Cash dividend policy and firm risk : UK evidence

This thesis aims at investigating the determinants of the dividend payout ratio in the UK. It contributes to the literature by examining the potential influence of systematic and unsystematic risks on the relationship between the dividend payout ratio and its determinants. This influence is studied through the introduction of interaction variables between the two types of risk and dividend payout determinants. The researcher explores the theoretical links in the context of important dividend theories including life cycle, agency and transaction costs, residual and signalling theories. An empirical model is developed and used to examine testable hypotheses. The sample covers UK non-financial firms in the period from 1991 to 2014.This focuses on1340 firms including both listed and de-listed companies, with the aim of avoiding survivorship bias. The period of the study includes the 2008-2009 global financial crisis. Therefore, examining the impact of the resulting shocks to the supply of credit and demand, as well as firm risks, on the dividend payout ratios of firms, over this period of time, provides a further contribution to the literature on dividend policy in the UK. The results robustly show that large-sized, more profitable firms have higher dividend payout ratios, in accordance with the transaction cost theory. In addition, the free cash flow hypothesis appears to dictate the dividend policy of UK firms. The abundance of free cash flow is likely to cause information asymmetry problems caused by overinvestment issues to escalate. In this instance, firms expel their excess cash flows rather than investing them in suboptimal projects that will increase unsystematic risk. In parallel, the small percentage of ownership by institutions and insiders is insufficient to substitute for dividends as a monitoring mechanism. Consequently, firms increase their payout ratios in line with the agency theory of dividends. Despite the fact that free cash flows are scarce for young firms, it appears that UK firms do not follow the life cycle theory in setting their payout ratios. UK firms in all groups appear to increase their dividend payout ratios when their earned capital is low. The researcher argues that firms consider the factors that encourage dividend payments to be more important, so that they increase their payouts and rely on debt to finance their growth. In this respect, firms could be using dividends to signal their earnings potential. In addition, large-sized, profitable firms such as utilities appear to accommodate their payout ratios and rely on debt to satisfy their growth needs. On the contrary, firms that belong to the technology sector preserve their cash flows by lowering their payout ratios to finance their investments, providing support to the residual theory of dividends. The overall results show that UK firms that belong to industrial and technology sectors set their dividend payout ratios based on the flexibility hypothesis. This is evident from their reported dividend payout ratios being relatively low in spite of their high liquidity. On the contrary, firms classified as having high payout ratios, pay high dividends despite their low liquidity since they are capable of raising funds with low transaction costs. The popularity of systematic risk as a determinant of the dividend payout ratio in the literature does not undermine the impact of unsystematic risk in setting the dividend policy of UK firms. The results significantly prove that firms lower their dividend payout ratios as their systematic and unsystematic risks increase. The coefficient of unsystematic risk, however, appears larger than that of systematic risk and significant across more groupings. In addition, the interaction effects between each of the systematic and unsystematic risks provide remarkable findings. The two types of risk appear to moderate the impact of profitability on the dividend payout ratio for the entire sample and for technology firms. Likewise, unsystematic risk moderates the impact of leverage and firm size for large-sized firms. On the other hand, systematic and unsystematic risks complement the impact of liquidity for the entire sample and for industrial firms, thus supporting the flexibility hypothesis and precautionary motives for holding cash. Similarly, the interaction terms between the two types of risk and the proxies of agency theory provide further support for the role of institutions and insiders in mitigating agency-related problems. Finally, the global financial crisis does not appear to have a profound effect on the dividend payout ratios of UK firms. Large-sized firms, with excess free cash flows, such as utilities, are more susceptible to the demand shocks caused by the crisis. Therefore, they increase their dividend payouts to solve agency problems and signal stability in their financial condition. Conversely, the impact of the credit supply shock appears more relevant to large-sized and technology firms, which decrease their payout ratios as their financial leverage increases so as to preserve their cash as an alternative source of financing.