Review of Literature

Introduction
This chapter explains the concepts of dividend announcements and Share prices and
existing research findings related to dividend announcement and share prices of the
public quoted companies. This chapter begins with describing Colombo Stock Exchange
in Sri Lanka and explaining theories related to the Dividend announcement and Share
prices. The present study concentrates to find out that whether the dividend
announcement impact on share prices or not?

Colombo Stock Exchange (CSE)

The stock exchange is a market where securities such as shares, debentures etc. issued by
companies are traded (CSE Hand book 2003). Companies which use the mechanism of
the stock market to raise debt or equity capital, commonly enter the stock market through
issuing shares or debentures to the public. Shares are allocated to the investors who
subscribed; they become share holders of that company respect of a share issue.
Thereafter these share holders are free to sell either part or in whole, their shares in the
stock market.

In any country capital market is an important body in contributing economic

development. The CSE is the organization responsible for the operation of the stock
market in Sri Lanka. The CSE has 15 stock broking firms. These member firms act as
market intermediaries performing a number of services to investors and companies.
Quoted public company is a company whose shares are quoted by any stock exchange
licensed by the Security Council. The company should be quoted right throughout the
year (Manual of Income Tax Law 2006)
Presently 243 companies are listed on the CSE; most stocks do not frequently traded,
representing twenty (20) business sectors with a market capitalization of 497 billion
rupees (over US$ 4.9 billion) as at 31st May 2005, which corresponds to approximately
24% of the Gross Domestic Product of the country. Market capitalization is a measure of
a company’s total value. It is estimated by determining the cost of buying an entire
business in its current state .Often referred to as “market capitalization”, it is the total
rupee value of all outstanding shares. It is calculated by multiplying the number of shares
outstanding by the current market price of one share.
CSE is an important emerging market of the region among the developing countries. It is
recorded by the Fortune Magazine that the CSE was named the second best emerging
market in Asia. Therefore the peace process, the political environment, the continuing
low interest rate and improved economic fundamentals have had a positive impact on the
performance of the CSE.
Market capitalization of listed companies gradually increased from during the period of
year 2000 to year 2004. It was Rs.88.8Bn in 2000 and moved up to Rs.382.1Bn in year
2004.The total turnover of the listed companies rose from Rs. 10,624 Mn in year 2000 to
Rs. 59,052 Mn in year 2004.Daily average turnover increased from Rs44Mn in year 2000
to Rs. 246 Mn in year 2004.However, the CSE is concentrated, in that two main price
indices such as All Share Price Index (ASPI) and Milanga Price Index (MPI). ASPI is
used to measure the movement of share prices in all listed companies. The base year for
this index is 1985(CSE Hand book 2003). MPI is used to measure the movement of share
prices of 25 selected companies. These Companies have been selected on the basis of
liquidity and market capitalization. This index is revised annually(CSE Hand book 2003).
The base year for this index is 1998. ASPI rose from 447.6 in the year 2000 to 1506.9 in
the year 2004.MPI rose from 698.5 in the year 2000 to 2073.7 in the year 2004(Fact book
2005).
Dividend.
Dividends are taxable payments declared by a company’s board of director and given to
its shareholders out of the company’s current or retained earnings (CSE Hand book
2003). Dividends are usually given as cash dividend, but they can also take form of stock
dividends or other property.
Cash dividends are those paid out in form of “real cash”. It is a form of investment
income and are taxable in the year they are paid. It is the most common method of
sharing corporate profits (.I:\Research 3\Dividend - Wikipedia, the free
encyclopedia.htm)
Theoretically, cash dividend is giving reward to the shareholders that are something they
already own in the company; hence this will be offset by the decline in stock value
(Porterfied 1959 and 1965). Unexpected increase (decrease) in regular cash dividends
generally elicit a significantly positive (negative) stock market reaction.(Fama et al 1969
and Petit 1972)

Companies should invest excess funds in the positive net present value projects instead of
paying out them to the shareholders. Literature also suggests that market valuation of
stocks depends on the expected future dividends. If company pays out all of the earnings,
funds for future investment will decrease and dividend may not increase in the future.
Moreover, when dividend is taxable, paying out more cash would increase the
shareholders tax liability. Despite these theoretical arguments for not paying dividends,
companies often pay cash dividends to their shareholders possibly to signal information
about the future earnings prospects. (Md.Hamid Uddin 2003)

Stock dividends or Scrip dividends (common) are those paid out in form of additional
stock shares of the issuing corporation, or other corporation They are usually issued in
proportion to shares owned .This is very similar to a stock split in that it increases the
total number of shares while lowering the price of each share and does not change the
market capitalization (I:\Research 3\Dividend - Wikipedia, the free encyclopedia.htm)

Property dividends or dividends in specie are those paid out in form of assets from the
issuing corporation, or other corporation .Property dividends are usually paid in the form
of products or services provided by the corporation. When paying property dividends, the
corporation will often use securities of other companies owned by the issuer. (I:\Research
3\Dividend - Wikipedia, the free encyclopedia.htm). The dividend can be a regular
dividend, which is paid at regular intervals. A special dividend, which is paid in addition
to the regular dividend. Finally, firms some times pay dividends that are in excess of the
retained earnings they show on their books(A.Damodaran 2001).
There are two issues related to dividend such as Dividend Policy and Dividend Theory.
Dividend policy
How the firms determine the amount of dividends to payout each quarter or semi –
annual or annual is dividend policy. In theory the objective of a dividend policy should be
to maximize shareholders’ return. Shareholders’ returns consist of two components such
as dividend and capital gain. Dividend policy has a direct influence on these two returns.
A capital gain is the amount by which an assets selling price exceeds its initial purchase
price. A realized capital gain is an investment that has been sold at a profit. An unrealized
capital gain is an investment that has not been sold yet but would result in a profit if sold.
Capital gain is often used to mean realized capital gain. Making a capital gain would
depend on the market price of the share. There are instance where one could also make a
capital loss. That is, if the market price were to fall beyond the price you purchased the at
and you sell it at that point, you would stand to make a capital loss(CSE Hand book
2003).

The percentage of earnings paid as dividends is called payout ratio. A low payout policy
may produce a higher share price because it accelerates earnings growth. A high payout
policy means more current dividends and less retained earnings, which may consequently
result in slower growth and perhaps lower market price per share (IM Pandey 1999).

In practice, may firms appear to follow what amounts to a compromise dividend policy.
Such a policy is based on the five main goals (S.A.Ross et al)

i. Avoid cutting back on positive NPV projects to pay a dividend.

ii. Avoid dividends cuts
iii. Avoid the need to sell equity.
iv. Maintain a target debt – equity ratio.
v. Maintain a target dividend pay out ratio.

The dividend Process

Generally pay dividends every quarter or Semi annual or annual basis. We can explicate
the dividend Process by using the dividend payment time line. Dividends in publicly
traded firm are usually set by the board of directors and are paid out to stockholdeders a
few weeks later. There are several key dates between the times the board declares the
dividend until the dividend is actually paid (A.Damodaran 2001).

i. The dividend declaration date

ii. The ex-dividend date
iii. The holder-of-record date
iv. The dividend payment date.

The first date of note is the dividend declaration date, the date on which the board of
directors declares the rupee dividend that will be paid be for that period. This date is
important because by announcing its intent to increase, decrease, or maintain dividend,
the firm conveys information to financial markets. Thus, if the firm changes its dividend,
this is the date on which the market reaction to the change is most likely to occur.

The next date of note is the ex-dividend date, at which time investors have to have
bought the stock in order to receive the dividend. Since the dividend is not received by
investors buying stocks after the ex- dividend date, the stock price generally fall on that
day to reflect that loss.

At the close of business a few days after the ex- dividend date, the company closes its
stock transfer books and makes up a list of the share holders to date on the holder-of-
record date. These shareholders will receive the dividends. Generally, there should be no
price effect on this date.

The final step involves mailing out the dividend cheque on the dividend payment date.
In most cases, the payment date is two to three weeks after the holder – of – record date.
Although stockholders may view this as an important day, there should be no price
impact on this day either.
 It can be presented in a time line as follows:

Announcement Ex-Dividend Holder-of Payment

Date Day Record Day Day

2-3 Weeks 2-3 Weeks 2-3 Weeks

Board of Directors Stock has to be bought Company closes books

Dividend is paid
Announces Quarterly by this Date for investor and Records Owners of
to stock holders
Dividend per Share to receive Dividends Stock

Source:- Corporate Finance 2001

Dividend Theories.
Generally dividend theories Explains how a firm’s dividend policy affect the firm value.
In the revolution of financial management, there are ten theories most linked with
dividend announcement and share.
I. Miller and Modigliani Irrelevance Theory
II. James E Walter Theory
III. Walter’s Model
IV. Bird-in-the – Hand Theory
V. Tax Disadvantage Theory
VI. Clientele Effect Theory
VII. Transaction cost Theory
VIII. Agency Cost Theory
IX. Information Signaling Theory

Miller and Modigliani (1961) proposed the dividend irrelevance theory. It has been
argued dividend policy has no effect on either the price of a firm’s stock or its cost of
capital. If dividend policy has no significant effects, then it would be irrelevant. They
argued that the firm’s value is determined only by its basic earning power and its
business risk. In other words, MM argued that the value of the firm depends only on the
income produced by its assets, not on how this income is split between dividends and
retained earnings.
In developing their dividends theory, MM made a number of following assumptions.
i. The absence of taxes and brokerage costs. Obviously, taxes and brokerage costs
do exist. So the MM irrelevance theory may not be true(A.Damodaran 2001).
ii. Perfect capital market.
iii. Investment policy given.
iv. No risk.

In additions they mention that a firm, operating in a perfect capital market may face one
of the following three situations regarding the payment of dividends.
i. The firm has sufficient cash to pay dividends.
ii. The firm does not have sufficient cash to pay dividends, and therefore, it issues
new shares to finance the payment of dividends.
iii. The firm does pay dividend but a share holder need cash.

In real world, however a change in the dividend policy is often followed by change in the
market value of stocks. The economic argument for investor’ preference to dividend
income was offered by Graham-Dodd (1951). Subsequently, Walter (1956) and Gordon
(1959 and 1962) forwarded the dividend relevancy idea, which has been formalized into a
theory, postulating that current stock price would reflect the present value of all expected
dividend payments in the future. Relevance theory explain in the practice reality between
the dividend and company valuation and it share.

James E.Walter (1956) argues that the choice of dividend policies almost always affect
the valuation of the firm. His model one of the earlier theoretical works, clearly shows
the importance of the relationship between the firm’s rate of return ,r, and its cost of
capital ,k, in determining the dividend policy that will maximize the wealth shareholders.
Walter’s model is based on the following assumptions:
i. Internal financing.
ii. Constant return and cost of capital.
 iii. 100 percent payout or retention.
iv. Constant EPS dividend.
v. Infinite time.

According to this model, the optimum dividend policy depends on the relationship
between the firm’s rate of return(r) and its cost of capital (k). He find out the optimum
dividend payout ratios such as growth firm (r>k), normal firm (r=k) and declining firm
(r<k).
Growth firm (r>k)
Growth firms are those firms which expand rapidly because of ample investment
opportunities yielding returns higher than the opportunity yielding returns higher than the
opportunity cost of capital. These firms are able to reinvest earnings at a rate ® which is
higher than the rate expected by share holders. The market value per share increases as
pay out ratio declines when r>k.
Normal firm (r=k)
Most of the firms do not have unlimited surplus-generating investment opportunities,
yielding return higher than the opportunity cost of capital. After exhausting super
profitable opportunities, these firms earn on their investment rate of return equal to the
cost of the capital ,r=k he dividend policy has not effect of the market per share in
walter’s model.

Declining firm (r<k).

Some firms do not have any profitable investment opportunities to invest the earnings.
Such firms would earn on their investment rates of return less than the minimum rate
required by investors. The market per share increase as pay out ratio increases when r<k.

However, this model fails to explain following

 i. No external financing
ii. Constant rate of return.
iii. Constant opportunity cost of capital.

Gordon(1963) explained in his relevance model that the payment of large dividend lead
to reduce risk and finally impact on stock prices. Higher payout ratio will lead to higher
equity value.
Model based on the following assumptions.
i. All equity firm
ii. No external financing
iii. Constant return.
iv. Constant cost of capital
v. Perpetual earnings.
vi. No taxes
vii. Constant retention.
viii. Cost of capital greater than growth rate.

Gordon’s revealed the following findings.

i. The Market value of the share increases with the retention ratio for firms with
growth opportunities when r>k – Growth firm
ii. The Market value of the share increases with the payout ratio for declining firms
with r<k. declining firm
iii. The Market value of the share is not affected by dividend policy when r=k.
Normal firm
We can conclude that there two models (Gordon and Walter) are similar in their findings
and limitations.
The "Bird in the Hand" Theory sates that Dividends are good because of the lower risk associated
with a rupee of dividends compared to a rupee of capital gains, suggesting that investors have a
preference for dividend paying companies. Implication is that higher payout ratios will lead to higher
equity values. Dividends are value enhancing. Further this study revealed that High dividend paying
stocks are less risky stocks.
 According to the Tax Disadvantage Theory, investors have an aversion towards dividend
paying companies since the implicit tax on dividends is greater than on capital gains (taxes
can be deferred). Implication of this theory is that higher dividend payout ratio will lead to
lower equity values. The different tax treatment of dividend and capital gain is also used
to explain the dividend puzzle. Investors who receive favorable tax treatment on capital
gain may prefer stocks with low or zero dividend payouts. Both theoretical and empirical
researches in dividends are struggling to answer so called. Dividend Puzzle. expressed in
Black (1976).

Brennan (1970)developed a version of the capital asset pricing model which takes into
account the effect of differential tax rates on capital gains and dividends. His version of
CAPM not only includes systematic risk, but also incorporates an extra term that causes
the expected return also dependent on dividend yield. His empirical results concerning
the model, however, are mixed.

Transaction Cost Theory Explicated Since going to the capital markets creates transaction
costs, a cost associated with high dividend payouts are increased transaction costs. Theory
suggests that, there is an incentive to avoid paying dividends to avoid the transaction costs
associated with going to the capital markets.
According to the Clientele Theory Some investors (need for income and risk adversion)
will prefer high dividend paying firms where as some investors (little need for income
and low risk aversion) will prefer low dividend paying firms. Theory suggests that even
with differences in risk and taxes, dividend policy may be irrelevant at the firm level even
if not irrelevant to the individual investor. Elton and Gruber (1970) attempt to test
clientele effects by investigating the average price decline when a stock goes ex-
dividend. They argue that favorable capital gains tax treatment should cause the price
drop to be less than the dividend payment and should cause investors to prefer stocks that
do not pay dividends. Using 4148 observations between April 1, 1996 and March 31,
1967, they did find that the average price drop as a percentage of dividends paid was
77.7%.

Dividend Information Signaling Theory (based on The Litner Model) Explicated to avoid
having to cut dividends, management selects a low target payout ratio and only raises
dividends if it is clear that the firm can support that level in the future ("Stick
Dividend Policy").Dividends become a signal of management’s asymmetric information.
Dividend cuts are value destroying while dividend increases are value enhancing but it is
not the dividends per se but the information that dividend changes will convey to
investors regarding future earnings that drives the change in value.

One of the most promising theories is signaling hypothesis by Miller and Rock (1985). It
is the first theory illustrating that dividends and external financing are merely two sides
of the same coin. The dividend surprise conveys the same information as earning
surprise. Managers are using the increase of dividends to signal that the firm is
undervalued, and because firms performing poorly can not mimic the signaling due to
their inability to sustain increased dividends, the signaling is credible. The empirical
implication is that firms announcing dividend initiations and increases should experience
positive announcement abnormal returns while firms cutting or reducing dividends suffer
negative abnormal returns. It also predicts that the larger the dividend changes, the more
pronounced the announcement-abnormal return would be. Most empirical studies support
signaling hypothesis by finding the sign of announcement abnormal return are in the
direction as dividend changes. However, the relationship between the magnitude of
dividend change and magnitude of market reaction is mixed. Christie (1994) finds that
the relationship between the percentage of dividend cut and market reaction is not
monotonic. He finds that prices fall an average of .4.95 percent for reductions less than
20 percent, and reductions exceed 60 percent induce an average of .8.78 price drop
However, for omissions, or in other words, reductions that equals 100 percent, the
average price drop is only .6.94 percent. Although dividend omissions trigger substantial
declines in stock price, these losses are significantly smaller than would be predicted
based on the relationship between percentage of dividend cuts and announcement market
reaction estimated across reductions of less than 100 percent. His results suggest that
neither signaling hypothesis nor agency cost hypothesis fully explain the information
conveyed by dividend omissions.
Generally, based on this theory, announcements of dividend increases and initiation of
dividends lead to an increase in stock price while announcements of dividend cuts and
elimination of dividends lead to a decrease in stock price.
According to Agency Theory, Agency problem arises when managers and shareholders
have different objective functions .Agency costs are a function of the firm's hording free
cash flow and, therefore, an increase in dividends, reduces free cash flow, decreases the
agency problem and will increase equity values, while a decrease in dividends, increases
free cash flow, increases the agency problem and will decrease equity values.
Alternatively, agency costs decrease if the firm needs to go to the capital markets
(monitoring) and, since, high dividend paying companies will be required to go to the
capital markets more often than low dividend paying companies (holding capital
expenditures constant), high dividend paying companies will have lower agency costs.
Implication of theory is Dividends are good as they decrease the agency problem and,
therefore, dividend increases will cause an increase in the value of equity as the agency
costs are lowered, while dividend decreases will cause a decrease in the value of equity as
agency costs are increased.

The implication for agency problem based explanation is that investors. Reaction to
dividend changes should also be associated with the firm’s profitability of future
investment. Empirical results for free cash flow hypothesis are mixed. Lang and
Litzenberger (1989) try to distinguish between signaling and free cash flow hypothesis.
They use Tobin’s Q as a proxy for the profitability of future investment. Firms with Q
higher than one are over-investors. They find that the market has greater reaction to low
Q firms around announcement of dividend changes. Several researchers (e.g. Agrawal,
Rozeff) provide empirical support for these agency explanations for paying dividends.
Other studies provide little or no support for the free cash flow hypothesis (e.g., Denis,
Howe).

Rozeff’s Rozeff (1982) suggests that the optimal dividend payout is a trade off between
flotation costs and benefits of reduced agency costs. Flotation costs arise when firms need
to raise capital by external financing while agency cost is due to the interests conflicts
between shareholders and managers. Shareholders are concerned that managers may
misuse the corporation.s resources for personal needs by means of more perquisites or
shirking. By paying out dividends, on one hand, there is increased need for more costly
external financing. On the other hand, raising money from the capital market will subject
mangers to greater monitoring by outsides. Thus, an optimal dividend payout ratio will be
the point where marginal flotation cost equals marginal benefits from reduced agency
costs. Similarly, Jensen (1986). free-cash flow hypothesis suggests that free cash flow
may be used by firms to invest in negative NPV projects. Increasing dividends by a firm
with this over-investment problem will reduce the cash that would otherwise by wasted in
negative NPV projects. Similarly, reducing dividends by such firms will increase the
probability that more negative NPV projects will be undertaken. Market considers
increasing dividends as value-adding and decreasing dividends as reducing the value of a
firm.

Prediction of High/Increased

Theory Dividend Payment on Stock Value

1. M & M Irrelevance Theory 0

2. James E.Walter -
2.1 Growth firm -
2.2 Normal firm +
2.3 decline firm

3. walter’s model
3.1. Growth model -
3.2. Normal firm 0
3.3. Decline firm +

4. Bird-in-the-Hand Theory +

5. Tax Disadvantage Theory -

6. Clientele Effect Theory 0

7. Transaction Cost Theory -

8. Agency Cost Theory +

9. Information Signaling Theory +

10. Rozeff’s Tradeoff Theory ?

(I:\Research 3\The Dividend Decision - Wikipedia, the free)

encyclopedia.htm
Upinder S .Dhillon et al (2004) examines the information content of dividends by using
an ex-ante measure of dividend changes based on Value Line forecasts and show that
using analyst’s dividend forecasts to measure unexpected dividend changes results in a
stronger (more parsimonious) and less noisy relationship between dividend changes,
stock price reaction, and future earnings. This approach has the additional advantage of
permitting the analysis of a sample not used in previous studies: firms announcing no
dividend changes for which investors (analysts) expect a change. They find that this no
change in dividends sample is associated with negative dividend surprises, stock price
reaction and earnings changes. Final results provide strong support for the information
content of dividends hypothesis.

Nissim and Ziv (2001) suggests that dividend changes convey information about future
earnings. Watts (1973), Gonedes (1978), DeAngelo, DeAngelo, and Skinner (1996), and
Benartzi, Michaely, and Thaler (1997) find that though there is a significant relationship
between dividend changes and contemporaneous earnings, the relationship between
dividend changes and future earnings is not significant. Recently, Nissim and Ziv (2001)
argue that the failure to find a significant relationship between dividend changes and
future earnings is due to variable omission and measurement error of the dependent
variable. After accounting for these econometric issues, they document a significant
relationship between dividends and future earnings changes.

The dividend change is defined as the difference between the current and past dividend.
As reported by Yoon and Starks (1995), the use of this dividend change may result in a
biased measure of unexpected dividend change. They suggest that the actual dividend
change model “may not be realistic…because the model does not incorporate the
market’s most recent dividend expectations.” In essence, the actual dividend change
model does not distinguish between expected and unexpected dividend changes. Bajaj
and Vijh (1990) summarize the problem in this area of research stating that "there is no
clear measure of the surprise component of a dividend change.”
Brown and Rozeff (1978) examine the relative accuracy of Value Line forecasts and time
series models, for both quarterly and annual earnings per share and summarize their
results as providing convincing evidence of Value Line’s superiority over time series
models. To the best of our knowledge extant studies on the information content of
dividends have not used large sample tests with an ex-ante measure of unexpected
dividend changes.
Benartzi, Michaely, and Thaler (1997) find that though there is a significant relationship
between dividend changes and contemporaneous earnings, the relationship between
dividend changes and future earnings is not significant. Nissim and Ziv (2001) argue that
the failure to find a significant relationship between dividend changes and future earnings
is due to variable omission and measurement error of the dependent variable. After
accounting for these econometric issues, they document a significant relationship
between dividends and future earnings changes.

Frederic Romon (2000) Who observes discrepancies in cumulative abnormal returns

according to the firm dividend policy level (low, medium or high) and the announced
dividend. Consequently, the informational effect of dividend announcement appears to be
different according to the firm dividend policy level. The most interesting results are
obtained around the ex-dividend days. When the market knows the firm dividend policy
level, the dividend clientele effect seems to be extremely limited. Indeed, we notice a
very low increase of Elton and Gruber ratio ((Pb- Pa)/D) according to the dividend yield
level. His result may introduce doubt over the dividend clientele hypothesis.

Frederic Romon(2000) He observe two event studies, his initial sample is made of 203
industrial and commercial French companies quoted on the Parisian stock exchange,
distributing a regular dividend each year between 1991 and 1995. The sample is divided
according to the firm dividend policies. Three groups of firms characterized by stable
dividend policies (low, medium and high) are made up. Then, he test the dividend
informational hypothesis and the dividend clientele hypothesis on each of those three
firm groups. Results differ according to the event study carried out. Around the dividend
announcement date, we observe discrepancies in cumulative average abnormal returns
according to the firm dividend policy level and the announced dividend. Consequently,
the informational effect of dividend announcement appears different according to the
firm dividend policy level. But, the most interesting results are obtained around the ex-
dividend days. When the market knows the firm dividend policy (low, medium or high),
the dividend yield clientele effect seems to be extremely limited. Indeed, he notice a very
low increase of Elton and Gruber ratio ((Pb-Pa)/D) according to the dividend yield level.
His result may introduce doubt over the dividend clientele hypothesis.

Nickolaos et al (1999) They examines the stock market reaction to announcements of

cash dividend increases and bonus issues (stock dividends) in the emerging stock market
of Cyprus. Both events elicit significantly positive abnormal returns, in line with
evidence from developed stock markets. This study contends that special characteristics
of the Cyprus stock market delimit applicability of most traditional explanations for cash
and stock dividends in favor of an information-signaling explanation. The empirical
results are generally inconsistent with these contentions.

Jensen (1986) suggests that managers, motivated by compensation and human capital
considerations, have incentives to over invest free cash flows even in the absence of
profitable growth opportunities (the free cash flow hypothesis). Dividend payout policy
in this case becomes a vehicle for monitoring the managers' potential to misuse excess
funds. Thus, the observed positive stock market reaction following dividend increases is
consistent, in addition to information-signaling, with a reduction in agency costs.

A number of conflicting theoretical models lacking strong empirical support define

current attempts to explain the puzzling reality of corporate dividend behavior. George
M. Frankfurter (1999) purpose of this study is to determine if the method of analysis
employed, sample period, and/or data frequency are responsible for this inconsistent
support. The results presented here are consistent with the contention that no dividend
model, either separately or jointly with other models, is supported invariably.

Kathleen P. Fuller (2002) his paper examines how the trading behavior of various
investors impacts the market reaction to a dividend signal. The dividend signaling model
presented incorporates asymmetric information among traders, firm insiders, and the
market. The interaction among market participants explains why not all dividend
increases are viewed by the market as good news. The model predicts that the
announcement day return for a dividend increase is inversely related to measures of
informed trading and is decreasing in the level of buy demand relative to sell demand.
Further, the more informed trading, the larger the dividend increase. Empirical tests
confirm the model’s predictions.

Atul K. Saxena (1994) The data for this study consists of 333 firms drawn randomly
from editions 1-10 of ValueLine Investment Survey dated December 22, 1989 through
March 16, 1990. The initial sample consisted of 500 firms, however several observations
were dropped due to incomplete information on all the variables. Instead of using the data
for the same years, this study uses data from approximately a decade after Rozeff's. Since
his sample was drawn from the same source in 1981, an important contribution of this
study is to see whether there are any significant changes in the parameter values over the
time period 1981 thru 1990. The total sample is split between 235 unregulated and 98
regulated firms and that cover 56 industries. The regulated industries represented in the
sample include commercial banking; savings and loan associations; investment and
brokerage services; life and property and casualty insurance; electric utilities; gas;
petroleum; telecom The main conclusions of this study is that a firm's dividend policy
will depend upon its past growth rate, future growth rate, systematic risk, the percentage
of common stocks held by insiders, and the number of common stockholders. Moreover,
the relationship is inverse in all cases except the number of common stockholders. These
relationships are comparable to Rozeff's [1982] and other earlier studies on unregulated
firms. More importantly, however, some of the determinants of dividend policy are
different for regulated and unregulated firms. Specifically, the percentage of common
stock held by insiders, and expected future growth rate, do not play a key role in a
regulated firm's payout ratio.

Collins, Saxena, and Wansley [1996] compared the dividend payout patterns of a sample
of regulated firms (from banking, insurance, electric utility, and natural gas industries)
with unregulated firms (from a variety of different industries). They did not find that the
financial regulators' role is one of agency cost reduction for equity holders. Utilities, on
the other hand, are different. They alter their dividend payout in response to changes in
insider holdings. Moreover, for a given change in insider holdings. this policy change is
more pronounced than the change for unregulated firms.

Yanli Wang (2005) his paper measures the effect of dividend initiation announcements
on firms’ stock returns using a propensity score matching approach. Unlike the traditional
event study methodology, propensity score matching can reduce the bias in the estimation
of dividend initiation effects by controlling for the existence of confounding factors.
Consistent with previous studies, the results show that dividend initiations have
significantly positive effects on stock returns. More interestingly, the reaction of stock
returns to dividend initiation announcements exhibits apparent heterogeneity. The overall
empirical evidence presented in the paper supports a tradeoff model based on the benefits
and costs of dividend payments.
 20

Share Price

A share is one of the equal parts into which a company’s capital is divided,
entitling the owner to a portion of profits which in other words, would mean
that a share you own is the state you have in a company. As a shareholder
you have the right to receive company reports, attend and vote at shareholder
meetings.
 21

Plain and simple, stock is a share in the ownership of a company. Stock

represents a claim on the company's assets and earnings. As you acquire more
stock, your ownership stake in the company becomes greater. Whether you say
shares, equity, or stock, it all means the same thing. Securities presently traded at
the CSE.

Stock prices change every day as a result of market forces. By this we mean that
share prices change because of supply and demand. If more people want to buy
a stock (demand) than sell it (supply), then the price moves up. Conversely, if
more people wanted to sell a stock than buy it, there would be greater supply
than demand, and the price would fall. So, why do stock prices change? The best
answer is that nobody really knows for sure. Some believe that it isn't possible to
predict how stock prices will change, while others think that by drawing charts
and looking at past price movements, you can determine when to buy and sell.
The only thing we do know is that stocks are volatile and can change in price
extremely rapidly.

Understanding supply and demand is easy. What is difficult to comprehend is

what makes people like a particular stock and dislike another stock. This comes
down to figuring out what news is positive for a company and what news is
negative. There are many answers to this problem and just about any investor
you ask has their own ideas and strategies.

That being said, the principal theory is that the price movement of a stock
indicates what investors feel a company is worth. Don't equate a company's
value with the stock price. The value of a company is its market capitalization,
which is the stock price multiplied by the number of shares outstanding.

The important things to grasp about this subject are the following:

1. At the most fundamental level, supply and demand in the market determines
stock price.
2. Price times the number of shares outstanding (market capitalization) is the
value of a company. Comparing just the share price of two companies is
meaningless.
3. Theoretically, earnings are what affect investors' valuation of a company, but
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there are other indicators that investors use to predict stock price. Remember, it
is investors' sentiments, attitudes and expectations that ultimately affect stock
prices.
4. There are many theories that try to explain the way stock prices move the way
they do. Unfortunately, there is no one theory that can explain everything.

Different Types of Stocks

There are two main types of stocks: common stock and preferred stock.

Common Stock
Common stock is, well, common. When people talk about stocks they are usually
referring to this type. In fact, the majority of stock is issued is in this form.
Common shares represent ownership in a company and a claim (dividends) on a
portion of profits. Investors get one vote per share to elect the board members,
who oversee the major decisions made by management.

Over the long term, common stock, by means of capital growth, yields higher
returns than almost every other investment. This higher return comes at a cost
since common stocks entail the most risk. If a company goes bankrupt and
liquidates, the common shareholders will not receive money until the creditors,
bondholders and preferred shareholders are paid.

Preferred Stock
Preferred stock represents some degree of ownership in a company but usually
doesn't come with the same voting rights. With preferred shares, investors are
usually guaranteed a fixed dividend forever. This is different than common stock,
which has variable dividends that are never guaranteed. Most preference shares
in Sri Lanka have a pre-determined dividend rate which the holders are entitled
to receive. Another advantage is that in the event of liquidation, preferred
shareholders are paid off before the common shareholder (but still after debt
holders). Preferred stock may also be callable, meaning that the company has
the option to purchase the shares from shareholders at anytime for any reason
(usually for a premium).

Some people consider preferred stock to be more like debt than equity. A good
way to think of these kinds of shares is to see them as being in between bonds
and common shares.

There has been a great deal of research examining the rationality of stock prices
with increasing attempts to check whether prices reflect the information in
earnings and dividends. This issue has been spurred by the variance bounds
tests of the simple present value relation developed by Shiller (1981)1, who
proposed a simple test to compare the annual variation in theoretical stock prices
from the dividend valuation model to annual variation in actual prices. Shiller
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found that, assuming a constant discount factor, stock prices are too volatile to
be compatible with subsequent dividend series. series. This evidence leads to
the conclusion that share prices exhibit too much volatility to be justified by
fundamental variables.

The decomposition of stock prices has important implications for other

issues.First, following the stock volatility tests stimulated by Shiller (1981) and
Leroy & Porter (1981), there have been a large number of papers analysing and
interpreting this apparent excess volatility that prices exhibit. West (1988)
indicates that it appears that neither a small-sample bias, rational bubbles4 nor
some standard models for expected returns adequately explain stock price
volatility. One possibility is a "fad" model while others provide a "bubble"
interpretation. If the price deviations are reversed slowly, it is a fad deviation. The
bubble price deviation persists forever. However, there is little direct evidence
that such fads play a significant role in stock price determination. Therefore, the
time-series behaviour of price deviations should shed some light on this debate.

Horst Entorf , Christian Steiner (2006) They studies the response of the German stock
market index DAX to the announcement of macroeconomic business cycle forecasts.
Returns are computed using high frequency data observed for 15-second intervals.
Results reveal immediate stock market reactions. Major reactions of both returns and
volatility occur within first 15 to 60 seconds after the announcement. Unanticipated
shocks cause asymmetric stock market returns: ‘good’ news lead to more pronounced
reactions than ‘bad’ news. Moreover, there is evidence of mean reversion and calm-
before-the-storm effects. Finally, serial correlation of returns is found to be a potentially
spurious result of non-anticipated announcements of macroeconomic news.

María Concepción Verona Martel et al (2006) They analyses the informative content of
the straight debt issue announcements by firms quoted on the Spanish Stock Market.
They have analysed the share price responses to the mentioned issue and the substitution
effect between debt and dividends as signaling devices. The obtained results suggest that
the Spanish market reacts positively and significantly when such announcements are
made by low dividends payout firms and the reaction seems to be irrelevant if the
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announcements are made by high payout firms. These results support the informative
content of debt issue announcements, which is higher for low payout firms, and also the
substitution argument between debt and dividends.

Ross (1977) examines that the financial structure of a company provides information
about its financial situation, and that the value of the companies will increase with the
level of leverage. The company’s choice of capital structure may convey management
expectations about the company’s prospects. Higher debt ratios are binding constraints on
the firm signalling positive management expectations concerning future cash flows. In
contrast, issuing new equity is a negative signal and may reduce the firm stock price.

On the other hand, Myers and Majluf (1984) and Miller and Rock (1985) defend the
opposite position, as they think that the announcement of new external financing conveys
unfavourable information and will have a negative impact on the market. Myers and
Majluf generate a negative market reaction to a company’s external financing by arguing
that relatively uniformed purchasers of the company’s security will demand a discount in
order to hedge against the risk that the security is overvalued. Myers and Majluf’s model
suggests that the riskier the security issued, the higher the (negative) issue impact on the
market value of the firm. Miller and Rock suggest that the company’s decisions about
obtaining funds reveal negative information about future internal financing, though as
opposed to the previous model, the market response will be the same with independence
of the financial asset.
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