Dividend Policy and Its Relationship to Investment and Financing Policies: Empirical Evidence Using Irish Data

INTRODUCTION This paper investigates the relationship between dividend, investment and financing decisions. The empirical evidence is based upon a questionnaire survey of those companies listed on the Irish Stock Market in 1989. Recent research has concentrated on examining the dividend policies pursued by Irish companies by way of an analysis of published financial data (see, for example, Barrett and Cotter 1990 and Green and McIlkenny 1991). A questionnaire approach is adopted in this paper, so that the perceptions of those managers who actually formulate dividend policy can be examined. Furthermore, the relationship between dividend, investment and financing decisions can be explicitly investigated. The results of the survey support the contention that the level of dividend payments is not residually determined, ie dividend levels are not totally dependent upon the values selected for investment and financing variables. The question of independence between dividend and investment policies is a more contentious issue. The empirical evidence presented here, however, does suggest that at least at the aggregate level, dividend decisions are taken with reference to the exogenous factor of dividend stability, but consideration is also given to investment and/or financing decisions. Thus it would appear that a simultaneous dividend policy, ie the dividend decision is neither totally residual nor totally independent, is pursued by Irish companies. The remainder of this paper is organised as follows: First a brief review of previous literature is provided; second the sample and methodology employed in the study are then outlined; thirdly, the results and implications are evaluated; next, some of the limitations of the study are discussed; and the paper concludes with a brief summary of the main results of the study. PREVIOUS LITERATURE There have been previous surveys of dividend policy, although none have been conducted in Ireland. Lintner (1956) developed a model to explain the intertemporal behaviour of dividend levels as a result of interviews with the managements of 28 US firms. The model assumes that a firm's target dividend level in year t (Dt*) is related to the earnings in that year (E sub t ) by a target payout ratio (r). This payout ratio is a function of the firm's borrowing and investment opportunities and shareholders' marginal tax bands: (1) Dt* = rE sub t Furthermore, it is argued that, in any given year, the firm will only partially adjust towards the target dividend level of the year. The extent of the adjustment is represented by the speed of adjustment factor (c), which reflects the degree of acceptance of the new target. Hence, the actual change in dividends from period t-1 to t is given by: (2) D sub t -D sub t-1 =a + c(D sub t *-D sub t 1) + U sub t The constant term (a) is introduced as a somewhat arbitrary way of reflecting the reluctance of management to reduce dividends. U sub t is an error term. Substituting equation (1) into equation (2) produces the familiar equation used in studies of dividend policy: (3) D sub t -D sub t-1 =a + crE sub t -cD sub t-1 , + U sub t Stewart (1987), Barrett and Cotter (1990) and Green and McIlkenny (1991) provide empirical evidence from an analysis of published financial data, both at the aggregate and individual firm level, which supports the contention that the Lintner (1956) model is descriptive of the dividend policies pursued by Irish companies. Green and McIlkenny (1991), however, find the constant term in the model to be statistically insignificant, whilst Barrett and Cotter (1990) suggest that there is a strong tendency for Irish companies to maintain dividends at constant levels. Such studies have provided a valuable insight into the dividend policies of Irish companies, but have provided relatively little information about the relationship between dividend, investment and financing decisions. …