loss-incurring firms declined to pay dividends, and
those of Goergen et al. (2005), who reported that 80 percent of German loss-incurring
firms declined to pay dividends. Furthermore, the percentage of firms that did not pay
dividends is similar to firms reporting an increase in profit and firms reporting a
decrease in profits. The figures also suggest that firms reporting an increase in profit
Omissiona
Total
%
Loss-incurring firms
Profitable firms
Increase in profit
Decrease in profit
Total
a

Maintain
Total
%

Increase
Total
%

Decreasea
Total
%

Total

125

100.00

0.00

0.00

0.00

125

106
54
285

29.61
31.58
43.58

64
70
134

17.88
40.94
20.49

168
21
189

46.93
12.28
28.90

20
26
46

5.59
15.20
7.03

358
171
654

Note: Dividend decrease is defined as a reduction in dividends, whereas omission represents a

100 percent reduction in dividend

Table III.
Annual dividend changes
associated with a firms
performance

JRF
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48

are more likely to increase or maintain dividend payments, whereas firms reporting a
decrease in profit are more likely to maintain or reduce dividend payments.
As of December 2006, in about 51.9 percent of sample firms, there are controlling
shareholders other than government or governmental institutions who have at least
10 percent of voting shares. The government owns at least 10 percent in 31.5 percent of
firms in the sample. In around 13 percent of sample firms, the government owns between
5 and 10 percent. In eight (14.8 percent) of the sample firms, both the government and
other controlling shareholders own at least 10 percent of voting shares.
III. Empirical results and discussion
Partial adjustment model
Table IV presents the regression results of Lintners model and its modified version. The
results show that the coefficient of lagged dividend payments is positive and statistically
highly significant. These results are similar to numerous studies on emerging markets
(Omet, 2004; Al-Ajmi, 2008; Andres et al., 2009) that report lagged dividend payments are
an important determinant of dividend payments; however, Aivazian et al. (2003) on some
emerging capital markets conclude that firms do not follow a stable dividend policy.
The coefficient of EPS has a positive sign, as hypothesized, and is statistically
significant. These findings are consistent with those reported by Jensen et al. (1992),
Aivazian et al. (2003, 2006), Wei et al. (2003), Amidu and Abor (2006), DeAngelo et al.
(2006), Anastassiou (2007), Bodla et al. (2007), Pandey and Bhat (2007), and Andres et al.
(2009).
The results of the modified version of the Lintners model show that the coefficients
on both lagged dividends and cash flow are positive and significant. These results
clearly indicate the importance of cash flow for dividend decisions. These findings are
consistent with Goergen et al. (2005) and Andres et al. (2009) in Germany, Amidu and
Abor (2006) in Ghana, and Renneboog and Szilagyi (2007) in The Netherlands. However,
they contradict Al-Ajmi (2008), who reports that cash flow is not significant in
determining dividend payments. The reconciliation between the two results may rest on
the difference between the sample used by the former studies and the sample used by
Al-Ajmi (2008), which comprises only banks in Saudi Arabia.
Speed of adjustment (SA) and payout ratio
Following the method of Fama and Babiak (1968), the speed of adjustment (SA) was
estimated, c 1 2 b0, and also the target payout ratio (TPR), r 1 2 b1/c.

Table IV.
Estimates of the Lintner
and modified Lintner
models

Model

(a) Firms fixed effect

(b) Firms fixed effect

LDPS
EPS
CFPS

0.290 * (0.035)
0.307 * (0.025)

0.377 * (0.034)

Industry dummies
Time dummies
R 2 (%)
Regression F
Note: Significant at: *5 percent or less

0.163 * (0.0174)
Yes
Yes
67.81
21.97 *

Yes
Yes
61.64
20.98 *

The SA reflects how quickly firms are able to adjust dividends toward the target ratio:
the higher the SA, the less smooth and stable will be the level of dividends. The results
are shown in Table V. These estimates are obtained from the regression coefficients,
b0 and b1, of the basic Lintner model (Table IV). Table V identifies the SA and TPRs of
the present and previous studies and investigations conducted in different
environments. The SA of Saudi firms is 71 percent and the implied TPR is
43 percent, whereas the average observed ratio is 66 percent. The results from the cash
flow model indicate that the SA is 62 percent, while the implied TPR is 26 percent.
The observed payout ratio (DPS to CFPS) is 53.37 percent for all firms included in the
sample. Again, there is a large difference between the implicit TPR and the observed
payout ratios. A large difference between the implicit TPR and observed payout ratios
for Saudi firms indicates that dividend decisions are not based on long-term target
dividend payout ratios.
Comparisons of estimates of SA and TPR between countries should be approached
with caution because of differences in tax systems, time period, methodology, and the
distribution of share ownership, which are likely to affect firms dividend decisions.
From the available comparative scores, the TPR of the Saudi firms is fairly typical, while
the SA is among the highest of all.

Corporate
dividends
decisions
49

Asymmetry in dividend behavior

Ross (1979) and Bhattacharyya (1979) argue that firms behavior is asymmetric; that is,
behavior differs depending on economic conditions. Lintner (1956) also notes that firms
are more reluctant to reduce dividends than to increase dividends, but Nakamura (1989),
using annual data for a sample of American and Japanese firms, finds that adjustment
estimates are lower for periods of dividend increases in nine of 12 firms for Japan and
eight of 12 for the USA. Furthermore, Brav et al. (2005) and Goergen et al. (2005), report
that US and German companies are more willing to cut dividends than to eliminate the
dividend altogether, respectively.
To test the presence of asymmetry in the dividend behavior of Saudi firms in the
present study, the sample (excluding firms that did not report changes in dividend
payments) into two subsamples: firms that increased dividends and firms that decreased
dividend payments. Lintners model and a modified version are used to test the

Study

Country

Lintner (1956)
Brittian (1966)
Fama and Babiak (1968)
Ariff (1990)
Mookerjee (1992)
Adaoglu (2000)
Omet (2004)
Stacescu (2006)
Ben Naceur et al. (2006)
Bodla et al. (2007)
Present study model I with EPS as independent
Present study model I with CFPS as independent

USA
USA
USA
Singapore
India
Turkey
Jordan
Switzerland
Tunisia
India
Saudi
Saudi

Speed of adjustment Payout rate

0.25
0.23
0.34
0.40
0.73
1.00
0.52
0.66
0.39
0.13
0.71
0.62

0.60
0.66
0.49
0.12
0.85
0.53
0.07
0.33
0.58
0.56
0.43
0.26

Table V.
Estimates of speed of
adjustment and TPRs

JRF
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50

hypothesis that the models can be used to differentiate between these two subsamples.
Table VI presents the Tobit regression results of the two subsamples.
The results reveal that the coefficients on lagged dividends and current profitability
have the expected positive signs and are significant for both samples. The SA
estimates for achieving the TPRs are 36 and 57 percent for decreases and increases in
dividends, respectively. Their respective implied TPRs are 94.44 and 52.63 percent,
respectively. The regression results of the modified Lintner model are qualitatively
similar to the results of the original Lintner model. The SA estimates for achieving the
TPRs are 47 and 80 percent for decreases and increases in dividends, respectively.
Their respective implied target dividend payout ratios are 40.43 and 11.25 percent,
respectively.
The above results indicate that firms are quicker to react to positive changes in
economic conditions, and are more reluctant to reduce dividend payments in the face of
unfavorable economic conditions. This is partly due to the companys attempt to reduce
the zakat base that will increase if the companies retain more profit than what is needed
to finance expansion.
Determinants of dividend payments
Table VII presents the estimated coefficients of the third mode. Similar to the results
reported in Table IV, the coefficients on current net earnings, lagged dividend payments,
and cash flow per share are positive and significant. These results are similar to those
reported elsewhere.
The coefficients of the two variables representing corporate governance are
insignificant. These results contradict the contention that dividends are used to mitigate
agency problem and do not support to the expropriation (tunneling) hypothesis, which is
prevalent in countries where legal protection of minority shareholders is low
(La Porta et al., 2000) (e.g. the Saudi market).
The non-significant relationship between dividend payment and government
ownership is inconsistent with the assertion that, ceteris paribus, state-controlled firms
tend to pay more dividends. These conclusions do not support the double principal-agent
hypothesis. However, the results are similar to those of Renneboog and Szilagyi (2007)
who assert that dividends and shareholder control are complementary rather than
substitute mechanisms in mitigating agency concerns, and to those reported by
Wei et al. (2003), Carvalhal-da-Silva and Leal (2004), Renneboog and Szilagyi (2007),
and Al-Yahyaee et al. (2008).
Dependent
variable

Table VI.
Results of Tobit
regression

Constant
LDPS
EPS
CFPS
Industry dummies
Time dummies
Wald test [x 2 (2)]

(a)

(b)

DDPS t , 0

DDPS t . 0

DDPS t , 0

DDPS t , 0

2 32.30 (29.51)
0.64 * (0.05)
0.34 * (0.06)

0.38 * (0.11)
0.43 * (0.10)
0.30 * (0.07)

0.11 (0.92)
0.53 * (0.05)

0.55 * (0.11)
0.20 * (0.08)

Yes
Yes
192.72 *

Yes
Yes
20.88 *

0.19 * (0.04)
Yes
Yes
136.68 *

0.09 * (0.04)
Yes
Yes
7.93 *

Note: Significant at: *5 percent or less

Variables
Constant
LDPS
EPS
CFPS
SIZE
DR
CS
GOV
LC
TANG
Industry dummies
Time dummies
R 2 (%)
Regression F
Pseudo R 2 (%)
Log likelihood

Firm fixed
effect (a)
0.21 *
0.34 *

(0.04)
(0.03)

0.05
(0.04)
2 0.20
(0.22)
0.03
(0.10)
0.10
(0.12)
0.02 *
(0.01)
2 1.59
(1.21)
Yes
Yes
85.87
26.92 *

Firm fixed
effect (b)
0.29 *

(0.04)

0.16 *
(0.02)
0.03
(0.04)
20.37
(0.23)
20.12
(0.11)
0.17
(0.13)
0.08 *
(0.01)
20.28
(0.17)
Yes
Yes
77.44
27.89 *

Logit (c)
23.91 *
1.95 *
1.49 *

(9.88)
(0.45)
(0.29)

0.70 *
2 1.67
2 0.46
0.30
0.08 *
2 1.65
Yes
Yes

(0.21)
(1.53)
(0.31)
(0.39)
(0.02)
(0.81)

68.15
447.50 *

Logit (d)
5.72
2.38 *

(3.70)
(0.38)

0.42 *
0.84 *
2 2.23 *
2 0.56
0.11
0.08 *
2 0.82
Yes
Yes

(0.12)
(0.16)
0.96
(0.32)
(0.38)
(0.02)
(0.76)

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51

66.96
438.167 *

Notes: Significant at: *5 percent or less; aLR Likelihood ratio; the dependent variable in models
(a) and (b) is DPS (annual dividends per share) and in models (c) and (d) equals 1 if a firm pays
dividends in a particular year and 0 otherwise

The coefficients of size are robustly non-significant. The effect of size on dividend policy
is robust to changing the measurement of size. For example, when the natural logarithm
of total assets is replaced with the natural logarithm of market capitalization, the proxy
of firm size remains non-significant. These results are not similar to those reported by
Aivazian et al. (2006), who found that size is positively related to dividends, and
Ben Naceur et al. (2006), who reported a negative relationship between a firms size
and its dividend payments.
Leverage is not found to be one of the determinants of dividend payments. A number
of previous studies report that highly levered firms are expected to have low dividend
payments (Agrawal and Narayanan, 1994; Aivazian et al., 2003, 2006). Our results can be
explained by the fact that Saudi firms are generally low geared.
LC, the proxy for life cycle, is found to play a significant role in determining the level of
dividends. Thus, the results provide support for the free cash flow hypothesis
(Easterbrook, 1984; Jensen, 1986). Moreover, these results are consistent with
Grullon and Michaely (2002) maturity hypothesis and with Julio and Ikenberry (2004),
who argued that the reappearance of dividends was partially due to the maturity
hypothesis, and with Grullon and Michaely (2002), who hypothesized that growth
opportunities tend to decline as firms mature, leading to lower capital expenditure
requirements, and thus, higher available cash flows for dividend payments.
TANG, despite having the expected negative sign as hypothesized, is insignificant.
Asset tangibility was hypothesized to determine dividend payments because they are
used as collateral for debt (Booth et al., 2001; Bevan and Danbolt, 2004). Aivazian et al.
(2003) argue that firms in emerging markets rely on short-term bank loans that require
short-term assets as collateral. The low level of borrowing in Saudi firms is likely to be
among the reasons that explain these results.

Table VII.
Predicting dividend
payments

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52

Factors affecting the probability of paying a dividend

Model IV aims to investigate the factors that affect a firms decision to pay dividends.
The logit regression results are shown in Table VII. The results from regression (Panel c)
indicate that the signs of lagged dividends, current profitability, size, and life cycle are as
expected and statistically significant. Therefore, one can conclude that, among firms
that have paid dividends in the previous year, dividend payers, relative to non-payers,
are profitable, larger, and mature. These results are partly similar to Aivazian et al.
(2006), DeAngelo et al. (2006), and Al-Malkawi (2008), who found that the probability
that a firm pays dividends is positively related to profitability and size. The latter also
found that growth is one factor that determines whether companies pay dividends.
When EPS is replaced with CFPS, the results from regression (Panel d) are identical to
results from regression (Panel c), with one exception: the coefficient of DR is negative
and significant.
IV. Conclusion and further research
This paper studied the dividend behavior of firms listed on the Saudi Securities
Market. Specifically, the studys goals are:
(1) to test the applicability of Lintners thesis of dividend policy to Saudi firms;
(2) to test the effect of cash flow on companys dividend behavior;
(3) to identify the determinants of the level of cash dividends; and
(4) to identify the factors that determine a firms decision to pay cash dividends.
In all of the tested models, lagged dividend payments and current profitability have the
expected signs and are statistically significant. The results support the partial
adjustment model advanced by Lintner, that is, dividend payments by companies listed
on the Saudi Securities Market seem to be affected by previous dividend levels and
current profitability. Life cycle is found to a play significant role in determining a firms
dividend per share. These results offer support for the role of life-cycle theory in
explaining the variations in dividend policies among firms.
Moreover, Saudi firms are found to act quickly to increase dividend payments,
confirming the traditional view that firms have a higher propensity to increase
dividends compared to their propensity to reduce dividends. Therefore, firms dividend
behavior might be better understood by analyzing the management response after
controlling for changes in economic conditions.
The results reveal that four factors can influence dividend decisions in Saudi Arabia.
More profitable firms, larger firms, firms that paid dividends in previous years, and
mature firms with few investment opportunities are much more likely to pay dividends.
On the basis of the empirical findings in this paper, it can be concluded that further
related research would be desirable. Possible questions for future research include: what
is the explanatory power of mainstream dividend policy theories applied to companies
participating in the capital market? What is the value relevance of dividends per share
relative to earnings per share? What is the relationship between stock prices and
dividends per share?
Further research could also examine whether dividend policy has an influence on
firm value. This aspect of dividend policy research has been very important in the
theoretical and empirical literature. In addition, research needs to test share price

reaction around ex-dividend days to make inferences about investor preferences for
dividends and capital gains. Furthermore, the signaling hypothesis could be examined
by observing the share price reaction to dividend change announcements. Finally,
another potential research area could involve studying how investors view dividend
policy and examining the portfolios of various investors and their demographic
attributes.

Corporate
dividends
decisions
53

Notes
1. www.dzit.gov.sa/CommerceZakat/commercezakat2.shtml
2. The effect of executive compensation is documented in Bhattacharyya and Elston (2009),
among others. However, it was not possible to test this hypothesis because Saudi firms do
not disclose information about executives packages.
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Corresponding author
Jasim Al-Ajmi can be contacted at: jasimalajmi@gmail.com

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