Dividend Policy Decisions in India | PDF

Article
Global Business Review
1–18
© 2018 IMI
Reprints and permissions:
in.sagepub.com/journals-permissions-india
DOI: 10.1177/0972150918803990
http://journals.sagepub.com/home/gbr
1 Senior Research Fellow (UGC), Department of Humanities and Social Science, Indian Institute of Technology Kharagpur,
West Bengal, India.
2 Current affiliation: School of Management, Presidency University, Bengaluru, Karnataka, India.
Corresponding author:
Nishant B. Labhane, School of Management, Presidency University, Bengaluru 560064, Karnataka, India.
E-mail: [e-mail]
Dividend Policy Decisions in India:
Standalone Versus Business
Group-Affiliated Firms
Nishant B. Labhane1, 2
Abstract
This study examines the determinants of two important dividend policy decisions specifically the dividend
payment decision and the dividend payout level decision of 781 sample Indian firms enlisted on National
Stock Exchange (NSE) over the period, 1995–2015, comparing the business group-affiliated firms with
the standalone firms. In term of characteristics, the business group-affiliated firms are larger, more
profitable and more levered than the standalone firms. The empirical results suggest that the dividend
policy decisions of business group-affiliated firms differ significantly from that of the standalone firms. In
the case of standalone firms, the firms with high investment opportunities, high financial leverage and
high business risk are less likely to pay dividends, and their dividend payout levels are lower. On the
other hand, the firms affiliated with business groups are more likely to pay dividends, and their dividend
payout levels are higher even when they have high investment opportunities, high financial leverage and
high business risk. Overall, the findings suggest that although the business groups are able to create
internal capital markets (ICMs) and shield their member firms from market imperfections, they may
suffer from other information asymmetry problems.
Keywords
Dividends, dividend policy, business groups, emerging markets, internal capital markets
Introduction
In their seminal paper, Miller and Modigliani (1961) propose that in an ideal world with no taxes, zero
transaction and agency costs and full availability of information, dividend policy is irrelevant. But in real,
the world is not ideal, and dividend policy affects the firm’s value and shareholder’s wealth. Black (1976)
coined the phrase ‘dividend puzzle’ concerning why the corporations pay dividends and why the investors
value them. Subsequently, researchers have developed several theories to explain this ‘dividend puzzle’
which include tax preference theory, agency theory, signaling theory and most recently firms’ life-cycle

2 Global Business Review
theory and catering theory of dividends (Aharony & Swary, 1980; Baker & Wurgler, 2004; Bhattacharya,
1979; DeAngelo, DeAngelo, & Stulz, 2006; Denis & Osobov, 2008; Easterbrook, 1984; Jensen & Meckling,
1976; Litzenberger & Ramaswamy, 1979; Rozeff, 1982). Therefore, there are several reasons for firms to
pay dividends such as to signal firms’ earnings quality, to return profits that are not required for investment
outlays to shareholders, to control free cash flow misuse by managers, and perhaps to return profits to
shareholders when capital gains are taxed higher than the dividends and so on.
In most of the emerging as well as developed capital markets, business groups are a common pheno-
menon. Business groups are the important ownership features of many private sector firms in such
capital markets. A business group is a set of companies that are bound together by inevitable formal and
informal ties and customarily take coordinated actions even if they are legally independent (Khanna &
Rivkin, 2001). Each company affiliated with particular business groups is a distinguishable legal entity
which publishes its annual financial report, has its board of directors and is responsible to its shareowners.
Leff’s (1976, 1978) market failure theory argues that the business groups are prevalent in the emerging
and developed markets due to the presence of information problems and market imperfections. Therefore,
it is important to examine the dividend policy decisions of firms affiliated with business groups vis-à-vis
standalone firms. There are around 400 business groups in India which are the representatives of the
business groups in many of the emerging markets (Khanna & Palepu, 2000a). The presence of corporate
organizational forms in India allows us to investigate the dividend policy decisions, comparing the
business group-affiliated firms with the standalone firms.
The present study examines the determinants of two important dividend policy decisions that is the
dividend payment decision (whether to pay or not to pay the dividends?) and the dividend payout level
decision (how much dividends to pay?), comparing the business group-affiliated firms with the standalone
firms from 1994–1995 to 2014–2015. We find significant differences in the determinants of dividend
policy decisions of standalone firms and business group-affiliated firms. The investment opportunities,
financial leverage and business risk affect the dividend policy decisions of standalone firms negatively;
whereas, they have significant positive impact on the dividend policy decisions of the business group-
affiliated firms.
The rest of the article is organized as follows: the second section reviews the empirical literature on a
firm’s dividend policy decisions concerning different corporate organizational forms; the third section
specifies the objectives of the study; the fourth section presents the rationale of the studies; the fifth
section describes the methodology; the sixth section discusses the analysis of the results and the last
section concludes the article.
Review of Literature
The literature on a firm’s dividend policy decisions concerning different corporate organizational forms
is not very large. Among the early studies, Dewenter and Warther (1998) find that the member
firms belonging to keiretsu group are subject to less information asymmetry and have fewer agency
problems than the independent firms in Japan during the period, 1982–1993. The managers of keiretsu
firms initiate and omit dividends more frequently than the managers of the US firms and change their
dividends more frequently than the managers of independent Japanese firms. Faccio, Lang, and Young
(2001) find that the business group-affiliated firms in Western Europe pay significantly higher dividends
than those in East Asia. The firms that are ‘tightly affiliated’ to a business group pay significantly higher
dividends through control links that constitute at least 20 per cent of the control rights. In contrast to

Labhane 3
this, the investors of the firms that are loosely affiliated with business groups (i.e., whose control
links are all above the 10% level but do not all exceed 20%) are less alert to the expropriation within
the firms, and such firms fail to pay higher dividends due to a wider discrepancy between ownership
and control.
Ferris, Sen, and Yui (2006) find that the independent firms (non-business group-affiliated firms) in
Japan are more sensitive to market forces and resemble closely to the firms operating in the USA and the
UK in paying dividends. But the industry groupings provide business protection to the keiretsu firms,
which help insulate them from the market forces and, thus, make dividends less useful as either signals
or devices to discipline managers of the firms belonging to keiretsu. Investigating the impact of the
strength of group affiliation on dividend policy, Aggarwal and Dow (2012) find that the dividends are
used to transfer cash from the weakly affiliated firms to the strongly affiliated firms for keiretsu firms,
and as the affiliation to the business group strengthens the probability of dividend payment declines.
Group equity has a positive impact while group debt has a negative impact on the decision to pay
dividends in all the firms but the most in weakly aligned firms. And as the group sales increase, the
strongly aligned firms are more likely to pay dividends; whereas, only the strength of group shareholdings
influences the dividend payment decision for the most weakly aligned firms.
Manos, Murinde, and Green (2012) find that the dividend-payout ratio of business group-affiliated
firms are higher than that of independent firms, and the dividend payment decisions of the business
group-affiliated firms are less sensitive to the dependency on external finance and life-cycle considerations
vis-à-vis non-affiliated firms. Examining whether the organization of the internal capital markets (ICMs)
can influence the dividend policy of the business group-affiliated firms, Gopalan, Nanda, and Seru
(2014) find that the business group-affiliated firms pay significantly more dividends than the standalone
firms (unaffiliated firms). Further, the responsiveness of the dividends is higher in countries with weak
legal regimes. Basu and Sen (2015) find that as the insider ownership increases, a firm affiliated with
business group pays out less dividends when sales decrease in the following year. This indicates that the
insiders act opportunistically when they retain capital even when future performance does not improve.
Examining the dividend smoothing behaviour of the sample firms in India, Labhane and Mahakud
(2018) find significant differences between the dividend smoothing behaviour of the standalone firms
and the firms affiliated with business groups. The business group-affiliated firms tend to smooth their
dividend payments more than that of the standalone firms, and the actual payout ratio as well as the target
payout ratio of the business group-affiliated firms are higher than that of the standalone firms.
After reviewing the available studies on this issue, we find at least three research gaps on the dividend
policy decisions concerning the different corporate organizational forms. First, it is true that business
groups are well researched in an emerging capital market like India (refer to Gopalan, Nanda, & Seru,
2007; Khanna & Palepu, 2000a), but they do not investigate the dividend policy decisions of business
groups, specifically. Second, previous studies do not consider the implications of most of the major
theories of dividend policy on business groups and do not consider an exhaustive list of the explanatory
variables taken from major theories of dividend policy. Third, there are around 400 business groups
in India; the business groups in India are the representatives of the business groups in many of the
emerging capital markets and few studies have examined the dividend policy decisions of the standalone
firms and the business group-affiliated firms separately in an Indian context. Therefore, it is important to
investigate the dividend policy decisions, comparing the business group-affiliated firms with the
standalone firms in India. The present study tries to fill the research gaps by investigating the dividend
policy decisions of the business group-affiliated firms vis-à-vis standalone firms in India.

4 Global Business Review
Objectives
The objectives of this study are (a) to determine the factors affecting the dividend payment decisions
(i.e., whether to pay or not to pay the dividends?) of the standalone firms vis-à-vis business group-
affiliated firms (b) to determine the factors affecting the dividend payout level decisions (i.e., how much
dividends to pay?) of the standalone firms vis-à-vis business group-affiliated firms.
Rationale of the Studies
In the global financial activities, the markets of countries other than the developed nations started to play
crucial roles continually since 1980. To refer these sets of developing countries’ markets, the International
Finance Corporation have framed the term ‘emerging financial markets’ (EFMs) in 1981. According to
Beim and Calomiris (2001, p. x), the EFMs underwent ‘some 50 experiments in privatizing economies
and building financial systems, none perfect, with different emphases and different problems’. While
setting the corporate dividend payout policies, the managers of EFM firms face several unique factors
that may differ considerably from the traditional determinants of dividend policies of the firms in
developed financial markets (DFMs). Thus, much research remains on EFMs. It has been found that the
firm’s dividend policy has greater implications for the firm’s performance such as profitability, stock
market returns and so on. (Maitra & Dey, 2012; Saravanakumar, 2011).
The EFMs differ from DFMs in many ways: first, there are legal constraints on the amount of
dividends that may or must be distributed to stockholders in EFMs; second, the EFMs have undergone
privatization and liberalization of capital accounts in the last two decades that affected dividend policy
decisions whereas DFMs were liberalized long back (Beim & Calomiris, 2001); third, EFMs are exposed
to more macroeconomic volatility than DFMs; certainly many EFMs have directly or indirectly
experienced one or more financial crises in the last two decades (Beim & Calomiris, 2001). Therefore,
it is important to examine the dividend policy decisions of the companies in EFMs too.
Methodology
Data Source
The empirical study is primarily based on the data collected from the Prowess database maintained by
the Centre for Monitoring Indian Economy (CMIE) which is a leading business and economic database
and research company in India. The reason to select the sample companies from National Stock Exchange
(NSE) is that it is mandatory for all the companies listed on NSE to follow the financial reporting and
regulatory norms set by Securities and Exchange Board of India. Another, reason is that NSE was
established on the eve of the implementation of a new economic policy in India.
Sample Frame
The period of the study is from 1995 to 2015 (i.e., from the financial year [FY] 1994–1995 to FY 2014–
2015). The main reasons to select this time period as a period of study are as follows: first, this time
period refers to the period of liberalization, privatization and globalization in India and second during