"The Effect of Dividend Policy on Share Prices: A Study of Commercial Banks Listed on theLondon Stock ExchangeName:Institution:Instructor:Course Code:Dividend Policy2Table of ContentsChapter 1: Introduction .............................................................................................................. 41.1 Introduction ...................................................................................................................... 41.2 Background ...................................................................................................................... 51.3 Research Aims and Objectives ........................................................................................ 81.4 Problem Statement ........................................................................................................... 81.5 Rationale for the Study .................................................................................................... 81.6 Scope of the Research ...................................................................................................... 91.7 Key Definitions ................................................................................................................ 91.8 Structure of the Study .................................................................................................... 10Chapter 2: Research Methodology........................................................................................... 122.1 Overview ........................................................................................................................ 122.2 Research Strategy........................................................................................................... 122.3 Type of Investigation ..................................................................................................... 132.4 Research Philosophy ...................................................................................................... 132.5 Research Approach ........................................................................................................ 142.6 Data Collection Method ................................................................................................. 142.7 Sampling Design and Size ............................................................................................. 152.8 Data Analysis Method.................................................................................................... 152.9 Study Variables .............................................................................................................. 162.10 Hypothesis of the Study ............................................................................................... 162.11 Accessibility Issues ...................................................................................................... 172.12 Ethical Considerations ................................................................................................. 172.13 Limitations of the research ........................................................................................... 172.14 Chapter Summary ........................................................................................................ 182.15 Project Plan .................................................................................................................. 19Chapter 3: Literature Review ................................................................................................... 203.1 Conceptual Framework .................................................................................................. 203.2 Stock market .................................................................................................................. 203.3 Dividend ......................................................................................................................... 213.4 Dividend Policy ............................................................................................................. 223.5 Relationship of Dividend policy on Share return .......................................................... 24 Dividend Policy33.6 Impact of Dividend policy on Share Return .................................................................. 26Chapter Four: Data Analysis .................................................................................................... 284.1 Introduction .................................................................................................................... 284.2 Analysis of Data ............................................................................................................. 284.2.1 Correlation Analysis ............................................................................................... 284.2.2 Regression Analysis ................................................................................................ 294.3 Discussion ...................................................................................................................... 32References ................................................................................................................................ 36Dividend Policy4Chapter 1: Introduction1.1 IntroductionFor several decades, the dividend policies have created complexities in the financialmanagement of corporations. Many researches have been conducted regarding the dividendpolicy among which the relationship between the share prices of firm and dividend policyhave been the most popular one. A study conducted by Agyei and Marfo-Yidom (2011) onthe model of dividend discount shows that the feasibility of augmentation in dividendpayment are supplemented by the increase of value of firms. However, Waithaka, Ngugi andKirago (2012) emphasises that firm?s value is not affected by the future and current decisionsrelated to dividend policy. Therefore, for any bank or business the maximisation ofshareholders wealth is the primary goal, which in return maximises the company?s valuewhose price is measured by the common stock. The corporations achieve their goals andobjectives by paying fair amount of investments back to its shareholders. Conventionally, a debate has been under argument that banks have the ability toinfluence their share prices by changing or by making amendments in the dividend policies.Within the debate the key argument that makes the difference that by increasing the pay-outratio businesses can significantly increase or enhance the value of its shares (Mokaya,Nyangara and James, 2013). The investors or shareholders of any bank prefer or demand adollar of dividends with a gain of dollar in capital. Therefore, investors and stakeholders aremore responsive towards the common stock of those banks that pay substantial amount ofdividend, in contrast to those similar businesses that pay less or few amount of dividends. In astudy conduct by Becker, Ivkovic and Weisbenner (2011) on the performance of share pricespoints out that banks do not allow its dividend policies to affect the decisions related toinvestments, and if the transaction costs and taxes are ignored then the dividend policy ofbusiness does not affect its share value at all. However, the presence of differential capital Dividend Policy5gains and taxes on income makes the prices of shares more desirable for banks that pay lowdividends which provide the opportunity to businesses to escalate their share price valuethrough reducing or lowering the pay-out ratio.The effect of dividend policy of the firm on the current share prices is significant notonly for the officials of corporate who are responsible for establishing the policies of thebanks, but is also important for planning the portfolios of investors, moreover for economistspursuing to appraise or understand the markets capital functioning (Asghar, et. al, 2011). Dobanks that have generous policies for the generous distribution of dividends sells at premiumconsistently as compared to those businesses that pay insufficiently? Is there any range ofratios or pay-out ratio that sells at optimum and maximise and enhance the share?s worth? Inlight of the study by Okafor and Chijoke-Mgbame (2011), it is assumed that bankshave anopportunity for selecting the most appropriate dividend policy according to its requirementsand which does not affect the policies of investments, because firms have different sourcesfor generating funds which can be substituted for dividends (Zakaria, Muhammad andZulkifli, 2012). Banks today adjust the policies of their dividend pay-out depending on thedemand of investors for higher and lower demand of dividend yield. Such adjustments helpthe business to supply shares at different yield levels which satisfies the investors withvarious choices of availability of yield ranges. These approaches facilitate the banks toachieve „supply effect? in which the firm reaches equilibrium level and its share prices are notaffected by changes in dividend policies.1.2 BackgroundAccording to Hussainey, Oscar Mgbame and Chijoke-Mgbame (2011), the dividendpolicy issues includes the theories that are devised for the payment of dividend, such as thetheory of stakeholders, the theory of pecking order, signalling theory, agency cost, clientele Dividend Policy6theory and bird-in-hand fallacy. The asymmetry information between shareholders andmanagers, along with the control and ownership of separation shaped the foundationsregarding the popularity of dividend policy. Investors face systematic risk due to the volatilityof the price of share, which possesses investments in ordinary shares. Investors and riskaverse by nature, and their investment?s volatility plays a significant role since it measuresthe risk level to which they are exposed. As stated by Hashemijoo, Mahdavi Ardekani andYounesi (2012) that the stock market of UK, which is not considered as an emerging marketdue to its matured market features, with comparative regulations that are moderate in contrastto other stock markets. Corporations are aware of the fact that investors pay close attention tothe returns that firms pay, and that their valuations regarding firm?s shares are affected by theinvestment?s riskiness in the long run. In the early practices of corporate financing, thepolicies of dividend were referred to as the choice of corporation that whether it chooses topay the investors dividend in cash or retain the earnings (Michaely and Roberts, 2012).However, in today?s corporations, the dividend policy expanded its purpose and scope furtherby including issues related to the distribution of cash through repurchase of shares orspecifically by regular dividend pay-outs. Other considerations related to dividend policyinclude the balance of relatively untaxed or highly taxed investors, and how to improve andmaintain the share?s value in the stock market.According to Baker & Wiegand (2015) and Nippel & Nekat (2009), the dividendpolicy of any business is undoubtedly the most significant decision related to the corporatestrategy since polices related to dividends determines the net earning?s percentage which thebusinesses pay out in the form of dividends which significantly affects the wealth of itsshareholders. In the light of study conducted by Kale, Kimi and Payne (2012), it has beenobserved that the dividend policies of businesses are a significant indicator which reflects theshare price and the value of business. There have been many studies conducted in the past to Dividend Policy7analyse the impact of dividend policies on the businesses share prices and their outcomessignified that stock prices are influenced by the pay outs of dividends. In a researchconducted by Profilet and Bacon (2013) investigated the sample of more than 500 firmsoperating in the United States through which they found that, businesses paying huge returnsin the form of dividends had stock prices that were less volatile as compared to businessesthat were paying low amount in dividends. The share prices of these businesses were lessrisky for the shareholders. These healthy returns signals the investors regarding theperformance of business through which future potential is analysed by the investors in orderto increase their investment portfolios (Chen, Liu and Huang, 2009). These indicatorspositively affect the prices of share in the short-run whereas Nirmala, Sanju andRamachandrans (2014) observed a bi-directional causal relationship in the long-run amongstock prices and dividends.Studies conducted is the past also provides evidence that in the long-run, the retentionrate of greater earnings in comparison to the rate of dividend pay-out results in greater growthof the share prices as the business invests its earnings in projects that have potentiallypositive outcomes in the future (Irons, 2014). The phenomenon was applicable more on thosefirms that were focused towards further growth as compared to businesses that were observedat maturity period. Similarly, Bierman (2008) observed that stock prices greatly influence thedividend pay-outs when the business has undervalued share prices. The size of the business isalso one the main factor which determines the relativeness of dividend pay-outs, since largeMNCs tend to pay more wealth to their shareholders (Vieira, 2011). However, it has beenobserved that high dividend pay-outs are only possible when the business is stable internally.Therefore, there is need to analyse how the different sizes of businesses affects their dividendstrategies which are to be investigated by selecting a particular industry. Dividend Policy81.3 Research Aims and ObjectivesThe main aim designed for this study in particular is to examine the impact of dividend policyon the share prices of banking stocks in the UK.Following are the objectives required to beachieved in order to conclude the study:1. To understand the concept regarding the dividend policies of companies.2. To critically assess the impact that dividend policy has on Stock Prices ofCommercial Banks in the London Stock Exchange (LSE)1.4 Problem StatementThe studies conducted in developed economies displays a significant relationshipbetween the stock prices and dividend payments of the banks. The current payment ofdividends reduces the uncertainty of investors allowing them discounts over the earnings offirm at lower return rate, whereas the reduction in dividend increases the uncertainty ofinvestors which raises the rate of return that is required (Milai, 2014). Therefore, it is evidentthat dividend policies have a significant influence on the prices of shares, however due tomarket per share price concerns, no theory and model have been developed till now whichcan display the effects of dividend pay-out policy on the value of share. Furthermore, somebanks often hold the dividends of their shareholders or investors and reinvest their earningsinto the business; due to such policies a negative impact towards the value of share isobserved which forces the investors to look for other firms for investment opportunities.1.5 Rationale for the StudyDuring the financial crisis of recent times, it has been observed by Henderson (2015)that among many businesses, especially the banking sector was majorly affected includingthe Royal Bank of Scott Land and Lloyds Banking Group were being bailed out by the Dividend Policy9government. The period of recession and the improvement observed in the economies, thebanks within UK also enhanced their performances. However, as noted by the FinancialTimes that in UK the dividend pay-out by banks were very low and after the aftermath offinancial recession many banks stopped paying dividends to their share and stakeholders(Dunkely, 2016). The pay-out of dividends, especially in the industry of banking is asignificant factor towards banks recovery after the financial crisis. Therefore, this followingresearch was intended to analyse the dividend policies impact on the prices of firm?s shares.1.6 Scope of the ResearchThe following study is focused towards analysing the impact of dividend policies ofshare prices of firms, for which the data has been collected from UK?s banking industry.These banks were all listed in the London Stock Exchange among which 6 were listed inFTSE250 and 5 were listed on FTSE100. The scope is aimed towards how the banksrecovered from recession period for which the data has been collected from 2011 to 2016which is also the post-recession period.1.7 Key DefinitionsDividend PolicyThe policies related to dividend are referred to as the guidelines that are set bybusinesses in order to decide the amount of earnings that will be paid to shareholders. Thereare few evidences that suggest that dividend policy of firms does not concern the investorssince they sell their portfolio?s portion of equites in return for cash.Dividend Pay-out RatioThe pay-out ratio of dividend refers to the dividend amount that is paid toshareholders against the amount of company?s total net income. However, the amount that Dividend Policy10the company does not pay to its shareholders retains it for further growth of the company.This amount is commonly known as retained earnings of the company.Stock ReturnsThe stock return is referred to as the increase in the price of stocks plus the dividendpaid on it, which is then divided by stock?s original price. The sources for income generatedby stocks are through dividends and its value increase.Retained EarningsIt is referred to as the net earnings percentage which the company do not pay to itsshareholders as dividends; however these earnings are utilised by reinvesting into businesscore operations or to be paid as debt. Retained earnings are recorded on balance sheet undershareholders equity.1.8 Structure of the StudyThe following structure of study is adopted for conducting the study;Chapter 1: Introduction is the first chapter of research dissertation which includes a detailedinsight about the topic and its background. Further it includes the problem statement, researchobjectives, research questions and significance of research.Chapter 2: Methodology is the third chapter and it is also the most important one since itincorporates the research paradigm, approach, design, and investigation, data collectionmethod, sampling method, technique and size. Furthermore it includes research limitationsand accessibility issues.Chapter 3: Literature Review is the second chapter that includes a comprehensive analysis ofprevious researches and literature regarding the variables which also includes the conceptualframework and theoretical framework. "